What Happens If Trust Not Funded

Revocable trusts can be an effective way to avoid probate and provide for asset management, in case you become incapacitated. These revocable trusts — also known as “living” trusts — are very flexible and can achieve many other goals.

Point Verda Recorder’s recent article entitled “Don’t forget to fund your revocable trust” explains that you cannot take advantage of what the trust has to offer, if you do not place assets in it. Failing to fund the trust means that your assets may be required to go through a costly probate proceeding or be distributed to unintended recipients. This mistake can ruin your entire estate plan.

Transferring assets to the trust—which can be anything like real estate, bank accounts, or investment accounts—requires you to retitle the assets in the name of the trust.

If you place bank and investment accounts into your trust, you need to retitle them with words similar to the following: “[your name and co-trustee’s name] as Trustees of [trust name] Revocable Trust created by agreement dated [date].” An experienced estate planning attorney should be consulted.

Depending on the institution, you might be able to change the name on an existing account. If not, you’ll need to create a new account in the name of the trust, and then transfer the funds. The financial institution will probably require a copy of the trust, or at least of the first page and the signature page, as well as the signatures of all the trustees.

Provided you’re serving as your own trustee or co-trustee, you can use your Social Security number for the trust. If you’re not a trustee, the trust will have to obtain a separate tax identification number and file a separate 1041 tax return each year. You will still be taxed on all of the income, and the trust will pay no separate tax.

If you’re placing real estate in a trust, ask an experienced estate planning attorney to make certain this is done correctly.

You should also consult with an attorney before placing life insurance or annuities into a revocable trust and talk with an experienced estate planning attorney, before naming the trust as the beneficiary of your IRAs or 401(k). This may impact your taxes.

Reference: Point Verda Recorder (Nov. 19, 2020) “Don’t forget to fund your revocable trust”


Incorporating Gifting with an Estate Plan

Kiplinger’s recent article entitled “Gifting sounds pretty simple, but there are many ways to do it, and several tax ramifications to be aware of as well” explains that no matter if a gift is made this year or in future years, there are some important questions to consider.

Increased exemption. The Tax Cuts and Jobs Act significantly upped the lifetime gift, estate and generation-skipping tax exemption to $11.58 million per individual ($23.16 million per couple). It’s set to expire at the end of 2025. Thus, there’s the prospect of possibly losing an opportunity to transfer wealth out of your estate and save on future estate taxes earlier than anticipated.

When to Give. A big question is whether a person should give away assets during their lifetime or at their death. Those who opt to gift while they’re alive often do so to reduce their estate and to share in the joy of seeing the effect it makes in the lives of the recipients. Others decide to gift after death for the security of having the assets on hand, if they’re needed. Gifting after death also gives recipients time to prepare for the responsibility that comes along with inheriting wealth.

Unified Federal Estate & Gift Tax Exemption. There are many ways to distribute assets. What works for one family isn’t necessarily the wisest strategy for another. Note that any transfer is gift tax-free up to the annual exclusion amount ($15,000 per person per donor in 2020). Any gift over this amount will count against the donor’s lifetime exemption amount. After that lifetime exemption is used, the gift will be subject to gift tax.

Outright cash gifts. This appears to be the most uncomplicated way of gifting. However, for those with significant wealth, this approach could have some drawbacks. These concern the ability and experience gift recipients have to manage money, outside risks, such as a spouse or high-risk professions, and demotivating recipients to live off their inheritance, instead of becoming productive on their own. Therefore, distributing large amounts of money—particularly at a young age—is generally discouraged.

Trusts. These are used frequently for larger gifts to provide for beneficiaries, while using controls by the grantor. These parameters can include things like distributing trust assets in stages (when the beneficiary reaches a certain age or achieves a specific goal). You can also leave assets in a discretionary lifetime trust, which would maintain the assets in a trust for the beneficiary’s entire lifetime. When set up by an experienced estate planning attorney, this offers a high level of protection from divorcing spouses, lawsuits, poor financial decisions and outside influences. It can also let the grantor create a lasting family legacy for many generations.

Gifts for education or medical expenses. Direct payments for college tuition or for medical expenses have no gift tax consequences. Educational gifts can also be made by funding a 529 educational savings plan. While there are no contribution limits for a 529 plan, gifts over the annual exclusion amount can have gift tax consequences or count against the lifetime exemption. You can also pre-fund an account up to $75,000 and it will receive the same tax treatment, as if it were gifted in $15,000 increments over five years.

Uniform Trust to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA). These custodial accounts are generally less restrictive than trusts and let minor beneficiaries access funds at age a specific age depending on state of residence.

Reference: Kiplinger (Oct. 30, 2020) “Gifting sounds pretty simple, but there are many ways to do it, and several tax ramifications to be aware of as well.”


Will I Owe Taxes on My Life Insurance Benefit?

MoneyWise’s recent article entitled “Are Life Insurance Benefits Taxable?” explains that, although the proceeds from a life insurance policy are usually tax-free, there are some exceptions. Life insurance payouts may be subject to taxes in the following situations:

A high-value estate. The federal estate tax exemption is $11.58 million this year, so if you leave an estate worth more than that, the IRS will charge a tax of 18% to 40% on the excess amount. It’s possible that life insurance proceeds could get taxed, if they’re part of a high-dollar estate. To avoid this, you could create an irrevocable living trust to shield your assets from taxation. Ask an experienced estate planning attorney for help.

State inheritance or estate tax. Estate and inheritance tax laws are different in every state, so your estate or heirs may have to pay taxes on the death benefit, depending on where you reside. There are six states that have inheritance taxes (IA, KY, MD, NE, NJ, and PA). There are also a dozen states and the District of Columbia that have their own estate taxes (CT, HI, IL, ME, MD, MA, MN, NY, OR, RI, VT and WA).

Gifts. You can also avoid estate or inheritance taxes by transferring your life insurance policy to a beneficiary, while you’re still around. You may have to pay a federal gift tax on the value of the policy when you do it, but the policy will be worth far less than the eventual death benefit. You can gift up to $15,000 a year to an individual without any tax. Remember that the policy’s new owner will still have to make the payments.

The death benefit skips a generation. If you decide to skip your child and give the death benefit to your grandchild, the money would be considered taxable income by the IRS. That’s due to the “generation skipping transfer tax,” which applies if you give any gift or inheritance to a family member who’s more than one generation younger than you — or to a nonrelative who’s more than 37½ years younger.

Life insurance installment pay-out. While life insurance benefits are typically paid out in a lump sum, some people opt to have their benefits paid out over time. I you do this, tell your heirs that they’ll have taxes on any interest that’s added to the benefits, while they’re being kept by the insurance company.

Withdrawal from your cash value of life insurance. With permanent life insurance policies that cover you for life (as opposed to time term life), there’s a savings component called “cash value.” During the life of the policy, some of your paid premiums funds the cash value account. You can make a withdrawal from this amount, provided you make a withdrawal that’s less than the amount you’ve paid into the policy. Otherwise, it’s taxed.

Group life insurance policies. Many companies offer life insurance as a benefit to their employees. If you have a policy at your job, the premiums won’t be taxable income unless the promised life insurance payout is more than $50,000.

Selling your life insurance policy. If you sell your life insurance policy for cash to a buyer or investor who will continue to make the payments and will receive the death benefit when you die, you’ll have taxes on any income from the sale.

If you still have questions about how insurance contracts work, speak to an experienced estate planning attorney.

Reference: MoneyWise (Oct. 12, 2020) “Are Life Insurance Benefits Taxable?”