Trust Fund Strategies: Investing A Million-Dollar Inheritance

Trust funds are becoming increasingly popular, especially among those with a high net worth. They are a useful tool for those who want to protect their assets for future use by their chosen beneficiaries. While they are often associated with the ultra-wealthy, trust funds can be useful to anyone who wants to ensure their assets are protected and managed according to their wishes after their death. In this case, with $1 million to invest, it is worth considering setting up a trust fund to ensure that your money is managed and distributed according to your wishes.

Estate planning: wills vs trusts

Estate planning is essential for everyone, regardless of the size of their estate. However, as an estate approaches $1 million, the complexities involved increase. Wills and trusts are both common tools for estate planning, but they serve different purposes and are suited to different situations.

Wills

A will is a legal document that specifies how your property will be distributed after your death. It should contain the following:

• The identity of an executor who will manage your estate until the probate process is complete.
• The identity of a guardian for your minor children, if applicable.
• The names of your beneficiaries and what you want to leave to each beneficiary.

Wills are a matter of public record, meaning anyone can find out the value of your estate and who your beneficiaries are. This may be undesirable for those who wish to keep their finances private. Additionally, wills must go through probate, which can be a lengthy and expensive process, especially if the estate is spread across multiple states.

Trusts

A trust is a legal arrangement where a grantor transfers property to a trustee, who manages it on behalf of and for the benefit of the beneficiaries. Trusts can be revocable or irrevocable. In a revocable trust, the grantor usually serves as the initial trustee and can modify the trust during their lifetime. Upon the grantor's death, the trust specifies that assets be distributed to the beneficiaries, or a successor trustee can be named to manage and control the trust for the heirs.

Trusts offer more privacy than wills, as information about the estate is not made public. They also tend to be more expensive and complex to maintain. Trusts do not need to go through probate, which can save time and money. However, setting up a trust requires additional steps, such as changing the title of applicable assets to the name of the trust.

Both wills and trusts are effective tools for estate planning, but they have distinct advantages and disadvantages. Wills are generally simpler and more cost-effective, while trusts offer more privacy and can help avoid the probate process. The choice between a will and a trust depends on individual circumstances, the size and complexity of the estate, and the level of privacy desired.

Revocable vs irrevocable trusts

Trusts are a popular tool for estate planning and there are two main types: revocable trusts and irrevocable trusts. Both types of trusts offer control over asset management and protection against probate court and privacy, but they differ significantly in terms of flexibility and tax protection.

Revocable Trusts

A revocable trust, also known as a living trust, is a trust in which the terms can be changed at any time. The owner of a revocable trust may change its terms, remove beneficiaries, designate new ones, and modify stipulations on how assets within the trust are managed. The grantor of a revocable trust can also name themselves the trustee and distribute trust property to themselves during their lifetime.

The main benefits of a revocable trust are:

• They are easier to set up than irrevocable trusts.
• They can be amended, saving time and money.
• They allow for continuous management of assets in the event of incapacitation.
• They bypass probate and preserve privacy.
• The grantor can be a trustee.

However, there are also some disadvantages:

• They do not minimize estate taxes.
• They are not shielded from creditors.

Irrevocable Trusts

As the name implies, when an irrevocable trust is created, the assets are transferred to a trust that is very difficult to change or terminate. The trust, rather than the creator, is considered the owner of the assets, and it holds those assets for the benefit of the beneficiaries. Irrevocable trusts are often used when the creator is trying to limit estate taxes and protect assets from being taken by creditors.

The main benefits of an irrevocable trust are:

• They minimize estate taxes.
• They protect assets from creditors.
• They can allow eligibility for government programs such as Medicaid.
• They bypass probate and can maintain privacy.

However, there are also some disadvantages:

• They can be more difficult to establish than a revocable trust and require an attorney.
• Assets are no longer owned or controlled by the grantor.
• They may be subject to higher income tax rates.
• The trust cannot be canceled without the approval of all beneficiaries and the grantor.

Tax implications of trusts

Trusts can be a great way to manage and protect your assets, but it's important to be aware of the tax implications that come with them. Here are some key things to know about the tax implications of trusts:

Types of Trusts

There are two main types of trusts: revocable and irrevocable. A revocable trust can be changed or closed during the grantor's lifetime, while an irrevocable trust cannot be amended or closed after it has been opened. Revocable trusts are often used to avoid probate and keep assets private, while irrevocable trusts are commonly used to protect assets from taxes and creditors.

Taxation of Trusts

The taxation of trusts depends on whether they are grantor or non-grantor trusts. In grantor trusts, the grantor is responsible for paying taxes on the income generated by the trust's assets. This includes revocable living trusts and intentionally defective grantor trusts (IDGTs). For non-grantor trusts, the taxation depends on whether the trust is simple or complex. In simple non-grantor trusts, the beneficiaries pay taxes on the income, while in complex non-grantor trusts, taxes may be paid by the beneficiaries, the trust, or a combination of both.

Tax Rates for Trusts

Trusts are taxed more aggressively than individuals. In the 2024 tax year, a trust reaches the top marginal tax rate of 37% after earning only $15,200, while an individual reaches this rate after earning $609,350. Trusts may also be subject to the net investment income tax (NIIT), which is a 3.8% tax on undistributed investment income or excess adjusted gross income.

Distributions to Beneficiaries

Distributions to beneficiaries from a trust can result in a lower overall tax bill. The trust can deduct the distribution, and if the beneficiary is in a lower tax bracket, they will pay less tax on the distribution than the trust would have. However, there are limits on how much income can be allocated to distributions made to beneficiaries. The tax liability of the distribution depends on the type of income the trust generates (e.g. dividends, capital gains) and how much is distributed to the beneficiary.

Choice of Trustee

The trustee plays a crucial role in managing the trust and is responsible for maintaining accurate records, documenting transactions, and applying complex trust accounting rules. For larger and more complex trusts, families often choose professional trustees with experience managing trusts.

Investment Management

When investing trust assets, the trustee must balance tax considerations with the trust's investment strategy, risk tolerance, and beneficiary needs. Trusts with mandatory income distributions, for example, will need an investment strategy that generates sufficient income without generating excess income or capital gains that could increase tax liability.

Choosing a trustee

A trustee can be an individual, a corporate trustee, or a combination of both. Here are some things to consider when making your decision:

Selecting an individual trustee

Choosing a friend or family member as a trustee has the benefit of that person likely having an immediate appreciation of your financial philosophies and wishes, as well as an understanding of the needs of the beneficiaries. However, naming a family member as a trustee can be a difficult decision, as what may seem like an honour to you might be perceived as a burden to them. It is also important to remember that just because someone is a friend or family member, it does not mean they are the wisest choice.

Selecting a corporate trustee

A corporate trustee will have significant expertise and resources, including an understanding of fiduciary requirements and extensive investment management experience. They can also lend an unbiased and objective approach to the process, detached from any personal conflicts.

Selecting co-trustees

In some cases, it may be best to name co-trustees, one individual, and one corporate entity. This can provide the benefits of both options, as both parties have a fiduciary responsibility to the person establishing the trust and the beneficiaries. In this scenario, you can include provisions that give one party preferential decision-making powers.

Important considerations

When choosing a trustee, it is essential to explore different scenarios and take the time to think through your options. It is also crucial to ensure that the person or entity you choose understands trusts and is up to the task of managing your wealth. If you are setting up a trust to grow wealth, you will want to appoint someone who understands how to do this.

Additionally, if you are considering a friend or family member, it is important to ensure they are up to the task of administering your trust and have the will to withstand any drama or resentment that may arise when managing large sums of money. It is also necessary to appoint an alternate trustee in case something happens to the primary trustee.

Professional advice

If you are unsure about who to choose as your trustee, it is recommended to consult a professional such as an attorney or financial advisor. They can help you navigate the process and make a decision that is best for your specific situation.

Rules for beneficiaries to withdraw money

• Role of the Trustee: The trustee is responsible for managing the assets in the trust and distributing them according to the grantor's wishes. The trustee is typically the only person allowed to withdraw money from the trust and must act in the best interest of the trust and its beneficiaries.
• Revocable Trusts: In a revocable trust, the grantor (also known as the trustor or settlor) can designate themselves as the trustee and maintain control over the assets during their lifetime. They have the authority to withdraw money from the trust but must follow the terms outlined in the trust document.
• Irrevocable Trusts: In an irrevocable trust, the grantor usually transfers control to a trustee. Only the trustee can withdraw money from this type of trust. If the grantor designates themselves as the trustee, they will be subject to strict scrutiny and must ensure they do not breach their fiduciary duty.
• Beneficiary Access: Whether or not a beneficiary can directly withdraw money from a trust depends on the trust document. The settlor may include language allowing beneficiaries to withdraw funds when needed or may give the trustee sole power to access the funds. Clear instructions should be provided in the trust document to outline the reasons and circumstances under which withdrawals can be made.
• Trustee's Fiduciary Duty: Trustees must always act in the best interest of the trust and its beneficiaries. They cannot use the trust funds for personal gain. They are responsible for keeping detailed records of all transactions and must ensure that withdrawals align with the terms of the trust.
• Permissible Expenses: Trustees can withdraw money from the trust to cover various expenses, including funeral and burial costs, property-related expenses, debts owed by the grantor, taxes, and fees for professionals hired to assist with administration. They can also use the funds to make investments that benefit the trust and its beneficiaries.

Frequently asked questions