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Beneficiary-Controlled Trusts (Part 1)

Estate planners use trusts to protect beneficiaries from their inability, their disability, their creditors and their predators. Included under “creditors" are the IRS and divorced spouses. Most traditional trusts distribute the assets when the beneficiary reaches a certain age or ages, with the last distribution terminating the trust.

More sophisticated estate planners generally create multi-generational dynasty trusts for their clients’ descendants that are (1) estate tax protected, (2) creditor protected and (3) divorce protected – while at the same time allowing the primary beneficiary to control the trust as a co-trustee. In essence, the primary beneficiary has nearly all the rights, benefits and control over the trust property that a person would have with outright ownership – in addition to tax, creditor and divorce protection not available with outright ownership. Such trusts are sometimes referred to as “beneficiary-controlled" trusts. Following are the design features of the typical beneficiary-controlled trust:

  • The donor (i.e., parent or grandparent) is the grantor of the Trust.
  • The child and his/her descendants are the beneficiaries of the Trust. However, the child is the “primary" beneficiary of the Trust during his/her lifetime and, therefore, the child’s needs take priority over the needs of his/her descendants.
  • The Trust has two trustees – the primary beneficiary (upon attaining the age of projected maturity) and an independent trustee. The independent trustee can be the primary beneficiary’s friend, trusted advisor or a bank.
  • The primary beneficiary has the power to remove and replace the independent trustee from time to time, thereby maintaining the beneficiary controlled feature of this trust design, so long as the replacement trustee is not a “related or subordinate party" as defined in Internal Revenue Code Section 672(c).
  • The trustees can distribute to the primary beneficiary (and his/her descendants) income and principal as needed for health, education, maintenance and support.
  • The trust agreement also allows the trustees to acquire assets for the primary beneficiary’s use and enjoyment (without remuneration) such as vacation homes, art work, jewelry, etc. The trustee could also invest in a business that the beneficiaries can be employed by.
  • The primary beneficiary can be given a broad non-general power to appoint the trust property during life and/or at death in favor of anyone other than the primary beneficiary, his/her creditors, his/her estate, or the creditors of his/her estate. Thus, the primary beneficiary can “re-write" the trust for future generations.
  • At the primary beneficiary’s death, the assets remaining in trust pass to his/her children (i.e., the grantor’s grandchildren), in equal shares, but in further trust. At that time, the grandchild becomes the primary beneficiary of his/her separate trust, which now benefits the grandchild and the grandchild’s descendants. To the extent of the grantor’s generation skipping tax exemption (which is the same as the estate tax exemption) plus the future appreciation thereon, there would be no estate taxes due.

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.

Julius Giarmarco, J.D., LL.M, is an estate planning attorney and chairs the Trusts and Estates Practice Group of Giarmarco, Mullins & Horton, P.C., in Troy, Michigan.

Additional resources provided by the author

For more articles on estate and business succession planning, please visit the author’s website, www.disinherit-irs.com, and click on “Advisor Resources”.

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