Estate planning is the process of arranging your assets and finances to prepare for incapacity or death. A comprehensive estate plan aims to maximize inheritance for your heirs and minimize taxes and legal issues. Trusts are a crucial component of many estate plans. There are many types of trusts that can help you meet specific goals like reducing estate taxes, avoiding probate, and setting up inheritance for minors or beneficiaries with special needs.
Most Common Types of Trusts in Estate Planning
Revocable Living Trusts
A revocable living trust, sometimes called an inter vivos trust (or just a revocable trust), is a popular estate planning tool that allows you to place assets into the trust while you’re still alive. The trust can be changed or revoked at any time as long as you are still competent. The terms of the revocable trust will specify how the assets are to be distributed upon your death.
A revocable living trust avoids the delays and expenses of probate. The assets in the trust pass directly to beneficiaries per the trust instructions, without court intervention. The trust remains private, unlike a will which becomes public record during probate.
To fund the trust, you retitle assets like bank accounts, real estate, and investments into the name of the trust. You control the assets as the trustee while you are living. After death, the successor trustee manages the trust for beneficiaries.
Irrevocable Trusts
Unlike a revocable trust, an irrevocable trust cannot be changed or revoked once executed. These permanent trusts are useful for tax planning and asset protection goals.
An irrevocable life insurance trust (ILIT) owns a life insurance policy outside of your taxable estate. This removes the policy value from estate taxes and provides liquidity to pay taxes.
A charitable remainder trust (CRT) provides income to you or beneficiaries for a period of time. Afterwards the remainder passes to charity. This qualifies for an income tax deduction.
An irrevocable trust also protects assets from creditors. Options like a spendthrift trust restrict how beneficiaries can access trust funds.
Bypass Trusts
Also called credit shelter trusts or family trusts, bypass trusts are used in estate planning for married couples to double the estate tax exemption. When the first spouse passes away, their exemption amount goes into a bypass trust. The surviving spouse can access the income but not the principal. Upon the second death, the trust assets pass tax-free to heirs up to the exemption limit.
Special Needs Trusts
A special needs trust benefits a beneficiary with disabilities without affecting eligibility for needs-based government benefits like Medicaid and SSI. It contains assets for costs not covered by public assistance programs. The beneficiary does not directly control the assets, so benefits are preserved. This ensures supplemental support over the beneficiary’s lifetime.
Gun Trusts
Gun owners can establish a gun trust to legally transfer firearms to beneficiaries without going through probate. These revocable living trusts provide an organized structure for owning, using, and distributing firearms. Proper setup is crucial for gun trusts to comply with state and federal regulations. Requirements vary based on the types of firearms owned. With a well-drafted gun trust, firearms can be passed down according to the owner’s wishes.
Benefits of Gun Trusts
- Avoid probate delays for transferring firearms to heirs
- Allow shared use of firearms among co-trustees during lifetime
- Provide clear instructions for distribution of firearms after death
- Enable transfer of NFA-regulated firearms like suppressors or full autos
- Keep firearms ownership private since trusts are not public record
Trusts for Tax Planning
Trusts allow for estate tax planning because you can place assets in a trust structure that reduces the value of your taxable estate. This enables you to maximize inheritance for beneficiaries.
Married couples can use an A-B or credit shelter trust to double federal estate tax exemptions. Each spouse leaves assets to the other in a marital trust. That amount is unlimited. The remainder goes into an exempt trust up to the estate tax exemption. Upon the second death, assets pass tax-free to heirs.
A qualified terminable interest property (QTIP) trust also utilizes exemptions for married couples. It provides income to a surviving spouse, then distributes principal to children or other heirs. The QTIP election enables using exemptions from the first spouse’s estate.
A grantor retained annuity trust (GRAT) reduces gift taxes when transferring assets to beneficiaries. The grantor receives annuity payments from the GRAT for a number of years. After that, the remaining assets transfer to beneficiaries at a reduced gift tax cost.
Generation-skipping trusts (GSTs) are specialized trusts created to pay benefits to grandchildren, thereby skipping estate taxes on the children’s generation.
Types of Charitable Trusts
Charitable trusts enable making charitable gifts while retaining benefits. There are two main categories: charitable remainder trusts and charitable lead trusts.
Charitable Remainder Trusts
These irrevocable trusts pay income to you or other beneficiaries for a term of years or lifetimes. Afterwards, the remaining principal passes to charity.
- Charitable Remainder Annuity Trusts (CRATs) provide fixed annuity payments to beneficiaries.
- Charitable Remainder Unitrusts (CRUTs) pay a variable percentage of trust assets each year.
Income tax deductions are available for the charitable gift portion. Assets are removed from the taxable estate.
Charitable Lead Trusts
Charitable lead trusts pay income to charity for a set period. Afterwards, the principal is distributed to heirs. Gift or estate tax deductions are possible for the charitable interest. This trust structure reduces transfer taxes on assets passing to beneficiaries.
- Charitable Lead Annuity Trusts (CLATs) make fixed payments to charity.
- Charitable Lead Unitrusts (CLUTs) pay a percentage of assets each year.
Charitable trusts require careful setup to achieve tax advantages. The payout structure, term, and underlying assets require strategic planning with an estate attorney.
Trusts for Inheritance and Asset Protection
In addition to tax planning, trusts are useful for controlling inheritance distribution.
A testamentary trust is created through instructions in your will. It directs inheritance to beneficiaries under conditions or restrictions set by the trust. For example, a spendthrift clause could protect assets from a beneficiary’s creditors.
A children’s trust provides inheritance to minors. It distributes assets at certain ages or milestones. This avoids the need for court-supervised guardianships.
A special needs trust or supplemental needs trust benefits a disabled beneficiary without affecting eligibility for public assistance programs.
For beneficiaries with potential creditor or divorce issues, an asset protection trust shields assets. Discretionary trusts limit beneficiary access to the trust funds and protect from creditors.
Totten Trusts
Known as payable on death accounts, Totten trusts allow naming a beneficiary on bank or brokerage accounts without probate. The assets transfer directly to beneficiaries upon the account owner’s death. Totten trusts avoid probate and provide access to funds if incapacity occurs.
Probate Process
Probate is the court process after someone dies to identify assets, pay debts, and distribute inheritance to heirs. Assets titled in the deceased person’s name alone must go through probate. It can be expensive and time consuming, with public records.
Trusts help avoid probate by transferring assets directly to beneficiaries. Other probate avoidance tools include joint tenancy, payable on death accounts, transfer on death for investments, and life estate deeds.
Even with a trust, some assets may still require probate if not properly funded into the trust while alive. Probate can take 6 months to 2 years. A pour-over will handles any leftover assets by transferring them into your trust upon death.
Creating a Trust
The first step in setting up a trust is to work with an estate planning attorney to decide your goals and an appropriate trust strategy. This may involve tax planning, succession planning for a family business, and coordination with your will or other estate documents.
The attorney will draft a customized trust agreement that names a trustee, beneficiaries, and terms of the trust. The trust will need to be signed and executed correctly to be legally binding. Funding the trust by retitling assets is essential for it to work as intended.
Trust Assets
The trust agreement governs trust assets. Typical assets include real estate, financial accounts, stocks/bonds, life insurance, business interests, and personal property. Homes and other real estate are commonly placed into revocable living trusts.
To fund the trust, each asset’s ownership must be transferred into the name of the trust through new deeds, account registrations, beneficiary forms, etc. Titling assets improperly can undermine the trust’s effectiveness.
Trust Administration
Trust administration involves managing the assets while you are trustee, keeping good records, and tax reporting. After death, the successor trustee will distribute assets and terminate the trust per the trust agreement. It is important to keep beneficiaries informed about the trust.
Benefits of Trusts in Estate Plans
- Avoid probate for faster distribution of assets
- Prevent assets from going through court process during probate
- Minimize estate taxes with specialized trust strategies
- Control distribution of inheritance
- Set conditions for inheritance payouts
- Protect assets from beneficiaries’ creditors and divorces
- Provide for beneficiaries with special needs
- Ensure smooth business succession planning
- Offer privacy compared to public wills
- Flexible to change during your lifetime
Trusts have tradeoffs to consider as well. There are upfront costs and administrative duties. Income may be taxed at higher trust rates. The rigid structure offers less flexibility after you pass. Still, trusts remain one of the most versatile estate planning tools to achieve a wide range of financial goals.
If you are considering setting up a trust, or have questions about the type of trust that would benefit you most, please schedule a complimentary consultation with estate planning and elder law attorney Benjamin Eckman. Click here to get started.
