Asset Protection using a Pre-Inheritance Trust (PIT)

by Bob Matthews

Another effective option of protecting your assets is a Pre-Inheritance Trust (PIT). A PIT was originally used by wealthy individuals to reduce their estate tax liability while providing an inheritance for their children. The PIT has since evolved into a powerful asset protection tool.

Let’s look at the two benefits the PIT offers separately to understand how it works:

Estate Tax Planning

The U.S. estate tax law allows each individual taxpayer a certain amount of exemption when you pass an estate on to your heirs without having to pay an estate tax. For 2012, the exemption amount is $5 million. This exemption amount will automatically go down to $1 million in 2013 unless Congress renews this exemption amount. In other words, if you die this year, the first $5 million of your estate is not subject to an estate tax. You might ask, “I’m not planning on dying this year. So how does that affect me?” Well, the tax code allows you to take that exemption any time in your life. So if you wish to gift $5 million to your children this year, they don’t have to pay a gift tax on that $5 million. Of course, any additional amount you leave to them in the future when you die will ALL be subject to estate tax since you have used up your $5 million lifetime exemption.

In addition to the $5 million exemption that might be reduced to just $1 million starting next year unless Congress acts, if you gift that $5 million to your children this year, the future compounded growth of that $5 million will not be counted toward your estate. Let’s say you don’t gift this $5 million now and keep it in your personal account and this $5 million earns a 5% annual return. Let’s also say that you’re going to live for another 25 years. The $5 million will grow to $17 million in 25 years. When you die, you will be paying an estate tax (currently at about 50%) on the $12 million cumulative earnings (or more if Congress allows the estate tax exemption amount to slide back down to $1 million after this year).

So if you gift that $5 million today to your heirs, you use up your lifetime exemption now but the compounded growth of that $5 million (the $12 million cumulative earnings) will no longer be counted toward your estate since they’re no longer yours. You’re effectively saving yourself a 50% estate tax on the $12 million cumulative earnings when you die.

“But, but, but if I gift $5 million to my children now, they will just squander it,” you might say. Well, that’s where the PIT comes in. By gifting the money to the PIT instead of to your children directly, they cannot actually touch the money until a certain time and manner determined by you. In other words, you can gift money to the PIT now to reduce your estate and your future estate tax liability while keeping that money from your children until you want them to have it.  A married couple can gift up to $10 million to the PIT without gift tax liabilities.

Asset Protection

The asset protection benefit of a PIT is very easy to understand. Since you have gifted the money to the PIT, it’s no longer yours. If you are sued in the future, your judgment creditor cannot collect from the PIT since it’s no longer your assets.

In addition, since your children are just beneficiaries of the PIT and not owners of the trust assets until the assets are distributed to them at the time and manner predetermined by you, court judgments against your children are not recoverable from the PIT either. The timing and manner of asset distribution from the PIT may be in one lump-sum or in small periodic payments.

In other words, the PIT completely protects your assets from lawsuits against you or your children.

Here are a few more important aspects of the PIT to consider:

In order to qualify as a gift and use up your $5 million lifetime exemption, you, the settlor of the trust, may not serve as the Trustee or Protector of the PIT. The Trustee and Protector can be a friend, financial advisor, your attorney or certain relatives.
You don’t have to gift $5 million into the PIT immediately. Any amount is perfectly fine. You may also gift in periodic chunks over time instead of in one lump sum upfront.

PITs are Irrevocable Asset Protection Trusts. Therefore the assets you place in the PIT may not be returned to you without tax consequences. You may, however, take out the earnings or interest generated from the assets.

A PIT can hold any assets including bank accounts, real estate, and ownership interests in companies (corporations and LLCs).

You can serve as the officer or manager of the corporations and/or LLCs owned by the PIT. As officer or manager of these entities, you may draw a salary or other non-salary compensation for your service. Since you are the officer/manager of these business entities, you have direct and executive control over the assets owned by these entities.

Your children can also be employed by these companies and draw compensation in amounts determined by you.

By proper construction, a PIT creates an insurmountable shield against the claims of creditors and ex-spouses as well as lowers your future estate tax exposure. If you want your children to have the use of your properties and assets, and not their spouses and potential step children, the PIT is a superior strategy to outright gifts. PITs are growing in popularity as estates of middle-class families become larger. For further question on how a PIT can protect your assets while you maintain control over them, please give us a call.

Thank you for your time and please contact us using the form below for further information regarding Asset Protection techniques.

Editors Note: For additional information on this and similar topics, please see PremierOffshore.com