Avoiding Settlor Remorse

Many estate planners must deal with their clients’ fear of “donor’s remorse” as the deadline for the current $5 million gift-tax exemption draws near (unless Congress acts, the current $5 million exemption will revert back to $1 million at the end of this year). While clients are interested in learning about irrevocable trusts to pass assets to heirs gift-tax free, these same clients fear they will later change their minds about the transfer or will need the money later in life.

While the irrevocable aspect of an irrevocable trust allows the settlor to pass assets tax free, this same aspect means a settlor is typically out of luck should he or she need the trust assets for personal use later on. Luckily, other trusts exist that are more flexible and still reduce the settlor’s estate tax bill. Four of these irrevocable trust alternatives are below:

1. Self-Settled Trusts: These trusts allows the settlor to pass on assets while reserving the ability to use the assets if needed. To reserve the ability to use trust assets, the settlor must designate him or herself as a beneficiary who is “eligible” but not “etitled.” However, only a handful of states authorize the use of these trusts, and these trusts have not been around long enough to go through many legal tests.
2. Trust Protectors: Settlors can designate a third-party “trust protector” who can drop beneficiaries, veto distributions, amend trust terms, or move the trust to another state with more beneficial laws.
3. Spousal Beneficiariess: Settlors can also maintain access to trust funds by naming a spouse as a “discretionary” beneficiary of a more traditional trust. If both spouses create two substantially different trusts naming each other as beneficiaries, they can still maintain access to trust funds while lowering their respective estates.
4. “Grantor” Trusts: Settlors should almost always designate trusts as grantor trusts—meaning the owner pays any taxes (capital-gains or income) owed on the trust assets each year. This way, those tax payments are not considered additional gifts to the trust since the settlor has a legal obligation to pay them.

See Kelly Green, The Rush to Avoid Gift Taxes: How to Make Sure You Don’t End Up With ‘Donor’s Remorse,’ The Wall Street Journal, Mar. 16, 2012.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.