Asset Protection

CHILDREN'S TRUSTS FOR SECOND-GENERATION GIFTING

The children's trust is another popular irrevocable trust. Specifically designed to benefit the grantor's children or grandchildren, it is an ideal vehicle to hold assets you gift to them. The giftusually an appreciating assetis removed from your ownership and taxable estate and transferred to the children's trust, where the asset grows in value and its income is taxed at a lower rate.

As grantor, you cannot be the trustee of the children's trust or it will be considered part of your taxable estate. Your children receive the gift at your cost basis and do not obtain the benefit of stepped-up valuation upon your death.

Assets in a children's trust are protected from their creditors (including divorce) and also from the grantor's future creditors. But to be an effective asset protector, the trust must be carefully drafted. For example, there can be no significant restriction on the rights of the trustee to either invade principal or accumulate income.

Children's trusts help to save taxes since they allow you to shift assets and income to your children. The children's trust has become particularly popular since the Tax Reform Act of 1986 when a number of income splitting strategies, such as the Clifford Trusts, were eliminated. Similarly, custodianships under the Uniform Gift to Minor's Act have become less popular since they require earned income above $1,000 accruing to children under 14 be taxable at the same rate as the minor's parents. The children's trust also can be a valuable alternative to other tax-saving tactics since the children's trust has a maximum 15 percent tax rate.