How a Preservation Trust™ Provides Asset Protection and Income Tax Flexibility

Padlocked Stack of Money Symbolizing Asset Protection by Preservation Trust

Trusts come in many forms and serve many purposes, including avoiding probate, protecting assets from creditors, and offering tax benefits. Many people also use trusts to protect beneficiaries whom they fear would not be able to manage assets if they inherited them outright. But what if you have a beneficiary that you trust to manage their financial affairs? You can still help them reap the other benefits of a trust while granting them more control over the assets in it. Learn how a Preservation Trust™ provides asset protection and income tax flexibility.

A Preservation Trust™ is more commonly known as a beneficiary-controlled trust. Beneficiary-controlled trusts are a subset of dynasty trusts. Using a Preservation Trust™, you can grant your beneficiary the authority to manage trust assets while still protecting the assets in the trust for their use and for that of future generations.

What is a Preservation Trust™ and How Does it Protect Assets?

A Preservation Trust™ is a trust in which the primary beneficiary also serves as the controlling, or primary, trustee. This allows the beneficiary to have nearly the same level of control over trust assets as if he or she had inherited them outright. The controlling trustee/primary beneficiary has complete authority over the trust's investment decisions. He or she may choose to use trust assets to buy rental property, to purchase certain stocks, or to fund a business venture, for instance.

How, then, does the Preservation Trust™ offer more protection for trust assets than outright ownership would? The answer is that the trust has a second, independent trustee, who has discretion over distributions made by the trust. (For this reason, the independent trustee may also be known as a "distribution trustee.") Because the controlling trustee/primary beneficiary is unable to dictate the timing and amount of distributions, the assets of the trust cannot be reached by creditors.

Furthermore, the use of a Preservation Trust™ keeps trust assets separate and apart from the beneficiary's personal assets, including marital assets. Why is this important? Because while inherited assets are generally not divisible in a divorce, they can be if they are commingled with marital assets. A Preservation Trust™ prevents this commingling.

Consider this example. Your daughter, Mary, inherits $300,000 from you upon your death. She puts that money in a joint bank account with her husband, Joe. The couple puts their paychecks into this account and uses it to pay bills and make purchases. If they divorce, the divorce court will divide the funds in that account between them. It will not attempt to "trace" where the money came from.

If, however, you place the $300,000 in a Preservation Trust™ for Mary, she will be able to decide how and where to invest those assets, but she will not receive any of the trust income or principal unless and until the independent trustee makes a distribution. If Mary and Joe divorce, the assets in the trust are clearly separate, or non-marital assets, not subject to division in a divorce.

What if your controlling trustee/primary beneficiary does not agree with the independent trustee? He or she has the power to replace the independent trustee, which means that he or she truly does control the trust—even though the trust assets are totally protected from ex-spouses, other creditors, and even the IRS.

Income Taxation of a Preservation Trust™

A Preservation Trust™ can be drafted as a complex trust (as that term is used for purposes of income tax). This means that the trust can retain income and need not distribute all income to beneficiaries. The trust would then have to file an income tax return and would be responsible for paying its own taxes. This works well if the trust is taxed at a lower rate than the beneficiary.

However, if a beneficiary of a Preservation Trust™ is in a lower tax bracket than the trust itself, it makes sense to distribute income to this beneficiary, who would pay tax on the income at his or her personal tax rate. If the personal tax rate is lower than that of the trust, the overall income tax burden is reduced, and the beneficiary maximizes enjoyment of trust assets. Often, the descendants of the primary beneficiary, who would also be beneficiaries of the trust, are young adults and in lower tax brackets, so this flexibility can be a great advantage.

The bottom line is that trusts aren't useful only to protect beneficiaries who don't know how to manage their money. A properly-drafted Preservation Trust™ can offer both protection and flexibility, and preserve your hard earned assets for the loved ones you want to see benefit from them.

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Ted Gudorf - Ohio Probate Lawyer

The tasks involved in probating an estate can be daunting, especially for those who have never been through it before. We are committed to relieving anxiety around the probate process and to helping Ohioans through an often-challenging time in their lives.

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