Q: I have a few questions regarding a trust my Mom set up for me. It was created upon her death and I am the sole beneficiary and the sole trustee, with virtually no limitations on what I do with the money she left in the trust. I’m a bit confused why she set it up this way. Are there any particular benefits to this? Tax advantages? Her attorney, who drew up her will, seemed to think that we could dissolve the trust (as it doesn’t involve a “great” amount of money). I don’t have any creditors after me so the idea of “protection” isn’t an issue.
A: Trusts have long been an integral part of many estate plans and serve a multitude of valuable purposes. It is difficult to completely answer your question without knowing more about your mother’s wishes and financial condition, as well as reviewing the document that established the trust. With this in mind, however, I can offer some general thoughts that may help answer your questions.
While trusts are used for many reasons, not too many years ago one of the primary purposes of a trust was to provide estate tax and income tax savings. With recent changes in the tax laws such as the significant increase in the estate tax lifetime exemption, increasing income tax rates, and the introduction of the Net Investment Income Tax, some of these benefits have been weakened or eliminated. Today three common uses for trusts are:
• Management of assets: A trust can provide financial benefits to a loved one without actually giving them managerial control of the assets. This is especially useful in cases where the beneficiary may be too young or not competent enough to manage the assets on their own.
• Creditor protection: Because assets in a trust are normally not legally owned by the beneficiary of the trust, creditors of the beneficiary usually cannot get their hands on the trust assets.
• Deferred distribution of assets: The objective is often to control who eventually benefits from the trust assets, after providing income to another party such as a surviving spouse. This has become one of the most important uses of trusts in estate planning especially in cases where there may be family disagreements or, in the case of a second marriage, where there are children from the previous marriage(s).
In your case, since you mother gave you control of the assets as trustee as well as made you the sole beneficiary; we can safely assume that the reasoning was not a concern over your management of the assets or family issues. Consequently, it would seem that the purpose was for creditor protection, or simply that the will was drafted prior to all the recent tax law changes. (One more reason to visit your attorney regularly and keep your documents up to date!) So consult with your attorney and consider carefully the reasons that your mother set up the trust. There may still be a good reason for the trust, but if not, under your professional advisor’s guidance, it may be prudent to go ahead and terminate the trust.
Q: I was also advised that any money I make, personally, could be put into a SEP IRA and instead I could draw from the trust for my income. What would the tax advantages be for this?
A: This is a potentially complex question and needs to be based on your specific tax situation. I almost always recommend taking full advantage of retirement plans such as a SEP. This is a great retirement account that can allow you to defer the tax on a significant amount of money (as much as $52,000 in 2014). Of course there are other retirement plans available for consideration including Traditional and Roth IRAs, employer plans such as 401(k) and 403(b) plans, defined benefit plans, and more. What is best for you is dependent on your income, how much you are able to put into the plan, and which types of plans you are qualified to utilize.
Because the trust tax rates ratchet up much faster than individual tax rates, and because the Net Investment Income Tax kicks in much sooner in a trust, it is likely that taking your living income from the trust and contributing your earned income to a quality retirement plan may have some potential benefits. But I urge you to consult with a knowledgeable tax advisor because the choice of a retirement plan is always dependent on your individual situation. And the addition of a trust in that equation will make this planning even more complex.
To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation. Peter Robbins is a partner in the Boise office of CliftonLarsonAllen LLP, specializing in tax matters for small businesses, individuals, and trusts and estates. Have a question for Robbins? Email your question to [email protected]. Enter “Talking Tax” in the subject line.