The financial world contains many lesser-known, unusual trusts that may correspond to a specific goal or financial situation you find you have. Let’s call them “niche” or unusual trusts. Understanding how they work can help you decide whether one is useful for your estate plan.
Terminology:
Keep in mind that a trust is a legal arrangement between a trustee and a trustor, who also can be referred to as a settlor or the grantor. The trustor establishes the trust and transfers assets into it. The trustee is responsible for managing the assets. Sometimes, the trustor is also the trustee or one of many trustees. However, there are also special-purpose, or unusual trusts for people with various needs and wishes.
Special Purpose Trusts:
Health and Education Exclusion Trust (HEET)
You want to provide for your grandchildren without the IRS imposing a generation-skipping trust tax. The funds in this type of trust pay only for the education and medical expenses of the beneficiaries. With enough assets, a HEET can pay the educational expenses of all grandchildren from kindergarten through graduate school. This helps the parents because they’re not responsible for these educational expenses. One caveat: At least one beneficiary of the trust must be a charitable organization. Often, the charitable organization is a school receiving qualified transfers per IRS rules. Keep in mind that HEETs are irrevocable.
Delaware Incomplete-Gift Non-Grantor (DING) Trust
A significant benefit of using trusts is the ability to minimize state-level income taxes. The availability of using this strategy depends on the residence of the trustor and the residence of the trust, the type of assets owned by the trust and the type of income earned by the trust. When all factors are aligned correctly, the trustor can minimize or even eliminate state income tax on trust assets.
The trust must be structured as a non-grantor trust for federal and state income tax purposes. The DING trust will be a separate taxpayer for income tax purposes.
For the strategy to work, the trustor appoints a trustee in Delaware or another state that authorizes so-called domestic asset protection trusts — Nevada or South Dakota. Delaware doesn’t impose income tax on these types of trusts.
The settlor doesn’t have to file a gift tax return nor use any of his or her federal estate and gift tax exemption on the transfer.
Rabbi Trust
This is a trust created to support the nonqualified benefit obligations of employers to their employees. A rabbi and his congregation first used this type of trust after an IRS private letter ruling approved its use, and it’s been referred to as a rabbi trust ever since. This type of trust is typically used by a company to provide its senior executives with additional benefits to their compensation package.
The assets within the trust are typically set up to be irrevocable. It protects employees from a company in financial hardship. The trust doesn’t protect employees from creditors so, if the company goes bankrupt, both the creditors and the beneficiaries have access to the funds. Rabbi trusts provide tax advantages for employees, as contributions made to the trust don’t count as part of their wages.
Niche trusts will work when your assets and your circumstances meet the definition of one or more of the trusts mentioned here. If you’re unsure whether a trust belongs in your estate plan, you don’t have to go it alone — you can consult with professionals. There’s a good chance they know of a trust for your situation.
Check out our previous post: Offshore Trusts: Right for You?
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