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For starters, there are many varieties of trusts in the old estate planning "toolkit" and figuring out the "rules of the road" for a given trust is key.
A recent Financial Planning magazine article, titled “How to invest trust assets,” took up this topic and offers both an explanation of commonly encountered trusts, along with some suggestions regarding prudent investment considerations for each.
Bypass or Credit Shelter Trust:
This is a very common trust in estate planning, since it is designed to shelter the federal exemption amount from taxation at death.
Usually assets are held in this trust to benefit the surviving spouse, although other relatives can be beneficiaries as well.
When the surviving spouse dies, the assets pass to heirs without being taxed in the estate of the surviving spouse.
Accordingly, a “bypass” trust avoids inclusion in the surviving spouse’s taxable estate.
But nothing in life and tax law is simple or static.
With recent changes to the tax laws raising the estate tax exemption to $5 million ($5.45 million for 2016, given the inflation adjustment), the surviving spouse’s estate may no longer have estate tax liability even when combined with the first decedent's estate.
Consequently, growth inside the trust will result in higher income tax costs to heirs in the form of capital gains taxes (i.e., there is no second step up in basis for assets inside the bypass trust at the death of the surviving spouse).
Possible solutions? Consider moving assets out of the bypass trust through permissible distributions, amending the trust tax planning provisions to make use of the new "portability" alternative or even terminating the trust if allowed.
QTIP Marital Trust:
These trusts are intended to qualify for the estate tax marital deduction and obligate the payment of income at least annually to the surviving spouse, who is required to be the sole beneficiary.
The income distribution requirement will affect the choice of investment allocation, and thought should be given to protecting the trust and growing it for remainder beneficiaries.
This is especially important if there are children from a prior marriage and the decedent formed the trust for the surviving second spouse.
This investment "tension" can create friction between the surviving spouse and the step-children. One obviously will want greater income and the other preservation of principal.
Can you guess which is which?
The assets of a QTIP trust will typically be included in the surviving spouse’s estate.
Practical translation: If the surviving spouse's estate is not itself expected to be taxable, assets in the trust will receive a step-up basis at death with no offsetting tax cost. If that estate is expected to be subject to an estate tax, however, then that risk should be reviewed.
Irrevocable Life Insurance Trusts: These days, life insurance is commonly held in trusts that own other substantial assets.
One should determine the cash flow needed to maintain current and anticipated life insurance—with any excess being invested under a longer-term plan.
At the insured’s death, the proceeds must be invested in a manner befitting the post-death trust objectives.
Revocable (Living) Trusts:
These trusts are controlled by the trustmaker who created the trust investments and most likely will serve as the initial trustee.
As a result, the allocations can be as the trustmaker/trustee elects.
What if the trustmaker becomes incapacitated and a successor trustee takes over?
The successor trustee will be subject to the standards of a prudent investor and state law.
If that is the case, maintaining the original investment plan might not work, unless the trust itself authorizes its continuation.
Be sure to confirm the identity of the successor trustee and that he or she understands the attending responsibilities.
Dynastic (Grandchildren’s) Trusts:
This trust was traditionally used to pay for college and was invested in a manner appropriate to achieving that goal.
But with more 529 plans available these days, grandchildren trusts are rarely used for this reason.
Now, such trusts are usually designed to provide long-term growth for future uses.
These future uses may include providing cash flow to grandchildren and future generations.
Note: these trusts may include a term allowing the trust to own personal use assets. If so, that may be relevant to the investment timeline and risk profile.
Grantor Retained Annuity Trusts:
Often called “GRATs,” these trusts are created to minimize estate taxes.
Historically, a GRAT was structured for the short term with a very detailed asset allocation.
A GRAT would have just one stock or one asset class, and if it grew substantially, it would be “immunized” by swapping in cash for the highly appreciated assets.
When the GRAT ended, the process would be resumed.
This strategy is known as “rolling” or “cascading” a GRAT.
With the potential for repeal, the ability to re-GRAT assets sequentially year after year is not certain.
GRAT planning for those who are not elderly should take a longer-term approach and might be funded with a diversified portfolio.
The goal might now be to shift any investment performance in excess of the current low interest rates out of the estate over the term of the GRAT. In turn, this would make investment planning for this potential new application dramatically different from how it has been done historically.
Whatever you do when it comes to creating and administering a trust of any kind, be sure to work with experienced professionals in estate planning, tax planning and financial advising.
So, how do you find an "experienced" estate planning attorney?
First, ask around. Friends, family and other professional advisors are trustworthy sources.
Second, conduct an "organic" search on "Google" for "estate planning" near you (e.g., "Estate Planning Anytown MoKan").
Third, either way, verify! Check out the education, experience, ratings and client reviews of any attorney before you contact him or her.
How?
Two helpful online resources are just a mouse click away to assist with your due diligence: Avvo.com and Lawyers.com.
Check any Avvo ratings, client ratings/testimonials and attorney endorsements on Avvo.com and any "peer ratings" by judges/other attorneys and any client ratings/testimonials on Lawyers.com.
In fact, I use both of these services to thoroughly vett attorneys before referring members of our "client" family for legal help in other areas of law or for matters in jurisdictions outside Kansas or Missouri.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
Reference: Financial Planning (August 1, 2016) “How to invest trust assets”