Enhancing Your Estate Plan: Types of Irrevocable Trusts
By Matt Grennell, J.D. & Nick Guido, CFP®February 20, 2020
Estimated Reading Time: 6 minutes
Enhancing Your Estate Plan
Throughout one’s investing life - whether you hire an advisor or manage your own money - there will be many strategies that you employ or come across. Most of these will be centered on investment allocation, trading strategies, various investment vehicles, and life insurance. These are all important foundational pieces that one should focus on, but they do not encompass all aspects of an individual financial picture. At Chicago Partners, the above-mentioned strategies are just two of five steps in our 5-Step Wealth Optimization Process.
Today, we are going to focus on giving you an introduction to different types of irrevocable trusts. In March, we will take a deep dive into each trust as well as an example strategy of when it may make sense for you. This will be our March blog series, Enhancing Your Estate Plan.
The five focus areas for today’s article are Irrevocable Life Insurance Trust (ILIT), Intentionally Defective Irrevocable Trust (IDIT), Grantor Retained Annuity Trust (GRAT), Qualified Personal Residence Trust (QPRT), and Charitable Trust (Charitable Remainder Trust (CRT), and Charitable Lead Trust (CLT)).
Irrevocable Life Insurance Trust (ILIT)
Intentionally Defective Irrevocable Trust (IDIT)
This type of irrevocable trust can be referred to by many different names including a “defective trust” or “defective grantor trust.” The primary goal of the IDIT is to transfer assets that will not be subject to estate tax, but will continue to be taxable, to the creator of the trust for income tax purposes. The trust is “intentionally defective” because the transferor of the assets will continue to be liable for the income tax generated by the assets of the trust. Although the concept sounds strange, it is a desirable tax planning strategy to enhance the total value of wealth transferred to the next generation or generations. By paying the trust’s taxes with money outside of the trust the trust assets will grow faster, increasing the value of the trust for the beneficiaries. Since the trust assets are owned outside of the estate, the growth inside the IDIT will not be subject to estate taxes. Paying the income taxes on behalf of the trust is, in essence, making additional gifts to the trust, but it is not treated as a gift for the purposes of income tax.
Grantor Retained Annuity Trust (GRAT)
A GRAT is a trust that an individual creates for his or her own benefit. It provides the Grantor (creator of the trust) with an annual annuity payment for a specified number of years, outlined in the GRAT document. These annuity payments are made with the assets used to fund the GRAT. At the end of term of the GRAT any remaining assets in the trust will be transferred to the trust beneficiaries outside of gift and estate tax. If at the end of the term of the GRAT the assets appreciate faster than the interest rate, determined by the IRS, of the annuity payments to be paid back to the Grantor of the trust, assets will be distributed to the named beneficiaries outside any gift or estate tax.
Qualified Personal Residence Trust (QPRT)
This trust is established to own a personal residence (or a fractional ownership interest in a personal residence) for a specified number of years. The creator of the QPRT retains the right to rent-free use of the residence during the term of the trust. Title to the property owned by the QPRT passes at the end of the term to the remainder beneficiary or beneficiaries of the trust. If the creator of the trust survives beyond the term of the trust, the residence should be excluded from his or her taxable estate for estate tax purposes.
The benefits of using a QPRT to pass a personal residence are threefold. First, the creator of the trust is able to remain in the residence and exercise-rent free use of the property. Second, when the property is transferred the value of the transfer is discounted due to ownership restrictions created within the QPRT. Third, the overall value of the estate is reduced by what can be one of the largest assets on the balance sheet.
Charitable Trusts
Charitable planning has many different types of vehicles and strategies, and as with all estate and charitable planning there is no correct strategy for everyone. We will cover two of the more common trusts. Two variations of charitable trusts are the Charitable Remainder Trust (CRT) and the Charitable Lead Trust (CLT). Like the name suggests, a CRT will commonly provide for an annual income payment to the creator of the trust over their lifetime, with the “remainder” portion of the trust assets passing to the designated charity upon death.
Alternatively, the CLT allows for periodic distributions to charity for a certain number of years, with the remaining trust assets at the end of the trusts term being distributed for the beneficiaries of the creator. In addition to the assets passing to the charity, the charitable lead trust may allow for income tax benefits to the grantor or creator of the trust.
That covers the five of the most common irrevocable trusts currently used today. In March, we will explore each of these strategies further and provide an example of how each can be used effectively. If you have any questions on how these strategies could be implemented for you, please reach out to your advisor at Chicago Partners.
Matt Grennell, J.D. is a Wealth Advisor at Chicago Partners. He focuses on helping clients create, manage, and optimize their financial plans and estate plans.
Nick Guido, CFP® is a Wealth Advisor at Chicago Partners. Nick helps clients create and manage their custom portfolios, plan for taxes, review their insurance plans, and create optimized financial plans.
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.
February 20, 2020
Estimated Reading Time: 6 minutes
Enhancing Your Estate Plan
Throughout one’s investing life - whether you hire an advisor or manage your own money - there will be many strategies that you employ or come across. Most of these will be centered on investment allocation, trading strategies, various investment vehicles, and life insurance. These are all important foundational pieces that one should focus on, but they do not encompass all aspects of an individual financial picture. At Chicago Partners, the above-mentioned strategies are just two of five steps in our 5-Step Wealth Optimization Process.
Today, we are going to focus on giving you an introduction to different types of irrevocable trusts. In March, we will take a deep dive into each trust as well as an example strategy of when it may make sense for you. This will be our March blog series, Enhancing Your Estate Plan.
The five focus areas for today’s article are Irrevocable Life Insurance Trust (ILIT), Intentionally Defective Irrevocable Trust (IDIT), Grantor Retained Annuity Trust (GRAT), Qualified Personal Residence Trust (QPRT), and Charitable Trust (Charitable Remainder Trust (CRT), and Charitable Lead Trust (CLT)).
Irrevocable Life Insurance Trust (ILIT)
Intentionally Defective Irrevocable Trust (IDIT)
This type of irrevocable trust can be referred to by many different names including a “defective trust” or “defective grantor trust.” The primary goal of the IDIT is to transfer assets that will not be subject to estate tax, but will continue to be taxable, to the creator of the trust for income tax purposes. The trust is “intentionally defective” because the transferor of the assets will continue to be liable for the income tax generated by the assets of the trust. Although the concept sounds strange, it is a desirable tax planning strategy to enhance the total value of wealth transferred to the next generation or generations. By paying the trust’s taxes with money outside of the trust the trust assets will grow faster, increasing the value of the trust for the beneficiaries. Since the trust assets are owned outside of the estate, the growth inside the IDIT will not be subject to estate taxes. Paying the income taxes on behalf of the trust is, in essence, making additional gifts to the trust, but it is not treated as a gift for the purposes of income tax.
Grantor Retained Annuity Trust (GRAT)
A GRAT is a trust that an individual creates for his or her own benefit. It provides the Grantor (creator of the trust) with an annual annuity payment for a specified number of years, outlined in the GRAT document. These annuity payments are made with the assets used to fund the GRAT. At the end of term of the GRAT any remaining assets in the trust will be transferred to the trust beneficiaries outside of gift and estate tax. If at the end of the term of the GRAT the assets appreciate faster than the interest rate, determined by the IRS, of the annuity payments to be paid back to the Grantor of the trust, assets will be distributed to the named beneficiaries outside any gift or estate tax.
Qualified Personal Residence Trust (QPRT)
This trust is established to own a personal residence (or a fractional ownership interest in a personal residence) for a specified number of years. The creator of the QPRT retains the right to rent-free use of the residence during the term of the trust. Title to the property owned by the QPRT passes at the end of the term to the remainder beneficiary or beneficiaries of the trust. If the creator of the trust survives beyond the term of the trust, the residence should be excluded from his or her taxable estate for estate tax purposes.
The benefits of using a QPRT to pass a personal residence are threefold. First, the creator of the trust is able to remain in the residence and exercise-rent free use of the property. Second, when the property is transferred the value of the transfer is discounted due to ownership restrictions created within the QPRT. Third, the overall value of the estate is reduced by what can be one of the largest assets on the balance sheet.
Charitable Trusts
Charitable planning has many different types of vehicles and strategies, and as with all estate and charitable planning there is no correct strategy for everyone. We will cover two of the more common trusts. Two variations of charitable trusts are the Charitable Remainder Trust (CRT) and the Charitable Lead Trust (CLT). Like the name suggests, a CRT will commonly provide for an annual income payment to the creator of the trust over their lifetime, with the “remainder” portion of the trust assets passing to the designated charity upon death.
Alternatively, the CLT allows for periodic distributions to charity for a certain number of years, with the remaining trust assets at the end of the trusts term being distributed for the beneficiaries of the creator. In addition to the assets passing to the charity, the charitable lead trust may allow for income tax benefits to the grantor or creator of the trust.
That covers the five of the most common irrevocable trusts currently used today. In March, we will explore each of these strategies further and provide an example of how each can be used effectively. If you have any questions on how these strategies could be implemented for you, please reach out to your advisor at Chicago Partners.
Matt Grennell, J.D. is a Wealth Advisor at Chicago Partners. He focuses on helping clients create, manage, and optimize their financial plans and estate plans.
Nick Guido, CFP® is a Wealth Advisor at Chicago Partners. Nick helps clients create and manage their custom portfolios, plan for taxes, review their insurance plans, and create optimized financial plans.
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.