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July 2, 2023


Last updated: June 29, 2024

FINRA Exam Prep Trusts and Estates

By: Securities Institute Staff

In this article we will examine what you need to know about Trust and Estates to pass your FINRA exam. You can expect to see a number of questions covering these topics on the SIE, Series 7, Series 65 and series 66 exams. 

Estate Planning Techniques

When someone dies, the individual is referred to as the deceased or the decedent. Because of estate taxes, the value of the decedent’s house, farmland, bank account, stocks, bonds, annuities, and life insurance, etc. owned at the time of death may be taxable. 

The decedent is no longer a natural or a legal person. Rather, the decedent’s possessions become part of a legal entity known as an estate. The estate, the entity comprising the deceased’s assets at the time of death, is what can be taxed by both federal and state tax collectors.


An estate is a legal entity in the same way that a trust, a corporation, or a partnership is a legal entity. None of those entities is a human being or natural person, but all are legal persons. 

When someone dies, the checking and savings accounts, real estate, life insurance, and personal possessions, etc., all go into the estate. A family member is typically named the executor of the estate, and it is the executor’s job to get several death certificates and do the paperwork required to transfer the checking and savings to a new bank account entitled, say, Jason Miller, Executor for the Estate of Maude L. Miller, Deceased. 

If the deceased owned stocks and bonds, they must be re-titled in the name of the estate, as well. 

We will look at the strategy of establishing trusts to minimize estate taxes, but, first, let’s make sure we understand how an estate is treated for the purposes of income tax. An estate account is, typically, open only as long as it needs to be, and, then, the beneficiaries receive payouts when the assets are liquidated.

What happens if the stocks, bonds, CDs, real estate, etc., earn income in the meantime? That income is taxable to the estate. But, the legal fees charged by the estate attorney may well cancel that income out. If, however, the estate earns $5,000 in investment income when the legal bills are $2,000, there is $3,000 of taxable income. The estate will file a tax return (a 1041) for that income.

Will the value of the estate itself be taxed through estate taxes? Usually, no. To calculate the potential estate tax liability, we start with the gross estate—the value of the assets before taking deductions. The following are included in the value of the gross estate:

  • House, farmland, savings account, checking account, investment accounts, clothing, oil paintings, etc.
  • Value of insurance and annuity contracts
  • Assets placed in revocable trusts
  • Does not include assets placed in irrevocable trusts (except certain property transferred within three years of death)

So, we add those values and then subtract things to reduce the value of this estate. If we reduce the value enough, we might avoid paying estate taxes. The following reduce the gross estate:

  • Funeral and administrative expenses
  • Debts owed at the time of death
  • Any charitable gifts made after death
  • The marital deduction

The “marital deduction” means husbands and wives pass their property to one another at death without paying estate taxes, which seems fair enough. It is when the assets then go from the “second to die” to the heirs that things get dicey. So, after we have added up the value of the assets (gross estate) and subtracted the first three bullet points above, maybe what is left is $1 million. Will we have to pay estate taxes?

No. Currently, there is a lifetime credit of $10 million for estates, indexed for inflation. Since the taxable estate is below that number, we avoid paying estate taxes. Specifically, the amount of the credit, indexed for inflation, is now $11,700,000.

How are the heirs taxed once they inherit their share? When the individual dies, there is no tax due on the securities if the heirs hold them. In that case, the heirs take the fair market value of the securities as their cost basis. When they sell the stocks and bonds for more than that fair market value, the excess is a long-term capital gain, even if realized in two or three months.

Generally, the state only goes after estate taxes when the estate is large enough to be taxed at the federal level.


What if several months ago the deceased had gone in for a regular checkup and found out some bad news? To avoid estate taxes, could the individual start handing out envelopes of cash to all the kids and grandkids?

Yes, but the gifts an individual gives while alive are also taxable if over a certain amount. That number is currently $17,000 a year and is called the “annual gift-tax exclusion.” That means if the individual gives anyone other than a spouse a gift worth more than that amount, the individual must start chipping away at the lifetime gift tax credit. The credit for the estate and gifts over the individual’s lifetime is unified, which means the amount of the credit that was used over her lifetime will reduce the amount of the credit the heirs can use when trying to reduce the size of the estate to avoid paying estate taxes.

Not many estates are worth anywhere near $10 million, but if the decedent had given away $9.5 million in gifts over a lifetime, suddenly, a relatively small estate could trigger estate taxes.

The IRS defines a gift as, “transferring property to someone else and expecting nothing in return.” The IRS also points out that the following can be considered gifts:

  • selling something at less than its value
  • making an interest-free or reduced-interest loan

So, whether the individual gives things away, or even sells land at below-market-value, if the gift exceeds the annual gift tax exclusion, the giver files a return and uses part of the lifetime credit. 

In the following cases, no gift taxes would be due, and no returns required to be filed:

  • Gifts made to a spouse
  • Gifts that do not exceed current exclusion amount
  • Paying tuition costs for someone else—payable directly to educational institution
  • Paying medical costs for someone else—payable directly to the care provider
  • Political and charitable donations

Gift Splitting

The IRS is clear on the topic of gift splitting, in Publication 950 from

Harold and his wife, Helen, agree to split the gifts that they made during the previous tax year. Harold gives his nephew, George, $24,000, and Helen gives her niece, Gina, $18,000. Although each gift is more than the annual exclusion ($16,000), by gift splitting they can make these gifts without making a taxable gift.

That means half of $24,000 ($12,000) and half of $18,000 ($9,000) would be less than the annual exclusion of $17,000, so they can treat each gift as half from Harold and half from Helen. No gift taxes would be due and none of the lifetime credits would have to be used up, but the IRS requires they file a gift tax return. 


From a financial planning standpoint, the worst way to die is without a will or trust. Individuals who do this are said to have died intestate. If that happens, not only do the deceased’s assets go through the probate process, but, first, an administrator of the estate must be named by the probate court.

At least with a will the deceased’s wishes are stated, and—if there are no challenges—the distribution of assets will be made according to the stated will of the now deceased individual. When someone dies with a will, an executor is named. Although that saves some time with the probate process, it puts the estate through that process. 

What is the problem with probate? The probate process makes the estate assets and their distribution a public record. It delays the distribution of the assets. And, it can easily consume 4% of the estate’s value, as the beneficiaries watch money that would have gone to them get eaten up in legal and accounting fees. 

Trusts, on the other hand, can be set up to avoid the probate process. Like an estate or a corporation, a trust is a separate legal entity with its own FEIN. The trust holds assets, as a corporation or an estate does. The person who administers and oversees the investments of the trust is the “trustee.” The one who grants the assets to the trust is called the “grantor.” And the ones who benefit from the trust are called the “beneficiaries.”

When an adult sets up an UTMA/UGMA account, the minor owns and controls the assets at the age of adulthood/majority, which is usually no later than age 21. If he sets up a trust, on the other hand, he can specify all types of things in the trust agreement about when the beneficiary is to receive distributions and how much he is to receive. The exam might point out other advantages of establishing trusts:

  • Faster and less costly way to transfer property upon death, when compared to a will
  • Avoids probate court process (time, expense), especially if property is owned in several different states
  • Eliminates challenges to estate—specifically disinherit anyone who poses a challenge to your wishes upon your death
  • Keeps transfer of property private
  • Reduces amount of estate taxable to heirs

Revocable vs. Irrevocable

Reducing the amount of the taxable estate can come down to the difference between revocable and irrevocable trusts. In general, assets placed in an irrevocable trust do not count as part of the estate, while assets placed in a revocable trust do. 

If the trust is revocable, the person who set it up (grantor) can revoke the assets and change the terms of the trust documents. Therefore, not only are those assets taxable to the grantor while alive, but when the grantor dies, those assets count towards the value of the estate, even if the assets were never “taken back.” 

If a grantor sets up an irrevocable trust, on the other hand, the assets cannot be revoked. Assets placed in an irrevocable trust are no longer taxable to the grantor while alive, and when the grantor dies, the assets do not count towards the value of the estate that the heirs are hoping to keep below the amount that triggers estate taxes.

The irrevocable trust will either distribute income to the beneficiaries, or it will not. Either way, the income generated by the investments is taxable. If the income is distributed to the beneficiaries, they include it on their own income tax forms. If the income is not distributed, it is taxable to the trust.

In a revocable trust, or even in an irrevocable trust where the grantor or grantor’s spouse benefits from the income, the grantor is subject to taxation while alive. In fact, because the IRS basically ignores the trust structure for revocable trusts, they are often called grantor trusts, because there is no separation between the grantor and the trust at this point. 

Simple vs. Complex

For purposes of paying federal income taxes, all trusts are either simple or complex in a given tax year. A simple trust is one in which the income generated over the year is distributed to the beneficiaries. No charitable donations are made from a simple trust, and distributions from the principal or corpus of the trust are not regularly made to the beneficiaries. The income distributed to the beneficiaries is known as either “DNI” or distributable net income. 

A complex trust is one that makes charitable donations or makes regular distributions to the beneficiaries from the corpus or principal of the account. To make a distribution from corpus/principal means the trustee sold assets and is distributing the profits to the beneficiaries. A complex trust is also a trust that retains some of the income generated by the account. If the trust does any of the three things mentioned, it is treated as a complex trust (charitable donations, retain income for corpus, distributed from corpus) for the tax year. 

In either case, income that is distributed to the beneficiaries is taxable to them, while income retained by the trust is taxable to the trust. 

Although we do not associate the simple trust with distributions from corpus, the trustee can use their discretion to make a distribution of, say, a capital gain on a large stock sale, to the beneficiaries. In any year that the trustee does so the trust is treated as a complex trust under the tax code. 

Inter-Vivos, Testamentary

A trust can be established while the grantor is alive or through the will upon death. A trust established while the grantor is alive is called an inter-vivos trust while a trust established upon the death of the grantor through the terms of a will is known as a testamentary trust. An inter-vivos trust can be either revocable or irrevocable. A testamentary trust is an irrevocable trust. In fact, all revocable trusts become irrevocable upon the death of the grantor, who is no longer able to revoke.

Inter-vivos trusts are sometimes called “living trusts” while testamentary trusts are sometimes called “will trusts.” Trusts established while the grantor is alive avoid probate, will testamentary trusts must still go through the probate process. For a testamentary trust, the executor must probate the will and as part of the probate process will create the trust.

Split Trusts

If a married couple wanted to leave money to their children and their favorite charity, rather than forming separate trusts, they could form a split trust. A split trust or “split-interest trust” is a type of trust account that names both charitable and non-charitable beneficiaries. The most common types of split trusts are charitable remainder trusts and charitable lead trusts. A charitable remainder trust is an irrevocable trust that can be set up in two ways. 

With both accounts the priority is to leave adequate funds to the non-charitable beneficiaries, while also leaving a donation to the named charitable organization. In a charitable remainder annuity trust the beneficiaries receive fixed payments for a stated period, after which the remaining assets are distributed to the charity. 

In a charitable remainder unitrust the non-charitable beneficiaries receive a stated percentage of the account’s fair market value for a set time period after which the remaining assets are distributed to the charitable beneficiary or beneficiaries. Typically, the grantor is also the income beneficiary of the charitable remainder trust. That means the grantor takes a charitable deduction on the amount contributed to the trust immediately and then lives off the prescribed income stream for life, knowing the remainder goes to a charitable beneficiary upon death.

A charitable lead trust is set up when the priority is to leave assets to the named charitable beneficiary/beneficiaries, while the non-charitable beneficiaries will wait for their distributions. A charitable lead trust can also be set up as either an annuity or a unitrust. Either way, the designated charitable beneficiaries receive regular distributions of assets from the trust at scheduled intervals for a stated time. Once the organizations have received the pre-set number of donations, the trust distributes the remaining assets to the non-charitable beneficiaries.

Pooled income funds are trusts that enable donors to pool their donations into an investment fund. Unlike the other split trusts, a pooled income fund is owned by the charitable organization that benefits from it. The donors themselves are the beneficiaries of the trust, receiving distributions from the income generated by the fund while alive. When the donors pass away, their share of the fund is then distributed to the charity. This type of trust allows donors to enjoy investment income throughout their lives while ultimately benefiting a charitable organization.

Totten Trusts

If you were to ask a banker how you can pass assets to your loved ones and avoid probate, chances are you would hear the term Totten trust. A Totten trust is a payable-on-death (POD) bank account. If someone wants the assets in the account to pass upon death to a named beneficiary, a Totten trust can be set up. All that is required is some paperwork establishing the account as a payable-on-death account, which the bank keeps on file. The POD beneficiary has no rights to the assets while the grantor is alive, and when the account owner passes away, the beneficiary typically needs to go to the bank with a death certificate and a photo ID. The bank could place a brief hold on the funds, but the transfer of assets does not go into the probate process.

A Totten trust is a bank account whose balance will pass to a named beneficiary. It is a revocable trust. 


One way for wealthy people to reduce estate tax liability while staying in their homes for a while is to create a Qualified Personal Residence Trust (QPRT). This maneuver would allow them to transfer the property to the trust at today’s value as opposed to the almost certainly higher value in the future. The grantor retains tenancy for 10 years, after which the property passes to the beneficiaries of the trust. The home could not be seized by creditors, as it would now be owned by a trust. Creditors could only claim the value of the remaining term of tenancy—the rental income, for example—but could not seize the property itself.

People who are in a second (or third, etc.) marriage often want to provide for their spouse’s income needs after death but also provide for their children of a previous marriage. This is often done by establishing a Qualified Terminable Interest Property trust or Q-TIP. The Q-TIP provides that the surviving spouse will receive a prescribed lifetime income stream from the trust when the other spouse dies. The trust principal then passes to the children after the spouse dies or remarries. Q-TIPs are common with second marriages because they preserve assets for the benefit of the children from an earlier marriage, rather than the spouse’s children or family. Q-TIPs can also protect a spouse when the grantor believes the individual may waste the assets during the spouse’s lifetime. 

To qualify for the marital deduction, income from the Q-TIP must be used only for the benefit of the surviving spouse during their lifetime. Estate taxes on the principal are then deferred until the surviving spouse dies. In other words, passing the income to the surviving spouse does not trigger estate tax liability. That happens when the assets transfer to the next generation.

Crummey Trusts

We talked about the annual gift tax exclusion amount earlier. And, we saw that the value of a life insurance policy is included in the gross estate, unless some fancy estate planning is performed, that is. A Crummey Trust is an irrevocable life insurance trust designed to pay the premiums on a life insurance policy owned by a trust and also get around the annual gift tax exclusion amount. In a Crummey Trust the beneficiaries have the stated right to withdraw the gifts made to the trust for a certain time. Because they never do that, the gifts are used to pay the premiums on the life insurance policy, which is owned by the trust to keep its value separate from the estate of the deceased.

Uniform Prudent Investor Act

Trustees are sometimes family members and sometimes financial institutions. Either way, a trustee is a fiduciary who can be sued for negligence or self-dealing by the beneficiaries of the trust. The Uniform Prudent Investor Act is a piece of model legislation that provides guidance to trustees interested in avoiding such lawsuits and regulatory actions. 

While in earlier times a “prudent investor” was expected to avoid risk, as the Uniform Prudent Investor Act (UPIA) clarifies, the trustee’s job is to consider the risk-reward nature of a portfolio so that a risky security here might be balanced out by an uncorrelated and safer security over there. For example, high-risk junk bonds might fit into an overall portfolio if balanced out by U.S. Treasury Notes. Therefore, there is no list of prohibited investments. Rather, the trustee needs to read the trust documents and manage the risk/reward nature of the portfolio in a way that best meets the needs of the beneficiary or beneficiaries of the trust. 

Diversification is considered a major part of any prudent investment strategy, and a trustee would only choose not to diversify if he had a good reason. For example, maybe the account needs to wait until a short-term capital gain can be turned into a long-term capital gain before selling and rebalancing.

Some executors and trustees are family members who have no training or experience in financial matters. While they would be held liable for fraud or self-dealing at the expense of the beneficiaries, their level of skill and care would not be assumed to be as high as that of bank’s trust department. So, the UPIA clarifies that amateur fiduciaries are not held to the same standard as professional fiduciaries in terms of exercising skill and care in financial matters. 

Again, though, a test question could have an amateur fiduciary spending the interest payments received on Treasury Bonds when that money should, instead, be going into the estate account and eventually distributed to the other beneficiaries. That is a matter of self-dealing and “breach of fiduciary duty” regardless of her knowledge of the securities industry. If the executor decides to move into the house of the deceased rather than get it sold for the benefit of the estate, this would also be a breach of fiduciary duty, no matter how often it probably happens in the day-to-day world.

In olden days, no responsibilities could be passed off, but the UPIA points out that a trustee could manage the investments of a pension trust while an insurance company handles payouts and actuarial calculations, for example.

Disclaiming an Inheritance

Say the wife of a recently deceased husband does not want or need the assets she is set to receive from the husband’s will or trust agreement. If she wants the assets to bypass her and go to the next generation, she must formally disclaim the inheritance without ever touching or benefiting from the assets. This means she must do it in writing and within 9 months of the death of the deceased individual. If she does it correctly according to federal and state law, the assets are treated as if she never touched them. However, the decision to disclaim the inheritance is irrevocable. She cannot come back later asking for help from the trust. Also, she does not get to designate who receives the assets. That is up to the probate court or the trust agreement.

Generation Skipping Tax Issues

As we have seen, when assets pass from parents to the next generation, estate taxes could be due. Therefore, if someone tries to bypass that generation and leave assets to a family member who is two generations younger, the transfer is subject to both a generation-skipping tax and the estate tax. The person who is two generations younger is known as a “skip person,” and an unrelated person is a skip person if he or she is more than 37.5 years younger than the one transferring assets. But, skip persons end up being off the hook if the parent dies before the transfer is made. 

Individuals and married couples can pass a certain amount to a skip person that is exempted from the generation-skipping tax, both numbers indexed for inflation. To leave assets for a skip person and avoid tax liability, many wealthy people establish generation-skipping trusts, whose sole purpose is to receive the maximum amount exempt from the generation-skipping tax and then provide benefits from there to the named beneficiaries.

We hope that this article has helped you better understand the complex nature of trusts and estates for your upcoming exam. Pass your exam guaranteed or your money back with our greenlight pass guarantee.