A Trust is a legal document that allows funds and other assets to be legally held by a third party on your behalf. Trusts are created by a fiduciary relationship in which one party is called the grantor or settlor who gives the trustee the authority to hold the title to assets or property for the benefit of another party, who is known as the beneficiary.
Trust and trust funds provide people an avenue with which to build wealth for future generations by likely reducing or minimizing estate taxes. Trusts are commonly established by grantors in order to legally protect their assets and to assure that the property will be distributed according to their wishes when they pass away. It helps to save time, and paperwork is reduced. In the same way, a Trust may help to reduce estate and inheritance taxes, depending upon your state. The federal estate tax exemption in 2021 is $11.58 million per person.
Benefits of Trusts
Trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries. Assets in a Trust may also be able to pass outside of probate, saving time, court fees, and potentially reducing estate taxes as well. By avoiding probate, your beneficiaries may gain access to these assets more quickly than they might to assets that are transferred using a Will.
Other benefits of trusts include:
- Control Your Wealth – You can specify the terms of a Trust precisely, allowing you complete control of when and to whom distributions may be made. You may also, for example, set up a Revocable Living Trust so that the Trust assets remain accessible to you during your lifetime while designating whom the remaining assets will pass to thereafter, even when there are complex situations such as children from more than one marriage.
- Protect Your Legacy – A properly constructed Trust can help protect your estate from your heirs’ creditors or from beneficiaries who may not be adept at money management.
- Avoid Probate, Maintain Privacy – Probate is a matter of public record, and when your Will goes through probate, it also becomes public record. Meanwhile, a Trust may allow assets to pass outside of probate and remain private, in addition to possibly reducing the amount lost to court fees and taxes in the probate process.
Types of Trusts
- Marital Trust – Also known as an “A” Trust, a Marital Trust is designed to provide benefits to your surviving spouse when you pass away. Generally, a Marital Trust is included in the surviving spouse’s taxable estate.
- Bypass Trust – A Bypass Trust or “B” Trust (also known as a credit shelter trust) is usually established to bypass your surviving spouse’s estate to allow them to take full advantage of federal estate tax exemptions. Remember that you only need to be concerned about this if your assets are over 11.58 million in 2021.
- Testamentary Trust – This kind of Trust is created within a Will, and activates after your death. These types of Trust funds will be subject to probate and transfer taxes, and will sometimes be subject to ongoing probate court supervision.
- Living Trust – A Living Trust, which can be revocable or irrevocable, are a kind of Trust that is in effect while the grantor is alive, unlike many other types of Trusts on this list. When the Trust grantor or settlor passes away or becomes incapacitated, the assets within the Trust flow to the beneficiaries according to the grantor’s wishes as outlined in the trust agreement.
- Irrevocable Life Insurance Trust (ILIT) – When you pass away, your life insurance proceeds (if you had a policy) may become taxable as part of your estate. To avoid this, you can set up an Irrevocable Life Insurance Trust to exclude these proceeds and provide more liquidity to your estate and your beneficiaries.
- Generation-Skipping Trust – This type of Trust applies to a tax exemption that allows you to distribute assets from your Trust to your grandchildren or later generations without incurring a tax on skipping generations or resulting in estate taxes on the assets when your children pass away.
- Qualified Terminable Interest Property (QTIP) Trust – When you set up this type of Trust, the assets in your Trust can be used to provide your surviving spouse with income. When they subsequently pass away, the Trust assets will pass to the additional beneficiaries you name. A QTIP Trust is usually used in second marriage situations, where a man wants to provide for his second wife, but when she dies, wants all of his remaining assets to pass to his children by his first wife. QTIP Trusts may also be used to maximize estate and generation-skipping tax or estate tax planning flexibility.
- Grantor Retained Annuity Trust (GRAT) – If you have lots of assets that appreciate quickly, such as real estate, stocks, bonds and CDs, you may want a Grantor Retained Annuity Trust, which is designed to shift future appreciation on these types of assets to the next generation during your lifetime.
- Charitable Trusts – If you want to leave a portion of your estate to charity or religious organizations, you can do so with a Charitable Lead Trust or a Charitable Remainder Trust. The difference comes down to how you want these charitable gifts distributed in correlation to the rest of your assets. A Charitable Lead Trust sends a certain amount or specific benefits to the charity, while the remainder goes to your other beneficiaries. Conversely, a Charitable Remainder Trust is used more for the benefit of your beneficiaries by reducing their taxable income. The Trust acts first by dispersing income to the Trust beneficiaries for a specified period of time and then donating the remainder of the trust to the designated charity.
- Special Needs Trust – This kind of Trust allows you to provide for a mentally or physically disabled or chronically ill person while still maintaining their eligibility for public assistance disability benefits provided by Social Security, Supplemental Security Income, Medicare or Medicaid.
Revocable vs. Irrevocable
From these types of Trusts, you can choose for the document to be revocable or irrevocable.
A Revocable Trust can help assets pass outside of probate, yet allows you to retain control of the assets during your (the grantor’s) lifetime. It is flexible and can be dissolved at any time, should your circumstances or intentions change. For example, with a Revocable Trust, the owner can designate a new beneficiary, remove beneficiaries, or change stipulations or conditions. Although a Revocable Trust may help avoid probate, it is usually still subject to estate taxes. It also means that during your lifetime, it is treated like any other asset you own.
You can name yourself trustee (or co-trustee) and retain ownership and control over a Revocable Trust, its terms and assets during your lifetime, but make provisions for a successor trustee to manage them in the event of your incapacity or death. A Revocable Trust typically becomes irrevocable upon your death.
An Irrevocable Trust typically holds assets transferred out of your (the grantor’s) estate and potentially out of the reach of estate taxes and probate, but cannot be altered by the grantor after it has been executed. So, once you establish the Trust, you will lose control over the assets and you cannot change any terms or decide to dissolve the Trust.
Typically, no changes can be made to an Irrevocable Trust; only in very rare circumstances are these types of trusts allowed to be modified. Unlike the Revocable Trust, assets that are put into an Irrevocable Trust are not subject to judgments and are not included in your estate’s value for estate tax purposes.
Which Trust is Right for You?
One of the primary benefits of selecting a Revocable Trust over an irrevocable one is the flexibility and ability of the owner to make changes to the Trust.
However, as with everything, there are disadvantages to a Revocable Trust. Since the owner of the Trust maintains a greater level of control over the assets in the Trust, they are not fully shielded from creditors. For example, if the owner of the Trust were to be sued while he is living, and a judgment is obtained against him, a court could order that the assets in the Trust be liquidated to pay the judgment. Additionally, when the owner of a Revocable Trust dies, the assets held in Trust are subject to both state and federal estate taxes.
People generally prefer an Irrevocable Trust over a Revocable Trust if their primary aim is to reduce their assets subject to estate taxes by effectively removing the Trust assets from their estate. Also, since the assets have been transferred to the Trust, you would be relieved of the tax liability on the income generated by the Trust assets (although distributions will typically have income tax consequences). An Irrevocable Trust may also be protected in the event of a legal judgment against you.
People who are younger may opt for a Revocable Trust simply because they will likely need to make changes to it at some time during their lives. Individuals who are in their golden years are less likely to make changes to their Trust and may benefit from the use of an Irrevocable Trust.
One thing to keep in mind; as long as the total value of your estate is below the Federal Estate Tax Exemption,which in 2021 is 11.58 million per person,you will not incur estate taxes, regardless of whether you have a Revocable or Irrevocable Trust. The downside, of course, is that you cannot make any changes to the assets in the Trust or revoke the Trust once it is established if it is an Irrevocable Trust.
Finally, state laws vary significantly in the area of Trusts and should be considered before making any decisions about a Trust and which one is right for you. Choosing and creating a Trust can be a complex process, and Gentreo is here to help with the estate planning expertise you need. For the vast majority of Americans , a Will is sufficient and there is no need for a Trust. It all depends upon your goals; size of your estate; and your life circumstances.