How to tell if it's right for you
Should You Create a Trust?
by Rick Kahler
Writing a Will
Expensive Legal Documents
How to Distribute Family Heirlooms
When passing wealth to your kids, consider creating a trust to limit the later generation's ability to tap into the principal. Several astute readers suggested this strategy after my recent column citing research that shows 90% of inherited wealth is gone by the third generation.
There is no question that a trust, done correctly, can go a long way to preserve wealth after the death of the wealth accumulator. Let's explore what "done correctly" means.
- Trust law is complex. Engage an accountant and attorney with strong skills and expertise in trusts.
- Be sure the assets you intend to go into the trust will actually transfer.
- Retirement plans like IRA's, 401(k)'s, and profit sharing plans will pass to whomever you listed as the beneficiary. This must be the trust. In addition, the trust must include a number of special provisions in order for a retirement plan to be distributed according to your wishes and not as a fully taxable lump sum.
Annuities, insurance policies, and accounts with a TOD (transfer on death) clause will also pass to the named beneficiary.
Assets held in joint tenancy will not pass to the trust. Many married couples jointly own most of their major assets, such as the family home, investment real estate, brokerage accounts, or bank accounts.
- Be sure there are enough assets in the trust to justify the trustee fees. Most professional corporate trustees charge $3,500 to $10,000 annually, or up to 1% of the trust assets. If a trust with $100,000 incurs an annual fee of $3,500, your hard-earned estate will benefit the trustee as much as your heirs. A trust probably doesn't make financial sense if the total fees will exceed 2%.
- If a trust still seems like a good strategy after the above caveats, the next question is how much to limit heirs' ability to withdraw money. From an actuarial standpoint, it's fairly simple. If you limit annual withdrawals to 3% of the principal, there's a strong probability of the money lasting several generations with its buying power intact. Provided, that is, the trustees pay close attention to the next point.
- To generate sufficient returns to pay out up to 3% annually to heirs and also keep up with inflation, the majority of the portfolio must be invested in assets that will grow over time, such as stocks, real estate, and commodities. It needs to be broadly diversified among many asset classes and countries. The trustees must also limit the fees paid to manage the investments. Many corporate trustees have an inherent incentive to use their own bank's mutual funds, which can have annual fees as high as 1.5%. One way to avoid this conflict of interest is to instruct the trustee to place the funds with a fee-only investment advisor who has a largely passive approach to managing money. This could cut the portfolio fees by 50% or more.
- Finally, before setting up any trust, pay close attention to taxes. Congress recently increased the top income tax bracket to 39.6% on wealthy taxpayers. Any trust which keeps more than $11,950 of annual income is considered "wealthy." So here is the problem. If the trust retains enough earnings to increase the principal to offset inflation, it will have to pay substantial income tax and will probably need to restrict withdrawals to 1 or 2%. All of a sudden a multi-million dollar inheritance becomes simply a source of secondary income similar to Social Security.
Trusts are valuable estate planning tools, but like any other powerful tool, they are best employed by someone with the skills to use them well.
Debt is preventing me from saving as much for retirement as I should be! Tell us: Yes, debt is hindering my ability to save for retirement! or No, debt is not a problem but I'd love to discover more ways to save as I head into retirement!
Take the Next Step:
- Will you leave thousands on the table by taking Social Security at the wrong time? Use this tool to maximize your retirement by determining the best age to take your Social Security benefits.
- You've learned how to work smarter, not harder. After 50 Finances is a weekly newsletter dedicated to people just like you. Subscribe and start saving today! Subscribers get a copy of our ebook Little Luxuries: 130 Ways to Live Better...For Less for FREE!
- Visit our Baby Boomers on a budget Pinterest board for more money saving ideas.
- If you're over 50 your financial needs are different. And so are your questions. You'll find information geared specifically for Baby Boomers on The Dollar Stretcher section dedicated to their financial issues.
Share your thoughts about this article with the editor: Click Here
Baby Boomer Tools & Resources
More Baby Boomer Articles
- How you can still get more money from Social Security
- Why you should think twice before downsizing to a mobile home in retirement
- A widow's guide to managing money on your own
- 6 ways to pay less tax, keep more retirement money
- What retirees need to know about powers of attorney
- Part-time jobs for retirees
- Downsizing without guilt