Why the Wealthy Use Trusts (2024)

The wealthy often use trusts to safeguard their money and minimize their tax burden. While trusts can be created by anyone, many people in the middle class are unaware of the advantages they offer. As a result, they miss out on financial benefits and asset protection.

There are various types of trusts that you can explore to determine which ones would be advantageous for you. It is recommended to conduct thorough research and seek advice from a lawyer. Meanwhile, let's take a closer look at two specific types of trusts that demonstrate how the rich utilize them to protect their assets and reduce their tax liabilities.

Grantor Retained Annuity Trust

The Grantor Retained Annuity Trust (GRAT) serves the purpose of reducing the taxable estate. The way wealthy individuals use this trust is by funding it with assets that have high growth potential, like stocks or business interests. The person who establishes the trust is called the Grantor and they have the right to receive an annual income from the trust, known as an annuity. This annuity is paid out over a specific period, usually 5 to 20 years. However, for the trust to be effective, the Grantor must survive this period.

The asset transferred to the trust must be equal to the present value of the annuity payments, calculated using the IRS section 7520 rate, which is currently 2.2%. The IRS assumes that the transaction will balance out over the life of the trust. If the assets in the GRAT appreciate at a rate higher than the section 7520 rate, any excess value goes to the beneficiaries without incurring gift tax.

For example, let's imagine that the asset in the GRAT grows at a rate of 15% per year over 20 years, while the current section 7520 rate is 2.2%. In this case, the excess value would pass to family members without being taxed. Furthermore, at the end of the annuity period (e.g., 20 years), the GRAT is terminated and the remaining asset in the trust is distributed to the beneficiaries, free from estate and gift taxes. This strategy clearly demonstrates its effectiveness, which is why it is commonly used by the wealthy.

For instance, Forbes reported that Mark Zuckerberg and Dustin Moskovitz, two of the original founders of Facebook, utilized this strategy by placing their pre-IPO stock into a GRAT. These shares were likely worth less than $1 per share at the time. As Facebook went public, the growth rate of these stocks surpassed the IRS's section 7520 rate, allowing Zuckerberg and Moskovitz to transfer this wealth to others without incurring taxes.

Land Trusts

One way that wealthy individuals maintain their privacy and hide their ownership of real estate is by using a land trust. However, land trusts are not exclusive to the rich and can be utilized by anyone. A land trust provides anonymity when buying, selling, or holding real estate because the property is not under your personal name; instead, it is held by the trust. Let me explain further.

In a land trust, one party (known as the trustee) agrees to hold legal ownership of a piece of real property for the benefit of another party (known as the beneficiary). The trustee holds both the legal and equitable titles to the property, while the beneficiary retains control over management, decision-making, and the right to receive profits from the property.

The terms "legal title" and "equitable title" have specific meanings in this context. Legal title refers to the name listed on the property deed, while equitable title represents the true owner behind the scenes. This arrangement exemplifies the concept of "controlling everything while owning nothing."

Additionally, a land trust can provide a basic form of asset protection by keeping your name out of public records. This is crucial because having your name publicly associated with real estate ownership is akin to displaying your financial information for all to see. It allows anyone interested to calculate your real estate holdings down to the last penny.