Many advisors recommend clients set up trusts for their children or grandchildren to take advantage of new large estate-tax exemptions.
But that advice is often overly simplistic, and sometimes it’s based on outdated strategies. Other than the uber wealthy, why would any client set up a trust for grandchildren? In most cases, that makes no sense because the same goals can be achieved through other strategies.
Worse yet, it seems that too many advisors have forgotten the unhappy clients who similarly pursued inappropriate strategies in the mad rush to do estate planning in 2012 before the exemption was supposed to decline from $5 million to $1 million in 2013 (which it didn’t). Clients that made large gifts to children or grandchildren, or trusts for them, later regretted those gifts because they could no longer access those assets.
So how can your clients have their cake and eat it too?
To plan better, advisors first need to identify how a client’s goals might be different today because of the 2017 tax changes. They may want to consider the following strategies:
The current estate, gift and GST tax exemption is a whopping $11.8 million, but that amount is halved in 2026, so clients should try to use as much as feasible before it is reduced. Using the exemption requires the client to make a gift that removes funds from the client’s estate (in tax parlance a “completed gift”).
Does the client need access to the assets given away? Without access, many clients will be uncomfortable making the large gifts necessary to use some of the expiring exemption.
Consult with the client’s estate planner and CPA to determine if the client would benefit from using traditional grantor trusts (the client setting up the trust and making gifts pays the income tax) or non-grantor trusts (the trust, not the client, pays income tax on trust income). Some plans, like those involving life insurance, are best held in grantor trusts. Other plans may seek to circumvent the income tax restrictions in the new law, for example to maximize charitable contribution deductions, salvage state and local tax deductions on real property or increase the 20% deduction under new Code Section 199A on pass-through business entities. Those strategies require the use of non-grantor trusts. This distinction between grantor and non-grantor trusts is critical as it requires different trust provisions. Advisors need to understand the nature of the trust’s structure, as it affects not only income tax planning but asset location decisions, as well.
Achieving any of those goals can be complicated, and doing so requires fine-tuning in the preparation of the plan and trust document. Too many articles about planning after the 2017 tax law have glossed over all of this. While financial advisors don’t need to be experts in all the nuances (after all, they can also rely on the client’s attorney), many advisors are active participants in the tax planning process and need some understanding of the nuances to do that.
All advisors, whatever role they take in tax planning, need to understand the big picture so that they can confirm their clients are getting the best planning.
If making a completed gift sounds inconsistent with preserving the client’s access to those funds, it isn’t. It just requires careful planning and drafting. Don’t advise the client to gift outright to an heir as that provides no protection or access. Instead, have the client gift to a trust to both protect the heir, and assure the client access.
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A common non-grantor trust plan used for years is the intentionally non-grantor trust or “ING” trust. These trusts have been used by high-income taxpayers to shift certain income out of a high-tax state. ING trusts may remain a great plan for ultrahigh-net-worth taxpayers who have already used all of their estate tax exemptions. But for most wealthy taxpayers, securing exemptions before those exemptions decline by half in 2026 (or sooner by a new administration) may be best.
These taxpayers need a different type of ING trust than the uber-wealthy use. If an ING approach is used it must be fundamentally different from all traditional ING trusts, which were incomplete gifts (and thus, did not use the exemption), so that transfers constitute completed gifts which use the exemption before it declines. Otherwise, a fundamental goal of the planning will be lost. This is why, when a client’s attorney recommends a type of trust, planners need to understand the nature of that trust. They also need to be cautious recommended ING trusts for all clients because this technique, unless modified, is not optimal for everyone.
Location matters: When clients set up a new trust, remember to ask the question: What state is being recommended for the trust? The client’s home state? In many cases, the type of planning the client will need will require that the trust be formed in what are called “trust friendly” jurisdictions.
There are about 17 states, of which Alaska, Delaware, Nevada and South Dakota are the most popular, that permit clients to set up a trust and be a beneficiary of that trust, yet have the trust assets be removed from their estate. This type of trust might be warranted for a single client that wants to assure access to assets transferred by using a self-settled domestic asset protection trust or DAPT. ING trusts discussed above also need to be formed in these states to work. If a client wants to save state income tax forming a trust (or moving an existing trust) to a no-tax state may be essential to the plan.
Forming a trust in a state other than the client’s home state will often require naming an institutional trustee in that better state. Planners should not deter such planning for fear of undermining their client relationship. Rather, financial advisors should establish relationships with purely administrative trust companies based in the better trust states, so that their clients can get the best planning without creating unnecessary complications or competition for the advisor.
Trusts should also often include a trust protector to provide flexibility. This might include the power to change institutional trustees and states where the trust is governed and administered. Other persons might be given the power to add a beneficiary or loan the client money from the trust. But be careful as the latter two powers may characterize the trust as a grantor trust for income tax purposes (which in some cases now is not desired).
There are also different views as to whether the trust protector should act in a fiduciary capacity (with the level of responsibility of a trustee) or not. If a person is acting in a fiduciary capacity, they may not be able to add a new beneficiary, for example, as that might dilute the interests of the beneficiaries they have a duty of loyalty to. While financial advisors do not need to be experts in all these matters, they should at least ask questions to be sure the attorney has considered these issues.
Given the current high estate tax exemptions, for many clients the trusts should be created to last forever or a very long time (dynastic) and the client’s generation skipping transfer (GST) exemption should be allocated to protect gifts to the trust. This can keep the trust assets outside the estate tax system for many generations or forever. Rarely should trusts be planned for wealthy clients that pay out large sums at specified ages (e.g. 30).
Overall, there are more variations of trusts than ever before, which means clients and their families have more strategies they can benefit from. That said, the expansion of these options has also increased the complexity of trusts as planning tools, and identifying the best option for clients is not always an easy task.
Planners should remain proactively involved in the estate and trust planning process to make sure that in the end, a client’s plan does not merely recycle older trust strategies, but rather it uses the latest options to build a tailored plan suited to modern times.
Martin M. Shenkman, CPA, PFS, JD, is a Financial Planning contributing writer and an estate planner in Fort Lee, New Jersey. He is founder of Shenkman Law. Follow him on Twitter at @martinshenkman