Trusts for tax-efficient estate planning

• Dana Dratch
• On 6:00 am EST, Monday November 2, 2009

Do you have an asset that you believe will increase significantly in value? Rather than eventually leave it to your heirs, estate planner Bill Kirchick suggests you put it in a trust.

"You must take annual payments, which drive down the value of the gift," says Kirchick, partner at Bingham McCutchen in Boston. The appreciation value, however, remains in the trust, apart from your estate and free of estate tax.

If the value of your estate is larger than the tax exemption, currently $3.5 million, you can put the overage in a charitable remainder trust. You get a deduction for the donation the year you set up the trust, you get income from the trust and, when you die, the assets pass to the charity without taxes.

You also can take the annual income from the trust and purchase life insurance to benefit your heirs. Put the insurance into an irrevocable trust to remove it from your estate and the money will pass to your beneficiaries without estate taxes, says Timothy M. Hayes, president of Landmark Financial Advisory Services LLC.

"The objective would be to replace the value of the asset," he says. "For somebody who has some kind of property -- appreciated securities, art collection, land -- this is the way they do a lot of these things." But remember, says Hayes, the premiums have to count against the gift exclusion for your beneficiaries.

Residential trusts

Some tax planners suggest clients consider a qualified personal residential trust. This is not for the faint of heart. Basically, you are automatically giving up ownership of your home to your heirs at some future date. If you die before that time, the house is still counted in your estate. If you die after, then you've succeeded in getting that asset out of your estate -- and it won't count against you in terms of estate tax.

Afraid the kids might throw you out? "Generally what happens with these deals in the real world is that the children sign (a document) that they will lease it back to you" at the lowest fair value rental rate, says Stuart H. Sorkin, a tax attorney with Frank & Associates PC, a Bethesda, Md.-based law firm. For your protection, he says, it's a good idea to corroborate the fair value when you enter into the lease.

Skip a generation

If you want to leave assets to your children and make sure they hang onto them despite divorce or lousy financial judgment, think about skipping a generation. When you set up the trust, leave the assets for your grandchildren with the income and principal from the trust going to your kids, says Sorkin. Technically, the asset is in the grandkids' names, but, says Sorkin, "with the trustee's permission in some circumstances your children may receive income and principal from trust." It's not the first asset they go to if they need the money for something, but it's there as a safety net if they need it.

This option has become popular, says Sorkin, especially among younger families who are building wealth and don't yet know what kind of marital or money sense their children will demonstrate.

Buzz up!