Passing on Wealth and Values with Irrevocable Trusts

For affluent individuals, irrevocable trusts have long been an effective vehicle for passing on wealth to future generations. Since assets placed in an irrevocable trust aren’t considered part of a taxable estate (although they are subject to gift tax when transferred into the trust), their value doesn’t count against the federal death tax exclusion. All of the growth on the assets after the gift will not be subject to both gift and estate tax. Accordingly, an irrevocable trust can be an important financial planning tool for mitigating estate taxes.

Multigenerational trusts are also useful in sheltering assets in divorce settlements and from creditors, and can be structured to last many generations. But the potential benefits of an irrevocable trust extend far beyond simple dollars and cents. For a growing number of Americans, an equally appealing aspect of an irrevocable trust lies in its unique ability to transfer to succeeding generations the values that guided the trust’s creator, or grantor.

Such “control from the grave” is possible because irrevocable trusts can be drafted to provide a high degree of specificity regarding how, when, and under what circumstances trust assets may be dispersed.

Creating incentive

Diligence typically ranks near the top of the list of values that many families want to pass on to their offspring. Parents worry that family wealth could transform an otherwise industrious child or grandchild into the proverbial “trust fund baby,” one with scant financial incentive to become a contributing and productive member of society. In the past, one type of incentive trust known as a W-2 was popular. With that vehicle, the trustee was instructed to match the annual income of each beneficiary.

In the modern trust era, however, that simplistic approach has given way to sophisticated applications of what the IRS calls the HEMS (health, education, maintenance, and support) standard, which gives the trustee significant discretion and latitude to determine how trust assets are dispensed.

For instance, trust documents can specify that beneficiaries receive money only for socially responsible activities, such as financing an education or paying for living expenses if they are employed in lower-paying professions, such as teaching or staying home with small children or ailing relatives. Trustees often encourage a grantor to provide guidance, but not mandatory rules, as no one can predict the family’s future needs. Though disputes between beneficiaries and trustees regarding interpretation of the grantor’s instructions sometimes result in the removal of a trustee, courts generally have been reluctant to substitute their own judgments for that of the trustee.

Charitable causes

Passing on personal values through irrevocable trusts may also involve a family’s philanthropic goals. Private foundations and other charitable arrangements may be used to make charitable contributions, both before and after the grantor’s death.

In the case of a charitable lead trust, the grantor receives a gift or estate tax deduction for the charitable contribution to the trust (but generally no income tax deduction), and a charity receives a specified amount for a predetermined number of years. After that period, money remaining in the trust goes to family beneficiaries named in the trust document.

Conversely, a charitable remainder trust is appropriate when a grantor wants to retain access to the income stream generated by the trust assets. Upon death, the remaining money passes to designated charities. Contributions to charitable remainder trusts may qualify for substantial income, gift, and estate tax deductions.

After a lifetime of accomplishment, wealthy individuals often want their legacies to reflect not only what they did, but who they were. When properly designed, an irrevocable trust may meet those objectives by providing beneficiaries not only with income, but with values that encourage a positive contribution to the world.

This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.