THE SAM LETTER manchester capital management Welcome TO Manchester Capital s SAM: Stuff About Money! In this issue we re going to talk about Trusts. The goal of SAM is to educate. Since our firm s inception in the early 1980s, we have learned that the families we serve as their trusted wealth advisors usually consist of multiple generations with varying levels of knowledge about wealth management. Each issue of SAM will present a different topic that we hope you or someone in your family will find helpful. Enjoy! Trusts can help individuals and families protect and transfer their assets. What is a Trust? A trust is a triangle-like relationship among three parties: a grantor, a trustee(s) and a beneficiary(s). The grantor asks a lawyer to prepare the trust document. The grantor then transfers assets he or she owns into the trust. A grantor can put practically any kind of asset into a trust (cash, stocks, bonds, insurance policies, real estate and artwork). The grantor selects a trustee to manage the property in the trust. Being a trustee is a serious responsibility. A trustee s duties come from the law and from the terms of the trust document. A trustee must always do what is best for the trust and the beneficiaries. The trustee should never do anything where he or she might benefit at the expense of the trust. The trustee must also keep complete and accurate records and prudently invest the trust assets. A trustee can hire professionals such as attorneys, investment advisors, accountants and bankers to help with trust management. www.mcmllc.com01
U Used in this Issue Trust: legal agreement that serves as a contract between the grantor and the trustee Grantor: the person who sets up the trust Trustee: person/entity that manages the assets and holds legal title to the assets in the trust Beneficiaries: people that benefit from the trust Inter vivos: another name for a living trust, Latin for between the living Creditor: person/entity to whom money is owed Capital gains: the amount by which an asset s selling price exceeds its purchase price Taxable estate: the total value of a deceased person s assets that are subject to taxation The grantor also names people (beneficiaries), who will benefit from the trust property. Beneficiaries are usually the grantor s family and loved ones, but they can be anyone, even a charity. The trust document often describes what a beneficiary is allowed to receive from the trust. For example, a beneficiary may only be permitted to receive a specified amount of money from a trust each year or may not be allowed to receive any money until he or she reaches a certain age. 02 www.mcmllc.com
THE SAM LETTER manchester capital management Grantor Creates Trust, selects Trustee and Beneficiaries, and funds the Trust with assets Trust Trustee Takes title to assets and manages the assets for Beneficiaries Beneficiaries Receive assets that are distributed from the Trust Example: Suppose Mom gave her oldest son, Dan, two ten dollar bills to use at the circus for himself and for his younger brother Steve. Mom said, The first ten dollar bill is for you. Buy whatever you want with it. The other ten dollars is for your brother Steve. Make sure he gets a snack, and bring me back any change. Dan was the complete owner of the first ten dollars. With respect to the second ten dollars, however, Dan was in effect only the trustee. Mom entrusted Dan with the money to spend for the benefit of his brother Steve, the beneficiary. Dan had possession of the money and the right to spend it, but he could only spend it as he was told. Steve did not have the money, but he had the right to have the money spent on his snack. In trust terms, Mom was the grantor, Dan was the trustee, and Steve was the beneficiary. If Dan had failed to buy his brother s snack and instead used the second ten dollars to buy candy for himself, Steve would likely have complained to his mother and sought enforcement of the trust. www.mcmllc.com03
What are the Primary Types of Trusts? A trust can be a living trust that is funded during the life of the grantor. A trust can also be testamentary, meaning it will take effect at the grantor s death. A testamentary trust is often created by a grantor s will. A living or inter vivos trust is used to manage a grantor s property during his or her life. A living trust can be either revocable or irrevocable. If the trust is revocable, the grantor maintains control over the trust, and can change the terms of the trust or even dissolve it. Because the grantor still has control over the trust, all income and capital gains from the trust property are taxed to the grantor. The property in the trust is also included in the grantor s estate when he or she dies. An irrevocable trust cannot be changed or dissolved after it has been created. The grantor generally cannot remove assets, change beneficiaries, or rewrite any of the terms of an irrevocable trust. An irrevocable trust can be a valuable estate-planning tool because the property transferred into the irrevocable trust is taken out of the grantor s taxable estate. However, because an irrevocable trust involves a permanent transfer to beneficiaries, the grantor must often pay gift tax when property is transferred to the trust. Income not paid out of an irrevocable trust is taxed to the trust, and income paid out of the trust is taxable to the beneficiary who receives it. Why Create a Trust? Legally, just about anyone who is of sound mind is allowed to set up a trust. Whether someone should set up a trust depends on whether it would help accomplish individual and family goals in a cost-effective way. A trust can be expensive to set up and maintain because of lawyer s fees, possible trustee fees, and possibly higher taxes. That is why most people consult with a lawyer and wealth advisor to see if a trust makes sense for them. People create trusts for many different reasons. Some of the primary benefits of setting up a trust are listed here. 04 www.mcmllc.com
THE SAM LETTER manchester capital management BENEFITS OF TRUSTS 1. Manage property. Grantors may create trusts to make sure their property will be managed for their loved ones in the event they can no longer manage it due to illness, old age or other constraints. If the grantor has created a trust, the trust document tells a trustee how to manage the assets and distribute them to the trust s beneficiaries to make sure the beneficiaries are cared for in the way the grantor wishes. 2. protect assets from creditors. When a grantor has put property into an irrevocable trust, the property is often protected against claims from possible creditors. 3. reduce taxes. Trusts can be used in family planning to reduce the amount of taxes a family has to pay. To reduce income taxes, a grantor who has a tax rate that is higher than a beneficiary s tax rate may use a trust to transfer income to beneficiaries. The beneficiaries will then be taxed on the income at their lower tax rate. Another type of trust, sometimes called a bypass trust, can be used to reduce the amount of estate tax a married couple s family has to pay. The bypass trust usually works this way. Suppose a married person (Husband) passes away. Under current law, Wife can receive all of Husband s assets, and no estate tax has to be paid because they were a married couple. Current law also provides for an estate tax exemption, meaning that a specified amount (currently $3.5 million) is exempt from any estate tax when an individual dies. To make sure that the family will get the benefit of Husband s estate tax exemption, Husband could have set up a bypass trust and funded it with the amount of the estate tax exemption, naming his children as beneficiaries. No estate tax is due on the assets in the bypass trust, and the family get to use both Husband s and Wife s estate tax exemption. www.mcmllc.com05
4. Minimize or avoid the probate process. Probate is a legal process that involves reporting information to a court. After a person s death, the person s property is identified and collected, debts and taxes are paid first, and remaining property is distributed to heirs. If a person dies having a trust, property does not have to be transferred through the probate process. Instead, it is transferred according to the instructions in the trust. Probate can be a time-consuming and expensive process, but it is not necessarily more expensive than the cost of setting up and maintaining trust. Using a trust rather than the probate process to transfer assets also gives people more privacy because the terms of a trust are private, whereas probate transfers become part of a public record. 5. provide benefits for charity. Sometimes people will use trusts to donate assets for charitable purposes while accomplishing tax savings at the same time. A charitable remainder trust allows a grantor to receive an immediate tax deduction and then receive income from property transferred to a trust during his or her life. After the grantor dies, the charity or charities chosen by the grantor get title what is left and no estate taxes are owed on the donated property. A charitable lead trust is similar except that a charity receives income from the trust during a specified number of years, and then the trust assets are transferred to charitable beneficiaries selected by the grantor. 06 www.mcmllc.com
THE SAM LETTER manchester capital management U Talk about flexibility in planning! In 2007, the late billionaire Leona Helmsley made headlines when the press found out that she left a $12 million trust fund for her white Maltese dog, Trouble. Apparently, some of Mrs. Helmsley s heirs challenged the trust, and the fund has since been reduced to about $2 million. The wealthy beneficiary Trouble is reportedly doing well. Currently, 39 states have statutes that recognize pet trusts. www.mcmllc.com07
Ask SAM Q. What is Inflation? A. You may have heard an older person talk about how certain items cost less when he or she was your age. It only cost a dime to see a movie. A candy bar cost a nickel. A brand new car, depending on the model, may have cost $2000. Seeing a movie in a theater today costs $10, a candy bar is $1, and it is hard to purchase a new car for less than $15,000. Inflation is the word used to describe a situation in which the general level of prices in the economy is rising and the value of money used to buy goods or services falls. As inflation rises, every dollar you own buys less of a good or service. There is no single cause of inflation. Inflation may result when demand for goods outpaces supply of goods; when this happens, prices will rise, and the demand for money to purchase goods and services rises. This usually happens in a growing economy. Inflation is closely related to the growth of the money supply. When the government increases the money supply by printing more money, inflation may result if there is an excess of money relative to the supply of goods and services. Some economists and investment professionals are concerned that the current U.S. government stimulus, which has been financed in part by an increase in the U.S. money supply, will lead to increased inflation. If you d like to suggest a topic or have a question you d like answered in the next issue of Ask SAM, just email us at info@mcmllc.com. Manchester, Vermont // 3657 Main Street // (P.O. Box 416) // Manchester, VT 05254 // {Tel} 802.362.4410 // {Fax} 802.362.1377 Montecito, California // 1155 Coast Village Road // Montecito, CA 93108 // {Tel} 805.969.5670 // {Fax} 805.969.5680 08 www.mcmllc.com