Wednesday, November 5, 2008

Part III: Fun with Funding!

Funding a trust is no fun. There are so many choices to make and so many tax consequences this is where a good tax lawyer or CPA comes into play. How you fund your trust has to be carefully tailored to your exact circumstances. You can fund it now or later, make it set in stone or flexible, or pay too much in taxes or not enough. Don’t ask anyone but the most highly trained professional to help you make those decisions. Like, for example, don’t ask me!

I can tell you what choices you have and why it matters. That I can do. Lets start with what poor people do. If you have enough animals this probably applies to you. We’ll lay off Cindy for a while and use me as an example. I am not the average horse owner, but I make a pretty good example for the worst-case scenario.

I am not rolling in cash. I have no investments, life insurance or retirements plans. In fact I do not even make much money. My funding plan for my trust does not take much tax expertise to figure out. I am not trying to get any favorable tax relief out of funding my trust; I am just hoping to take care of my animals. So I have 2 choices: 1) I can fund my trust with stuff left over when I die or 2) I can fund my trust with piles of cash and assets lying around now. Taxes will be effected by whether I make my trust “revocable” or non-revocable”. But like I said, taxes are not my problem. Cash is. I don’t have any.

What I do have is some real estate. Its not worth much, but its enough to care for a few pets after I am gone. However, how long will it take to convert that land into cash for board payments and hay? Who is going to pay the bills until the land is sold and the assets converted to cash? In my plan its me. Yes, I know I said I have no cash, but I am worth more dead then alive.

I can buy a small life insurance policy and make my trust the beneficiary. I don’t need a huge policy with huge monthly payments, but one large enough to instantly start paying out $$$ to my trust. Then the trustee can sell the land and put that money into the trust too. Its sort of a gap policy for land rich, cash poor people. The IRS doesn’t care about any of this because they are still going to continue to tax my income as income. As long as I can change my mind (revocable) and use the assets (my land), they don’t want to be bothered with me. Leaving all your assets to a trust you create in life but reserving the right to change it until your death is a revocable living trust. Leaving all your assets to the trust is a pour-over provision that lets those assets stay out of probate and get right to work taking care of your pets.

What if I had no land? Then I would buy a much larger life insurance policy and pour all the coverage into my trust. That’s still going to cost me money, but not all at once and not money I can’t get a hold of if I need it. You can borrow against a good life insurance policy with no interest. Its low risk with no returns in your lifetime, but its a great way to build up wealth for a trust you only want after you are dead. You die, the trust gets funded fast and all is well. Yeah, I know, it still sucks you died, but you won’t care.

Some states require you find your living trust immediately to make it valid, but that does not mean fully fund it out of your savings account. It means tell us where this money is coming from. For me it’s coming from my life insurance policy. Just like taxes, there is no way to avoid someday dying. They can be pretty sure it’s going to get cashed in at some point. Or another method is to fund it with something—like $10. It does not have to be fully funded for all your purposes; they just want a sign you understand you are doing something legally binding and formal. Don’t put a bunch of money that should be out working for you into a living trust to just sit there and wait for you to die.

Now lets pretend I am rich.

Sorry, I was enjoying that. It honestly took me a long time to understand trust law because its simply not conceivable to me that someone has SO much money they need to give it away. But guess, what, its true. Our laws were set up to prohibit any situation that could rise to a monarchy or upper class like we left behind in England a few hundred years ago. Dynasties, legacies, or keeping way more then you need have never been part of the American way. If you have more then you need they will take it way in the form of taxes. That’s not the position of any political party, that is just what we ran away from.

Since paying so much in taxes galls most of us we have all kinds of ways for rich people to get rid of all that excess money but still not give it to the government. Things like trusts. If you really don’t want to “own” that income you create a trust for someone who pays less in taxes like your children or you create a trust that is its own “person”. It gets its own tax ID and pays its own taxes. You can dump a large chunk of change into a trust and not have to pay income taxes on it. Or give it way on death. Nice.

In fact if you are so burdened with money now you could set up mutual trusts with a like- minded friend and put all your animals into a trust now. The trust would just carry on after you are gone. You just probably shouldn’t set up a trust for your animals with you as the trustee alone. The law thinks you already have a duty to provide for your children so that wont work with kids and I expect a court would find the same with animals. Or not. I kind of think it’s cheating so I wont recommend it.

The purpose of most trust tax laws and trust laws is to keep the small proportion of people who want to have their cake and eat it too from cheating the IRS, their children, their creditors, or their ex-wives. If you are the only trustee and the only beneficiary and you get to play with all your toys alone then people can reach that money. If you aren’t then they can’t. Trusts are often used to not only avoid the tax man but to protect assets from judgments against the owner of the property or to keep a person entitled to funds from getting them. If you set up a trust for your animals then you are not the beneficiary.

For a large farm owner with lots of liability and great tax burdens dumping a chunk of money into a irrevocable trust for pets now could be a safe way to make sure those funds are there later. If someone gets hurt on your farm they can’t “win” that money in lawsuit. You can’t spend it or use it either, but the point is to protect those assets from others who want it and to protect your animals if you die or become incapacitated.

Rich people have to do lot of estate planning. An honorary trust for pets in addition to other the other trusts and tricks and treats is not complete estate planning. Remember the rule—you find a way to protect your assets or its “redistributed” to all. The estate taxes are up in the air at any time. Right now the death tax is up over 2 million. When you actually die? Who knows?

So the rules are fairly simple after all, but complicated too. If you just want to provide for your animals leave some form of funding in a revocable trust and reference it in your documents and will. If you have excess money or a need to protect your assets talk to a professional and see if a irrevocable trust funded now is a better tax bet for you. Taxes may mean state and federal estate taxes, income taxes or property taxes. If you are cash poor fund with a life insurance policy and pour over other assets when they can be liquidated. If you are cash flush go find a really good professional to work out a complete estate plan.

Then there is the rule against perpetuities, which you can just plain ignore. It doesn’t apply to honorary trusts for animals and it will just make your brain hurt!

Now I guess I have to stop pretending I am rich:>

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