In my last column, I explained what a trust is and about some different types of trusts. This week I’ll focus on some additional trusts, including the Generation Skipping Trust, the Qualified Minor's Trust, the Irrevocable Life Insurance Trust, and a Charitable Trust.

The Generation Skipping Trust, similar to the By-Pass Trust discussed last week, is designed to avoid taxation of the trust assets when your children die. The intent of the Generation Skipping Trust is to provide indirectly for the benefit of your children and then distribute the trust assets directly to your grandchildren. It usually includes something like the following:

Because your son doesn’t "own" the trust assets, they are not part of his gross estate and are not taxable at his death. This property, while subject to tax at your death, is not subject to tax at either your spouse's death or your son's death. Whatever assets remain in the trust will not be taxed again until your grandchildren die. This is sometimes referred to as a "Dynasty Trust."

The next category of trusts is what we commonly refer to as "gifting trusts." They are usually established during your lifetime and are intended to reduce estate tax at your death. The first of these is the Qualified Minor’s Trust.

Federal law allows you to give away up to $11,000 per recipient per year as a present interest gift. If you and your spouse join in the gift, you can give a total of $22,000 per year to each person. You can do this every year without tax consequence so long as the present tax code does not change.

The "present interest" requirement means the person to whom you give the money must be able to take possession of it immediately. You cannot hold it in front of your son and say "I’m giving you this $11,000, but you can’t have it until 2020." Your son must be able to use the property or funds immediately. You must give the funds or property to your son, and not to your brother to give to your son sometime later (such as when he marries or turns 35).

There is an exception to this rule and it applies to minors. The government realizes you won’t want to give $11,000 to your 10-year old son. To overcome this hesitancy, the law allows you to put this $11,000 into a Qualified Minor's Trust which:

There are several advantages to this type of transfer. First, any income from the assets should be taxed at your child's presumably lower tax rate. Second, this transfer does not count against the $1.5 Million exempt amount you can transfer without incurring estate tax. Finally, the transferred assets are out of your estate and will not be taxed at your death

The next type of trust is the Irrevocable Life Insurance Trust. Life insurance usually serves little purpose during your lifetime, but it can be a great estate planning asset. If you have a taxable estate (over $1.5 Million), own life insurance, haven’t pledged it as security for a loan, and won’t need to borrow against or withdraw the accrued cash value of the insurance policy in the foreseeable future, you may want to consider transferring the policy to a life insurance trust.

If you transfer the policy to a properly prepared trust, it will escape taxation since it will no longer be part of your estate at your death. In addition, you can transfer the life insurance policy to the trust for a mere fraction of its death benefit value. The "transfer value" is the amount your insurance company would charge you to purchase the policy on the date of the gift, commonly called its "interpolated terminal reserve" value, which usually equals the cash surrender value of the policy plus any unearned premium.

As an example, if you own a $100,000 life insurance policy with a cash surrender value of say $10,000 and an annual premium of $1,000, and you transfer this policy to an irrevocable life insurance trust, you have only made a "gift" of approximately $11,000. This wouldn’t even be reported on a gift tax return since it does not exceed the allowable annual exclusion amount. Yet you have just removed $100,000 from your estate and avoided tax on this amount at your death.

The Charitable Remainder Trust has become quite popular because it allows you to make a charitable gift, receive a current income tax deduction, and continue to receive income from the asset. For example, if you transfer $200,000 worth of property to a Charitable Remainder Trust, the value of the "remainder interest" is deductible on your income tax return. For older people without children, this may well be the best planning technique available. You receive an immediate tax deduction and may well receive more income each month than you would if you left the funds in a certificate of deposit.

Next week I’ll talk about some additional estate planning options with trusts. Please stay tuned.

© Jerry E. Shiles 2004

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