Personal Portfolio

There may be no better tool than a trust to protect your assets

Mention a trust or a trust fund, and most people think immediately of old money. If that's your reaction, think again. There may be no group in the country that stands to benefit from trusts more than entrepreneurs who own fast-growing, privately held companies.

Think of a trust as a safety-deposit box whose key you give away. Before you relinquish that key, however, you're allowed to set some rules--within IRS guidelines--about what will happen to the box's contents. People frequently use trusts to transfer wealth while minimizing estate taxes; you should also explore them if you want to give someone the benefit of an asset without giving him or her total control of it.

Is a trust right for you? Unfortunately, the only way to find out for certain is to spend some time with your corporate accountant and a lawyer specializing in estate planning. There are, however, a number of common situations when a company owner might want to consider a trust.

Trusts for Growth Companies
Some of those situations don't even require accumulated wealth. Believe it or not, if you're running a promising start-up and can scarcely afford to pay yourself a salary, a trust might make sense. "If you're involved in a business venture and have confidence about the future, the time is right to set up a trust," emphasizes Carlyn McCaffrey, a partner in the New York City law firm of Weil, Gotshal & Manges LLP. She recently helped the owner of a new business set up a trust into which he put half the company's stock. "That trust will be managed for the benefit of his wife and child, and it will accomplish a tremendous amount if his company gains in value, as he believes it will," McCaffrey explains.

By transferring the stock when its value was minimal, the company owner avoided paying taxes on the gift. (Each year, every person is allowed to give up to $10,000 per recipient without paying gift taxes. The recipients can include trusts that are properly structured.) If the owner had decided to wait until later to transfer the stock--and the stock's value soared--that tax bite would have been huge.

Trusts for Well-Established Businesses
If your company stock is already worth a bundle, trusts can still help you pass that wealth to your heirs without giving up control of the business. Consider this scenario from Joe Hurley, the partner in charge of taxes at the accounting firm of Bonadio & Co. LLP, in Rochester, N.Y. "One of our clients was a man in his fifties who ran a successful business and wanted to give some of its stock to his son, who had started working for the company," Hurley recalls. "But the stock was so valuable that the tax bill would have been enormous."

Hurley's solution? He set up a grantor-retained annuity trust (GRAT), which received his client's gift of stock. GRATs, Hurley explains, can be very effective in reducing taxes, because the gift giver retains the right to an annual payment from the trust for a period of years. From the IRS's point of view, that privilege makes the gift much less valuable than an outright transfer of stock. And less valuable means...less taxed. (In the case of Hurley's client, the IRS assessed only a tiny tax liability on the father's gift of a minority stake in his company.)

Life-Insurance Trusts
Even if you don't plan to transfer stock while you're alive, you should explore another kind of trust: an irrevocable life-insurance trust. Notes David Scott Sloan, chairman of the Trusts and Estates Department at Sherburne Powers & Needham, a Boston law firm: "If you set up an irrevocable life-insurance trust, and it owns and is the beneficiary of your life-insurance policy, then any death benefits from that policy will be considered tax-free by the IRS."

That's a key benefit, since the federal estate-tax rate alone can total as much as 55%. Married business owners who intend to leave the company to their children can set up this type of insurance trust with a second-to-die life-insurance policy. The proceeds from such a policy will kick in only after the death of both you and your spouse. That's also the point at which estate taxes on the company will typically be due.

Trusts to Protect a Gift
On a cheerier note, trusts can at times also help with long-term goals like saving for a child's education. Here the issues are a little different. "There's not a tax advantage to saving for college through a trust, because the income that a trust earns is taxed at a very high rate: 39.6% on any income over $8,100," explains Richard Rampell, a certified public accountant with Rampell & Rampell, in Palm Beach, Fla. "But there are very real control advantages, especially for grandparents or other relatives who might be willing to make cash gifts if they were certain the funds would be used only for college purposes. A well-structured trust can give them that guarantee."

Remember that $10,000 per recipient that each person can annually give tax-free? It does take some planning to ensure that a gift to a trust will qualify for the same tax-free status it would have if given directly to a person. One method is to use a trust but add something called "Crummey power" to it. Crummey power "gives trust beneficiaries a small window of opportunity to remove funds after the gift is made, typically 30 days," explains Rampell. "That gets around the IRS rule that normally requires people to receive a gift outright in order for givers to qualify for the $10,000 tax break." Check with your lawyer on this one.

Jill Andresky Fraser is Inc .'s finance editor.

Now what? Trust Test

Before you start shelling out thousands of dollars to set up a trust, it pays to answer two big questions:

  • Am I a control freak? Be honest. If you're not comfortable giving up at least some degree of control over your important assets, many trusts just won't work for you. That's because most trusts must be "irrevocable" in order for the IRS to recognize them. You may have some room to maneuver when it comes to techniques that help you retain voting control of company stock. However, if you set up a trust to give valuable artwork to your children, you probably won't be able to keep hanging the pictures on your living room wall.
  • Which assets do I want to transfer through a trust, and why? Here's an extremely simple rule of thumb: Trusts usually make the most sense with assets that you expect to appreciate significantly in value. That's because you can avoid estate or gift taxes on the appreciation. However, even if you're the next Bill Gates, it probably doesn't make sense to stick everything you've got into a trust. (Even tycoons need financial flexibility!) To develop a plan that makes sense for you, consult estate-planning experts.


Most estate-planning guides are so dull--or so complicated--that they could, well, kill you from boredom. And guides to trusts are usually targeted to accountants or lawyers. So instead of a specialty guide, let us recommend Ernst & Young's Personal Financial Planning Guide: Take Control of Your Future and Unlock the Door to Financial Security, Second Edition (John Wiley & Sons, 800-225-5945, 1996, $16.95). The book does an outstanding job of discussing both overall estate-planning strategies and the intricacies of specific types of trusts. One particularly admirable (and wonderfully brief) discussion analyzes the pros and cons of revocable versus irrevocable trusts.

BONADIO & CO., Joe Hurley, 1850 Winton Rd. South, Rochester, NY 14618; 716-244-2000; 113

RAMPELL & RAMPELL, Richard Rampell, 122 N. County Rd., Palm Beach, FL 33480; 561-655-5855; 113

SHERBURNE POWERS & NEEDHAM, David Scott Sloan, One Beacon St., Boston, MA 02108; 617-573-2700; 113

WEIL, GOTSHAL & MANGES, Carlyn McCaffrey, 767 Fifth Ave., New York, NY 10153; 212-310-8000; 113