Though the ink isn’t even dry on your first contract, you’re already thinking about sharing your good fortune with friends and family. Suddenly, a whole new world has opened to you, with its own financial lingo. For instance, you may have heard that trusts can be used to pass money down and save on taxes. But you’re young and healthy. Isn’t it too early to think about putting this in place? Not necessarily. If you’re looking to make gifts to those closest to you, establishing a trust now can amplify and multiply the benefit provided to both you and your loved ones.
Keeping It All in the Family
While there are many types of trusts, a “Friends and Family Trust” (an “FFT”) may be the best way for elite athletes and prominent artists to financially support their inner circles. What should you know about an FFT? It’s a trust that cannot be changed later (known as irrevocable, in technical terms), which is handled by an independent trustee (that is, someone other than you or a trust beneficiary). The independent trustee may distribute trust property to your selected beneficiaries (for example, your parents, siblings, mentors, and future descendants). While you cannot direct how distributions are made, the independent trustee can consult with you on decisions impacting the trust and you can reserve the right to remove the independent trustee for any reason and appoint a replacement.
Benefits of an FFT
An FFT offers a host of benefits, including enhanced control and access, valuable tax savings, and protection from creditors. Let’s discuss each in turn.
Increased Control and Access
When you set up an FFT, you determine who will receive the trust assets, even after the death of another beneficiary. Let’s say you purchase a beautiful new home for your parents. You might assume that you will ultimately have control over the property after their passing. But, if you give it to them outright, your parents’ estate plan—or worse, state law (if they die without a will)—dictates who will inherit this gift. If you purchase the home through an FFT instead, the property or the proceeds from its sale can be retained for the person you choose as the beneficiary under the terms of the trust.
What if you need access to the trust’s assets? An FFT can help here, too.1 For example, if you experience a short-term cash crunch, the trust may lend funds back to you at a much lower interest rate than what banks might charge. What’s more, the trust may allow you to swap a trust asset for a different one of equal value (this is known as exercising a “swap power”). So, where a direct gift of property might leave you stranded if your circumstances change, contributing to an FFT gives you the flexibility to access the property down the road.
Valuable Tax Savings
An FFT can also be an attractive way to save on both income and estate taxes.
- The trust can be structured as a separate taxpayer for income tax purposes to take advantage of favorable state income tax laws in the trust’s home state. It can also generate an additional state and local tax (“SALT”) deduction for federal income tax purposes.2
- Alternatively, you can structure the trust so that a loved one will be deemed the owner of the trust’s assets for income tax purposes.3 This will shift the trust’s income to the beneficiary’s lower income tax bracket and utilize his or her SALT deduction.
- Lastly, an older trust beneficiary (such as a parent) can be given a broad power to direct the distribution of FFT assets under the beneficiary’s estate planning documents—provided that family member or friend can be trusted not to use the power.4 Simply including this power will trigger inclusion of the impacted trust assets in the beneficiary’s taxable estate for estate tax purposes. In turn, this will eliminate any built-in gain in such assets at the older beneficiary’s death that might otherwise trigger a later capital gains tax liability.5
- The trust assets (and any appreciation in their value) may be excluded from your taxable estate and those of the trust’s beneficiaries. This includes life insurance on your life, which may otherwise be subject to tax.
- You can make yearly annual exclusion gifts (currently, $16,000 per year per gift recipient) to the trust for the benefit of family and friends. Such gifts are not considered taxable and will not reduce your available lifetime exemption from federal estate and gift tax, which may then be used later in life or at death.
Some elite athletes and entertainers live a leveraged lifestyle and may inadvertently rack up a significant amount of debt. What happens when creditors come calling, looking for repayment at a time when you’re short of funds? An FFT will protect the trust’s assets from your potential creditors—as well as those of family and friends who benefit from the trust. Keep in mind, a creditor can only seize property owned by the debtor. Because you no longer own the assets in the FFT, your creditors cannot seek payment from the trust.6 And, since the independent trustee has total control over distribution decisions, others to whom friends and family are indebted can be blocked from tapping the trust’s assets, too.
The Softer Side
While these financial benefits are compelling, the larger appeal for many pro athletes and celebrities may be less tangible—including privacy and the ability to defuse tension among those closest to you. Consider that rather than having to say “no” to a loved one, you can rely on the FFT’s independent trustee to play the decision-maker (and, if needed, the “bad guy”). In this way, an FFT’s independent trustee can act as a buffer between you and hard conversations with friends and family members. This is true for both distributions from the trust and requests for investment in a loved one’s business venture.
An FFT can also protect your privacy. For instance, rather than your name, an unrelated trust name (for example, the “Mind Your Own Business Trust”) can appear in the land records when purchasing a home or other real estate for family members. Additionally, an FFT can be structured as a “silent trust” that limits or eliminates beneficiary notice requirements. In other words, you can set aside savings for the benefit of your loved ones without their knowledge (and potential interference).
Superstar athletes and artists can both be subject to a sudden rush of wealth and fame. But that doesn’t mean you have to rush the outflow of money and gifts to your loved ones. By taking the time to put in place and utilize a Friends and Family Trust, you can create a more meaningful, longer-lasting, and mutually beneficial financial legacy.
- Jennifer B. Goode
- Director—Institute for Trust and Estate Planning
1 Note that, in order to preserve the creditor protection and tax savings provided by the trust, you cannot be a beneficiary of the FFT or otherwise access the trust funds in a way that would reduce the trust’s value.
2 This strategy is dependent on the law of your state of domicile and may not be available in all circumstances.
3 To accomplish this treatment, the beneficiary must be given a withdrawal right over the property contributed to the trust, which may erode the creditor protection provided to such beneficiary.
4 Trust assets subject to the general power of appointment may be accessible by the trust beneficiary’s creditors, if any.
5 The full nuance of this strategy is beyond the scope of this article. For further information, see “Introducing the Power of Appointment Support Trust”, Austin, B., et. al. (2015, November 15) https://www.wealthmanagement.com/estate-planning/introducing-power-appointment-support-trust.
6 This is subject to certain fraudulent transfer exceptions.