Health and Education Exclusion Trusts, known as HEETs, are appealing in part because the money distributed from them can be used to pay for grandchildren's private education, from nursery school to boarding school, and even ballet or karate school. By contrast, the money from 529 accounts, which are far more popular, can only be used to pay for college costs.
A HEET does not trigger a generation-skipping transfer tax, which is 47 percent for 2005, because all distributions must go directly to a school or medical provider, rather than the grandchild. Another requirement is that a charity must get a significant slice of the funds - generally between 10 percent to 20 percent of the trust's income each year. Some grandparents name their own family foundation as a beneficiary.
"The rules are pretty straightforward," said David Handler, a partner with law firm Kirkland & Ellis in Chicago. Done correctly, the trust is a tax-efficient way grandparents can take care of their descendants' health and education, "two core things you want to make sure your family always has," he said.
In fact, the typical client who sets up a HEET has probably already used up the lifetime GST tax exemption, which is $1.5 million for 2005, but wants to do more to provide for grandkids, said Mel Warshaw, a wealth adviser for J.P. Morgan Private Bank in Boston.
The HEET is able to avoid the GST tax because one of its beneficiaries is a charity, which has a perpetual life and therefore allows the HEET to avoid a "taxable termination." But the annual distributions to the charity must be significant, so as not to raise red flags with the Internal Revenue Service. If the charity's interest is too small, the IRS could deem the family as setting up the HEET to simply postpone or avoid the GST tax.
There's no hard-and-fast rule for what's "significant," but Warshaw tells clients to draft the HEET so that 20 percent of the trust's income goes to charity. "Don't set this thing up thinking it's all going to go to your grandkids," he said. "It's for someone who has a proven track record of being charitable."
Most clients thinking about a HEET have more than $25 million in financial wealth, and plan to place $1 million to $3 million in the trust, he said. The HEET is generally part of a sophisticated estate plan, and not for the mass-affluent, who might prefer 529 plans.
Mike Whitty, an estate-planning attorney with Winston & Strawn in Chicago, agreed that HEETs are becoming more popular with the ultra-wealthy "who are looking to help their grandkids above and beyond the traditional ways of dynastic trusts and 529s."
The HEET doesn't replace the 529 account because funds from a 529 can be used for books, supplies, equipment and room and board along with tuition at a post-secondary education. HEET funds can only be used for tuition, but at any type or level of school.
Medical expenses covered by the HEET can include health-insurance premiums and related travel expenses. Wealthy people who have family offices often use the HEET as a tax-efficient way to fund family members' medical insurance.
HEETs provide for the payment of education and medical expenses for grandchildren, great-grandchildren and "the whole tribe," Whitty said. Other vehicles, such as 529s, are set up in an individual's name.
The term HEET was coined in a 2000 article in trade publication Trusts & Estates, and the technique has grown in popularity since then, experts said.
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