Lifetime Benefit Trust

Overview

Assets contained in this trust can be used for the benefit of the beneficiary throughout the beneficiary’s lifetime while remaining insulated from the beneficiary’s creditors or from divorce. A beneficiary could never create a trust like this for themselves. It must be created as a testamentary trust by another person.

What are the benefits?

1. The assets in the trust are protected from certain liabilities a beneficiary may encounter, such as car accidents, bankruptcy, and certain other types of lawsuits.
2. The assets in the trust constitute the beneficiary’s separate property and are protected from division in divorce.
3. If the beneficiary becomes incapacitated, the assets can be managed by the successor trustee for the beneficiary’s benefit without necessity of a costly court conservatorship.
4. When the beneficiary dies, the assets pass on without necessity of a costly and time consuming Probate Court proceeding.
5. When the beneficiary dies the assets will not be subject to estate taxes in the beneficiary’s estate; they will “skip” a generation of taxes when the beneficiary dies—provided this is specified in the decedent’s trust. The Trustor is allowed to leave a specified amount in this fashion without a penalty tax.

How does this trust work?

Instead of a beneficiary receiving their inheritance outright and free of trust, a trust for the beneficiary’s lifetime benefit will own a portion or all of the beneficiary’s inheritance. The Lifetime Benefit Trust and its terms are set out in the trust of the deceased person who left the assets.

The Lifetime Benefit Trust will have its own Federal Tax Identification Number, which will be used instead of the social security number of the beneficiary to report income earned by the trust assets. Title to the trust assets will be in the name of the trustee of the trust in his or her capacity as Trustee of the Lifetime Benefit Trust.

Who is the Trustee of the Lifetime Benefit Trust?

The Lifetime Benefit Trust may have a special trustee, who may be the beneficiary or someone else. If it does not specify a trustee, then the trustee is the same as the trustee on the main trust. Successor trustees are usually named to serve in the event of illness or incapacity of the first appointee.

Can the beneficiary change the Trustee?

Some trusts provide that the beneficiary can change the trustee by an instrument in writing. Others do not give this power, and in that event the trustees must serve in the order appointed. If no successor is named, usually the acting trustee may appoint a successor or, if he or she fails to do so, the majority of adult beneficiaries may be given the power to appoint a successor.

How is income of the trust reported?

A trustee of the Lifetime Benefit Trust must file a fiduciary tax return for the trust under the trust taxpayer Identification Number to report taxable trust income. If the beneficiary of the trust is also the trustee with the power to distribute the income to himself or herself, the tax return is informational only and the income passes through to the beneficiary’s tax bracket. If someone other than the beneficiary is the trustee, the tax on the income distributed to the beneficiary will be paid by the beneficiary. The tax on undistributed income will be paid by the trust at the trust rate which, depending on the amount of income, may be higher than the beneficiary’s income tax rate. Therefore the fiduciary needs to consult with an accountant about income distributions.

When and how does the Trustee get a tax identification number for the trust?

When the creator of the main trust passes away and assets are distributed to the Lifetime Benefit Trust, the trustee must request a Federal Tax Identification Number from the Internal Revenue Service. A trust attorney or accountant can assist in this process.

For what can the income of the trust be used?

The Lifetime Benefit Trust will specify whether all income is to be distributed or income distributions are discretionary. Discretionary distributions are generally for support, health, maintenance and education of the beneficiary.

For what can the principal of the trust be used?

The Lifetime Benefit Trust usually permits distribution of principal for the support, health, maintenance and education of the lifetime beneficiary. If so provided, the trustee may distribute principal for the needs of the beneficiary, but the assets may not be given away. Occasionally, more restrictions are placed on the use of the principal in an effort to preserve the assets for the remainder beneficiaries.

What happens if the funds are misused?

The remainder beneficiaries may sue to recover the misused assets. If, however, the lifetime beneficiary has a very broad power to change who the remainder beneficiaries will be, a challenge to the lifetime beneficiary’s use of the assets would likely fail. If the remainder beneficiaries are fixed, however, they could seek recovery. Additionally if the assets are taken out of the shelter of the Lifetime Benefit Trust and put into the name of the life beneficiary, they may be taxed as part of the beneficiary’s estate when he or she dies and they will also be exposed to the liabilities of the lifetime beneficiary.

Can the Beneficiary borrow money from the trust instead of taking distribution?

The trustee may lend money to the beneficiary or to the beneficiary and the beneficiary’s spouse if the loan is handled within allowed guidelines. This can be a good way of allowing a married beneficiary to obtain assistance for the beneficiary and spouse to buy or enhance a home or business, for example, while maintaining the protection of the assets from division in divorce, from estate taxes, and from liability. The loan would have to be properly secured. An accountant and estate planning attorney should be consulted about the parameters of any such transactions.

Who makes investment decisions for the trust?

The trustee of the trust makes all decisions about how the assets are invested. The trustee has a duty under the law to make prudent investments, keeping in mind the purpose of the trust and the needs of the lifetime and remainder beneficiaries. The trustee must balance the portfolio with respect to factors such as inflation, income needs, and safety of investment. If the lifetime beneficiary and the trustee are the same, then the trustee/beneficiary makes all the investment decisions. If the trustee is different from the beneficiary, the beneficiary has the right to demand prudent investment decisions from the trustee and reasonable production of income.

Who gets the principal of the trust when the beneficiary dies?

Many Lifetime Benefit Trusts give the life beneficiary the power to name who will get the remainder of the trust at his or her death within a given group of potential beneficiaries. This power is called a “Limited Power of Appointment.” In order to keep the protections of this trust, the power of appointment must at least be limited to beneficiaries other than the lifetime beneficiary, his estate, his creditors, and the creditors of his estate. This is sufficient to protect the assets from being included in the beneficiary’s estate, and yet leaves the beneficiary with a very broad power to select beneficiaries. Sometimes the power of appointment is limited to lineal descendants in the family or some other group, or there may be no power to specify remainder beneficiaries.

How can the beneficiary exercise his or her Power of Appointment?

If the Trustor left the beneficiary the power to appoint beneficiaries of the assets remaining in the Lifetime Benefit Trust at his or her death, this power can be exercised at any time after the Trustor dies. It must be exercised in a document signed by the beneficiary and delivered to the trustee of the Lifetime Benefit Trust. The power of appointment usually will specify that the exercise must refer to that particular power of appointment and not to powers of appointment in general. It is best to have an estate planning attorney prepare the power of appointment and coordinate it with your overall estate plan.

Conclusion

The Lifetime Benefit Trust is an excellent estate planning tool. It affords great flexibility to the beneficiary and still provides protection from creditors and Federal Estate Taxes.

 

 

Please call for a no cost initial consultation.


 

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Santa Barbara County:

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