Vegas isn’t just a hot spot for bachelor parties. It’s also a popular spot to hold a trust. While most of our clients domicile their trusts in their home states, Nevada is a popular alternative when they can’t because it’s a trust-friendly state.
How your trust works is determined by the state it’s domiciled in. While some might want to keep their irrevocable life insurance trusts (ILIT) close to home, sometimes there’s a better option. There’s common law out there that can get tricky if you’re using a dynasty trust, so it’s always worth looking into alternatives.
How the Rules Change by the State
Probate is handled at a state level. That means all the laws that apply to trusts are going to change. In some states, life insurance policies are protected from creditors and judgments. In others, they’re not. In some states, you’re permitted to structure how a trust will pay out into eternity. In others, your time is limited.
The biggest difference you’re going to see on a state-by-state basis is related to the rule against perpetuities. The rule against perpetuities originally came into play when the courts wanted to stop people from controlling their assets for years after their death. They called it “exercis[ing]’ dead hand control over property.”
Simply stated, you can only control your estate for 21 years after your last-named beneficiary dies, according to common law. But sometimes there’s a good reason for wanting to continue funding for a project into perpetuity.
Legacy trusts are specifically designed to last for generations, as are certain charitable trusts. As such, some states passed laws to work around this rule against perpetuities. If you’re building a trust to create a legacy, you may want to choose a state that allows it. There are eight states that repealed the rule. They are:
- Alaska
- Delaware
- Idaho
- Kentucky
- New Jersey
- Pennsylvania
- Rhode Island
- South Dakota
Now, Nevada still has a rule against perpetuities — but it lasts for 365 years. A lot of people choose Nevada not just because it has a friendly stance on the rule against perpetuities. It’s also a tax-friendlier state to store your money.
The Best States for Trusts
The big concern with most trusts is the tax on interest in the trust account. That interest can be taxable as ordinary income. With ILITs, this issue is resolved. Life insurance policy earnings aren’t taxable until received. That means that these trusts are protected from the need to file an income tax return.
But what about when the policies are cashed in and the trust starts paying out? While generally, the proceeds of life insurance are tax-free at a federal level, certain states have an inheritance tax. That inheritance tax might be imposed on the trust. The six states with inheritance tax are:
- Nebraska
- Iowa
- Kentucky
- Pennsylvania
- New Jersey
- Maryland
Nevada is considered a trust-friendly state because it doesn’t have state income taxes. It levies no inheritance or estate tax either. New Hampshire and Alabama have equally friendly statutes that protect dynasty trusts as well. Finally, Florida is a good tax haven. These are the most common options when someone doesn’t want to hold the trust in their home state.
But trust residency is often a problem. Courts have decided in the past that a trust should be governed by another state than where it was initially kept. This is why most trust owners tend to leave their trust at home.
Keeping Your Trust At Home
One of the key factors in whether a trust is considered domiciled in a certain state is where the trustee is located. Many courts have held that as the trustee has the most responsibilities in the trust, their home state is the one that rules where the trust is located.
As most people like to be in contact with their trustee regularly, they choose to keep that trustee close in their home state. For the most part, this works for our clients. The unique structure of ILITs protects them from having to file tax returns. Only in instances where life insurance proceeds may be subject to inheritance tax do we recommend looking to another state. It keeps things simple and allows the client to stay in close contact with their trustee.
Of course, the digital age has made it so you can get a meeting with anyone, just about anywhere, with no waiting. That might make domiciling a trust in another state easier. Regardless, funding that trust with life insurance is the best way to eliminate tax problems.
No matter where you keep your trust, we have the right life insurance policies to put in it. We use strategic policy purchases as a means of sheltering funds from the government so you can pass them onto your beneficiaries. Our strategies can work in any state and will reduce your family’s eventual estate tax. For more information on our strategies, contact Howard Kaye today at 800-DIE-RICH.
