I was speaking to Bob, a 42 year old acquaintance who told me that he received a trust fund when he was 35 because his parents sold his grandparent’s company for around a hundred million dollars. Can you imagine getting a phone call from dad one day after busting your butt in high school, college, and work for 21 years to find out you just inherited $10 million bucks? What’s more, you learn that your seven year old son also inherited $3 million dollars with a trust of his own. Time to kick back and do nothing!
I asked Bob why he was still working, and he said, “For pride. I want to see what I can do on my own. I never want to touch my grandparents’ money because I would feel a lot of shame. What business do I have using their money to pay for a first class plane ticket when he bent over backwards building his own company.” Bob said he would never touch his trust fund for as long as he lives.
Bob is a rare breed because I’m pretty sure most of us would molest the trust fund in some way. I’m looking to buy a house in San Francisco, for example. What’s withdrawing $200,000 for a downpayment when there is $9.8 million left? At least I’m not buying a mega-mansion for $8 million. I’m going to London for Wimbledon this summer. Instead of going back home in the middle of the tennis tournament due to work and insane $1,500 tournament ticket prices, I’d just stay through to the end.
Maybe I’m being dishonorable with my grandparents’ money, but gosh darn it. I’m telling you guys the truth! Can you handle it?
RING RING DAD
After hearing Bob’s story on inheriting a multi-million dollar trust fund in his mid-30s, I shot an e-mail to my dad that evening and wrote,
I hope all is well. Any chance I have a trust fund?
Your loving son”
My father, true to form, responded in his usual curt manner, “No, you don’t.”
Damn it! Back to the salt mines I go.
THE BASIC THOUGHT PROCESS BEHIND TRUST FUNDS
The quick and dirty way to think about trust funds is to first think about the death/estate tax. The estate tax is basically a tax the greedy government deploys whenever you die with assets above a certain amount. For those who love to spend everything they have, you guys might just be on to something!
For the year 2014, $5.34 million of your estate will be excluded from taxation upon your death. For couples who are legally married, the federal exemption of $5.34 million may pass directly from the first-to-die to the surviving spouse, thus providing a federal exemption upon the second spouse’s death that will increase from $5.34 million to $10.68 million.
In other words, if you have less than $5.34 million in assets as an individual or less than $10.68 million in assets as a married couple, there’s really no need to set up a trust fund to avoid taxation for an offspring. All you’ve got to do is write in your will who gets what upon your death. 99.5% of all estates fall under this amount so for practically all of us, this post is irrelevant. On the flip side, now you have a good idea of who the really rich people are if you find out they have a trust fund.
If you do have more than $5.34 million as an individual or $10.68 million as a married couple, creating a trust fund per person is a smart way to go because you get to avoid the estate tax on any money over those amounts for singles or married couples. The highest rate for the estate tax is currently 40% (down from 55% in 2001). Either way, taxing people more when they die seems like a very peculiar thing to do since their incomes were already taxed when they were alive.
But given there’s been such a widening of the wealth gap over the past century, it might not be a bad idea to redistribute some of the wealth to those who need money the most. Unfortunately, the government has proven time and time again to be inept at helping people in need.
Another fantastic reason to set up a trust fund is to avoid potentially messy probate proceedings upon your death. Can you imagine family members fighting over your assets, no matter how small or large they are? “If you know exactly how you want to distribute your assets, why make your beneficiaries go through all the paperwork after your death to handle this when you can spend a small amount up front to set up the trust,” says John in the comments below. John said his trust cost $5,000 to set up.
UNIFIED CREDIT AND ANNUAL GIFT TAX EXCLUSION
If you’re really rich then you should be aware of the unified credit in estate planning. It gets its name because the federal gift tax and estate tax are integrated into one unified tax system.
The unified credit allows you to give away $5 million (plus the annual inflation adjustments) during your lifetime without having to pay gift tax. Heck, why there is a gift tax in the first place is beyond me.
For 2014, you can give $14,000 a year to as many people as you want without triggering the gift tax. The amount is indexed each year for inflation.
In addition to the annual exclusion amounts, you can also give the following without triggering the gift tax:
- Charitable gifts.
- Gifts to a spouse.
- Gifts to a political organization for its use.
- Gifts of educational expenses.
- Gifts of medical expenses.
MORE QUESTIONS AND ANSWERS ABOUT TRUST FUNDS
Given I’m not a lawyer, but I have slept at a Holiday Inn Express, I’ve asked my Yakezie blogger buddy Evan from My Journey To Millions help answer some follow up questions I had that you may also have about trust funds. Evan is an estate planning lawyer out in New York City.
Sam: How much does it cost a typical family to set up a trust fund with a lawyer? What determines the cost of setting it up? e.g. time, amount in the trust, etc.
Evan: Are you talking about inter vivos trust (during life? to receive gifts?) or testamentary (created at death for inheritance). I can’t really answer time and cost they are all relative to where one lives and what type of attorney they are using. Living in the NYC area you can find a competent attorney at $1,000 for a plan all the way up to $50K in some larger firms in the city (and everything in between).
Sam: What are the list of rules you can institute before the trust beneficiary can legally withdraw money from the fund? e.g. age seems to be a common one, but what about saying “Only if the trust beneficiary gets married,” “Only if the trust beneficiary has a job making less than $50,000,” “Only if the trust beneficiary gets a graduate degree in Philosophy from a top 20 school,” etc.
Evan: The rules can vary from pure age (the majority) to some of the examples you provided. What one has to avoid is using a rule that is either ambigious and/or against public policy. An example that I remember seeing was “income as long as they are following Jewish customs.” It is easy to imagine the horror that would incur in court over “what is Jewish enough for a payout.”
Sam: I’d like to know how many rules one can create. I imagine a lot of trust beneficiaries grow up to be not the ideal people in the eyes of the trustees. How do we make sure good people get the money and not spoiled, lazy folks?
Evan: If we are talking inter vivos (i.e. created during life) then often you’ll see provisions where the Grantors/Settlors/Trustors are able to fire the trustee and replace with someone who is not subordinate under IRC 672 (e.g. no kids no employees). If we are talking about at death beneficiaries often have the power to replace trustees and if not expressed specifically there is often a provision in a State’s laws to provide for same.
Sam: What are the main tax advantages of setting up a trust fund?
Evan: The main tax advantage is for estate taxes not income taxes. Especially when you consider that Trusts are taxed at a compressed tax schedule for income tax purposes.
Sam: Is the trust fund only necessary for those who are worth more than $5.34 million since $5.34 million is exempt from the death tax as of now?
Evan: ABSOLUTELY NOT. A trust is nothing more than a tool. It is hard to get people to think about trust outside the connotation of a stuffed shirt Ivy League brat. For example could 21 year old Sam have inherited his parents’ money? No way, he would have blown it on the BMW you’ve talked about since you’re pretty frugal. Me? I would have went for the Benz. So you lock it up in a trust until an age someone thinks is appropriate.
Sam: What if you have a child with special needs and isn’t very good with money?
Evan: Then you’d have to look into a 3rd party special needs trust REGARDLESS of how much money the family has.
Sam: Can you basically set up a trust so that only a certain amount can be withdrawn a year by the trustee? e.g. $3 million trust, max $30,000 a year for the next 30 years?
Evan: You wouldn’t do it but you could limit your Trustee’s discretionary power. Often one is looking for flexibility with control.
Sam: What’s the most common misconception about trust fund babies in your experience?
Evan: That they must be wealthy beyond belief. As explained above there are tons of random examples.
Sam: At what income and net worth level do you see trust funds start to be created?
Evan: All depends on the situation – Special Needs Trusts (SNT) get created with anything, while dynasty trusts (multi-generational trusts) usually take millions to make sense. Something good to know: Invter vivos vs testamentary do not refer to when the child gets the money – it refers to when it is funded. Inter vivos trusts are funded while the parents are alive (i.e. using the $14k/yr gifts) while testamentary trusts are funded while mom and dad die.
TRUST FUNDS FOR ALL!
Thanks to Evan’s feedback, it looks like trust funds are available not just for the very wealthy, but for everyone who wants to have more control over how their funds get dispersed during their lifetimes and after death. There are plenty of people out there who need financial help, but would probably waste their windfall given the lack of discipline or money management skills. A trust fund can help make the money last longer to a loved one, besides just avoiding estate taxes upon death.
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