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Trusting in trusts.


Trusts can be a useful toot to help meet your client's needs. Understanding the various options will allow you to create the appropriate trust to fit the task at hand.

Trusts play a major role in financial planning--estate planning and creditor protection--yet few customers really understand what they are, when they should be used and how they operate.

So, what is trust? A trust is a legal entity through which the legal title to property is separated from the right to its beneficial enjoyment. Legal title to trust property is held by the trustee but the right to its beneficial enjoyment belongs to the beneficiaries of the trust. This means that the trustee as a fiduciary must manage and distribute trust property for the beneficiaries of the trust in accordance with the terms of the trust and applicable state law.

There can be more than one trustee and trustees may be individuals or corporations such as a bank or a trust company. As to beneficiaries, every trust must have at least one beneficiary, though there may be more. Likewise, beneficiaries may be individuals or organizations and they may have interests in the income or principal of the trust or both. Regarding "income" beneficiaries, they are parties who have a right to receive income from the trust or to whom the trustee has the discretion to distribute such income. On the other hand, a party that has a right to trust principal after the interest of the income beneficiary terminates is called a "remainder" beneficiary or "remainderman."

Living and testamentary trust

Trusts are basically classified as living or testamentary trusts. Living trusts are established by a person called the grantor or settler and take effect during that person's life. Testamentary trusts are established under the terms of a person's will and only take effect at that person's death. (The person who creates a will is called the testator.)

Revocable living trusts

In addition, living trusts may be revocable or irrevocable. Revocable trusts are those over which the grantor retains total control including the right to change the trustee, remove trust property or terminate the trust. (It should be noted that these trusts become irrevocable upon the grantor's death.) Revocable trusts are typically designed to provide the following benefits to the grantor or their family:

* Probate costs reduced. Property that passes through an executor's hands is subject to executor's commissions and probate court costs, but property including life insurance proceeds received by the trustee of a revocable living trust is not, and therefore, may go to the family at lower cost.

* Elimination of probate delays. A revocable living trust avoids the delay of probate proceedings and permits beneficiaries to receive property more quickly.

* Financial management. A trustee can provide financial management for beneficiaries who are not capable of handling such matters themselves.

* Privacy. Will and estate accounting are matters of public record in many states. On the other hand, a trust document does not need to be revealed and the beneficiaries and trust assets do not have to be known to outsiders. Consequently, by passing property to the family through a revocable trust rather than under the grantor's will, the grantor can avoid publicly disclosing who received what and how much.

* Children's inheritances. A trust permits parents to avoid placing large sums of money in children's hands at a young age. Moreover, since minors may not receive funds directly at their parent's deaths, the estate must go through the expensive process of having a guardian appointed. If the funds go into a trust this problem is avoided.

* Management of property in the event of disability. The trustee can manage the trust property for the benefit of an incapacitated grantor without the need to have a guardian or conservator appointed by a court. This can be a very significant benefit to the grantor and the family if the grantor becomes disabled because the process of getting a court to act is time-consuming and expensive.

Irrevocable living trusts

As previously stated, irrevocable living trusts are established during the life of the grantor and, as their name implies, may not be modified or revoked by the grantor. One of the main reasons for creating such trusts is to remove the trust property from the grantor's estate. Various types of irrevocable trusts are as follows:

* Irrevocable Life Insurance Trusts ("ILITs") A common use of irrevocable trusts is to acquire life insurance to provide estate tax liquidity without causing the life insurance to be included in the grantor's gross estate. (Remember that the estate tax is scheduled to return on Jan. 1, 2011.) These trusts are generally for the benefit of family members and are funded with a life insurance policy on the grantor or the grantor and the grantor's spouse. Premium payments are made by the trustee with gifts that the grantor makes to the trust. Moreover, to keep the death proceeds out of the grantor's estate, the grantor retains no rights in the trust or life insurance purchased by the trustee. In any case, once the death proceeds are paid to the trustee the trustee can make those funds available to pay estate taxes by purchasing assets from the decedent's estate or by making loans to the decedent's estate.

* Spendthrift Trusts. A spendthrift trust is one in which the beneficiary cannot transfer their interest in the trust to a third party and the beneficiary's creditors cannot reach the assets in the trust as long as they remain in trust. The result is that a discretionary spendthrift trust provides protection from creditors in bankruptcy, divorce and post-judgment collection proceedings. Fortunately, life insurance can be used as an excellent means of funding such trusts. In such cases, the trustee should be the applicant owner and beneficiary of the policy with the premium dollars provided to the trust through gifts by an appropriate family member such as a parent or grandparent.

* Dynasty Trusts. A number of states allow trusts to last for long periods of time, and consequently, they are called "dynasty trusts." A life insurance policy can be the best funding vehicle for such trusts that function as a family bank or family asset pool that keeps assets in the trust while making them available to the trust beneficiaries. For example, the trust can purchase recreational property like a vacation home or a boat for the use of trust beneficiaries. In addition, the trust can make secured loans to beneficiaries such as for the purchase of a home or to start a business. In fact, the business can be owned by the trust and the appreciation on the business kept in the trust and shielded from transfer taxes and the creditors of beneficiaries.

* Charitable Remainder Trust. Assume that an individual has highly appreciated property that they would like to sell and use the proceeds for retirement income. Assume further that they do not want to pay capital gain taxes on the sale but would like to benefit their favorite charity in the process. All of these goals may be accomplished by having the individual create a charitable remainder trust through which the property can be sold without incurring a taxable gain. This is because under such a trust the grantor can retain the right to receive income from the investment of the sale proceeds and at the end of their income interest, the remaining property in the trust goes to the charity. In addition, the individual gets a charitable income tax deduction for the value of the remainder interest going to the charity. The bottom line is that the individual gets a higher income stream while enjoying an offsetting charitable deduction.

* Wealth Replacement Trust. As noted above, in the case of charitable remainder trusts, the individual grantor and the charity are happy. The problem is that the grantor's family may be displeased because they have lost a part of their inheritance that has gone to the charity. This can be made up for the family, however, by having the grantor establish a wealth replacement trust. Under this approach, the grantor of the charitable remainder trust would also create an irrevocable life insurance trust or ILIT for the benefit of the family and make gifts to the trust with which the trustee may purchase life insurance. Due to the improved income stream that the grantor has from the charitable remainder trust, this should be affordable and will present the family with income-tax-free death proceeds at the grantor's death.

* Grantor Retained Annuity Trust. In the case of a grantor retained annuity trust or "GRAT," an individual establishes an irrevocable trust and transfers property to the trust in return for a right to receive income for a certain period of time or the grantor's life, whichever is shorter. At the end of the grantor's income interest, the property remaining in the trust typically passes to family members. That remainder interest going to the family is a gift at the time the GRAT is established and valued for gift tax purposes using certain published government interest rates. The bottom line is that if the property placed in the trust is producing a greater rate of return than the government interest rates, the remainder going to the family will be undervalued for gift tax purposes and that means a savings in gift taxes. This is particularly significant during this time of low interest rates to the extent that it is more likely that the grantor has property producing a greater rate of return than the government rates.

Testamentary trusts

Testamentary trusts are established under a person's will and have no effect until the testator's death and the probate of the will. Since the trust does not take effect until the testator's death, the trust may only be modified or revoked by amending the will and becomes irrevocable upon the testator's death.

It should be noted that a testamentary trust may be named as the beneficiary of a life insurance policy on the life of the testator. This might be the case where the testator has minor children and wants the death proceeds to be held in trust for the children until they become adults. The downside of such an arrangement is that the death proceeds would be included in the testator's gross estate for federal estate tax purposes if the tax is in effect when the testator dies.

Keeping up with change

Trusts are one of a number of tools that we have at our disposal to help meet a prospect's needs. Like any tool, a trust is only good as long as it fits the task at hand. This means that you should be asking prospects if they have trusts that are either owners or beneficiaries of life insurance policies. If so, you need to ask if the reasons that the trust was originally established still apply. If not, the prospect needs to consider speaking with their lawyer about what can be done to modify or terminate the trust to better fit their current needs.


Questions should be asked as to whether the life insurance is performing as originally illustrated and as currently needed. This may require getting an in-force illustration to compare the policy's performance to current needs. If the policy is not performing as currently needed, it may have to be modified or replaced in conformity with applicable state regulations.

By Louis S. Shuntich, J.D., LL.M.

Louis S. Shuntich is Senior Vice President, Advanced Planning, Lincoln Benefit Life Company, Jacksonville, Fla. He has published five books on advanced marketing subjects and is a frequent speaker at industry events on the topic.

This information is provided by Lincoln Benefit Life Company [LBL], Home Office, Lincoln, Neb. This material is intended for general educational purposes and is not intended to provide Legal, tax or investment advice, LBL issues fixed and variable insurance products that are sold through agreements with affiliated or unaffiliated broker-dealers or agencies. ALFS, Inc. serves as principal underwriter of certain SEC-registered contracts for LBL.

For broker-dealer or agent use only. This material may not be quoted, reproduced or shown to members of the public, nor used in electronic or written form as sales Literature for public use.
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Title Annotation:ESTATE PLANNING
Author:Shuntich, Louis S.
Publication:Life Insurance Selling
Date:Nov 1, 2010
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