How a Pour-Over Will Works

Instead of governing the distribution of all your property, a pour-over will state that any assets that have not been funded into your revocable living trust should go there when you die. It effectively names your trust as the beneficiary of any property it does not already hold. That property does not pass directly to a living beneficiary through some other means, such as a beneficiary designation on a life insurance policy or a retirement account.

Probate Issues IN Millcreek Utah

One of the beauties of having a living trust is that they avoid probate of the property with which they’ve been funded. Unfortunately, any of your property that isn’t funded into your trust before you die will require probate. Your property will pass to your heirs according to state law if you neglect to fund it into your trust, don’t create a pour-over will, or don’t have any other will in place directing where those assets should go. These are called laws of “intestate succession,” and they can vary somewhat by state.

Each state has a list of kin so closely related to a decedent that they inherit from them by law for lack of any other estate plan. The list invariably includes surviving spouses, your parents, and your descendants—children, grandchildren, or great-grandchildren. Siblings and more distant relatives are often left out in the cold. This state-by-state guideline means if you don’t have a pour-over will or other documents that direct property to a specific beneficiary, your wishes may not be followed. Say you forget to fund your new vacation home into your trust. Then that home might go to the son you’ve been estranged from for years—if you’re not married—simply because of your blood tie to him.

Your Pour-Over Will Should Be a Safety Net

Ideally, you won’t need your pour-over will. You’ll know it’s there in a worst-case scenario, but it won’t have to go into effect because all your property has been transferred into your living trust at the time of your death. Make it a point to sit down with your trust documents at least once a year. Make sure you haven’t acquired any new property over the last 12 months that should be funded into the trust. If you want a particular beneficiary to receive that new asset in the event of your death, you can add this provision to your trust agreement. Revocable living trusts can be changed at any point during your lifetime as long as you’re mentally competent.

Dynasty Trust

A dynasty trust is a long-term trust created to pass wealth from generation to generation without incurring transfer taxes such as the gift tax, estate tax, or generation-skipping transfer tax (GSTT)—for as long as assets remain in the trust. The dynasty trust’s defining characteristic is its duration. If it’s properly designed, it can last for many generations, possibly forever. A dynasty trust that’s established in the right state can theoretically last forever.

How a Dynasty Trust Works

Historically, trusts could only last a certain number of years. Many states had a “rule against perpetuities” and stipulated when a trust had to come to an end. A common rule was that a trust could continue for 21 years after the death of the last beneficiary who was alive when the trust was established. Under those circumstances, a trust could theoretically last for 100 years or so. Some states, however, have done away with rules against perpetuities, making it possible for wealthy individuals to create dynasty trusts that can endure for many generations into the future.

The immediate beneficiaries of a dynasty trust are usually the children of the grantor (the person whose assets are used to create the trust). After the death of the last child, the grantor’s grandchildren or great-grandchildren generally become the beneficiaries. The trust’s operation is controlled by a trustee who is appointed by the grantor. The trustee is typically a bank or other financial institution.

• Dynasty trusts allow wealthy individuals to leave money to future generations, without incurring estate taxes.
• Under current law, an individual can put up to $11.58 million in a dynasty trust.
• Dynasty trusts are irrevocable and their terms cannot be changed once funded.
A dynasty trust is a type of irrevocable trust. Grantors can set strict (or lax) rules for how the money is to be managed and distributed to beneficiaries. But once the trust is funded, the grantor will not have any control over the assets or be permitted to amend the trust’s terms. The same is true for the trust’s future beneficiaries.

Assets that are transferred to a dynasty trust can be subject to gift, estate, and GSTT taxes only when the transfer is made and only if the assets exceed federal tax exemptions. As a result of the Tax Cuts and Jobs Act passed in 2017, the federal estate tax exemption is $11.58 million for 2020 and $11.7 million for 2021. The amount is adjusted annually for inflation. Of course, Congress could also raise or lower the estate tax exemption in future years, or do away with the estate tax entirely. So, for now, an individual can put $11.58 million in a dynasty trust for his or her children or grandchildren (and, in effect, their children and grandchildren) without incurring these taxes. Moreover, the assets that go into a dynasty trust, as well as any appreciation on those assets are permanently removed from the grantor’s taxable estate, providing another layer of tax relief.

A trustee can distribute money from the trust to support beneficiaries as outlined in the trust terms. But because beneficiaries lack control over the trust’s assets, it will not count toward their taxable estates. Similarly, the trust’s assets are protected from claims by a beneficiary’s creditors because the assets belong to the trust, not to the beneficiary. However, income tax will still apply to a dynasty trust. To minimize the income tax burden, individuals often transfer assets to dynasty trusts that don’t produce taxable income, such as non-dividend paying stocks and tax-free municipal bonds.

What Is a Grantor Retained Annuity Trust (GRAT)?

A grantor retained annuity trust (GRAT) is a financial instrument used in estate planning to minimize taxes on large financial gifts to family members. Under these plans, an irrevocable trust is created for a certain term or period of time. The individual establishing the trust pays a tax when the trust is established. Assets are placed under the trust and then an annuity is paid out every year. When the trust expires the beneficiary receives the assets tax-free.

A grantor retained annuity trust is a type of irrevocable gifting trust that allows a grantor or trust maker to potentially pass a significant amount of wealth to the next generation with little or no gift tax cost. GRATs are established for a specific number of years. When creating a GRAT, a grantor contributes assets in trust but retains a right to receive (over the term of the GRAT) the original value of the assets contributed to the trust while earning a rate of return as specified by the IRS (known as the 7520 rate). When the GRAT’s term expires, the leftover assets (based on any appreciation and the IRS-assumed return rate) are given to the grantor’s beneficiaries. Under a grantor retained annuity trust, the annuity payments come from interest earned on the assets underlying the trust or as a percentage of the total value of the assets. If the individual who establishes the trust dies before the trust expires the assets become part of the taxable estate of the individual, and the beneficiary receives nothing.

Grantor Retained Annuity Trust Use

GRATs are most useful to wealthy individuals who face significant estate tax liability at death. In such a case, a GRAT may be used to freeze the value of their estate by shifting a portion or all of the appreciation on to their heirs. For example, if a person had an asset worth $10 million but expected it to grow to $12 million over the next two years, they could transfer the difference to their children tax-free. GRATs are especially popular with individuals who own shares in startup companies, as stock price appreciation for IPO shares will usually far outpace the IRS assumed rate of return. That means more money can be passed to children while not eating into the grantor’s lifetime exemption from estate and gift taxes.

Important Notes

• Grantor retained annuity trusts (GRAT) is an estate planning tactic in which a grantor locks assets in a trust from which they earn annual income. Upon expiry, they receive the assets tax-free.
• GRATS are used by wealthy individuals and startup founders to minimize tax liabilities.

Example of a Grantor Retained Annuity Trust

Facebook founder Mark Zuckerberg put his company’s pre-IPO stock into a GRAT before it went public. While the exact numbers are not known, Forbes magazine ran estimated numbers and came up with an impressive number of $37,315,513 as the value of Zuckerberg’s stock.

Intentionally Defective Grantor Trust

An intentionally defective grantor (IDGT) trust is an estate-planning tool that is used to freeze certain assets of an individual for estate tax purposes, but not for income tax purposes. The intentionally defective trust is created as a grantor trust with a loophole that allows the trustor to continue paying income taxes on certain trust assets, as income tax laws will not recognize that those assets have been transferred away from the individual. Because the grantor must pay the taxes on all trust income annually, the assets in the trust are allowed to grow tax-free, and thereby avoid gift taxation for the grantor’s beneficiaries. Thus, it is a loophole used to reduce estate tax exposure.

Important Notes

• An intentionally defective grantor (IDGT) allows a trustor to isolate certain trust assets in order to segregate income tax from estate tax treatment on them.
• It is effectively a grantor trust with a purposeful flaw that ensures the individual continues to pay income taxes.
• IDGTs are most often utilized when the trust beneficiaries are children or grandchildren where the grantor has paid income tax on the growth of assets that they will inherit.

Grantor trust rules outline certain conditions when an irrevocable trust can receive some of the same treatments as a revocable trust by the Internal Revenue Service (IRS). These situations sometimes lead to the creation of what are known as intentionally defective grantor trusts. In these cases, a grantor is responsible for paying taxes on the income the trust generates, but trust assets are not counted toward the owner’s estate.

Such assets would apply to a grantor’s estate if the individual runs a revocable trust, however, because the individual would effectively still own property held by the trust.

For estate tax purposes, though, the value of the grantor’s estate is reduced by the amount of the asset transfer. The individual will “sell” assets to the trust in exchange for a promissory note of some length, such as 10 or 15 years. The note will pay enough interest to classify the trust as above-market, but the underlying assets are expected to appreciate at a faster rate. The beneficiaries of IDGTs are typically children or grandchildren who will receive assets that have been able to grow without reductions for income taxes, which the grantor has paid. The IDGT can be a very effective estate-planning tool if structured properly, allowing a person to lower his or her taxable estate while gifting assets to beneficiaries at a locked-in value. The trust’s grantor can also lower his or her taxable estate by paying income taxes on the trust assets, essentially gifting extra wealth to beneficiaries.

Selling Assets to an Intentionally Defective Grantor Trust

The structure of an IDGT allows the grantor to transfer assets to the trust either by gift or sale. Gifting an asset to an IDGT could trigger a gift tax, so the better alternative would be to sell the asset to the trust.

When assets are sold to an IDGT, there is no recognition of a capital gain, which means no taxes are owed. Due to the complexity, an IDGT should be structured with the assistance of a qualified accountant, certified financial planner (CFP), or an estate-planning attorney. This is ideal for removing highly appreciated assets from the estate. In most cases, the transaction is structured as a sale to the trust, to be paid for in the form of an installment note, payable over several years. The grantor receiving the loan payments can charge a low rate of interest, which is not recognized as taxable interest income. However, the grantor is liable for any income the IDGT earns. If the asset sold to the trust is an income-producing one, such as a rental property or a business, the income generated inside the trust is taxable to the grantor.

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