After decades of diligently working to build and grow your nest egg, your focus naturally shifts from accumulating assets to protecting and transitioning them. The tasks you undertake in support of these goals often fall under the umbrella of “estate planning,” though they can also benefit your financial plan during your life.
In the world of estate planning, few tools are as useful or as frequently misunderstood as the trust. This legal avenue is often associated with the ultra-wealthy, but a trust can be a useful tool for anyone looking to maintain privacy, avoid probate, and protect their heirs. By understanding the basics of trusts, you can determine if one would be beneficial in your situation.
What is A Trust?
A trust is a legal relationship that is primarily used for estate planning. It involves three parties:
- The Grantor. The person who creates the trust and adds assets to it.
- The Trustee. The person or entity who manages the trust.
- The Beneficiary. The person, or persons, who receive the benefits of the trust.
In many cases, the grantor and the trustee are the same person during the grantor’s life. Then, a successor trustee takes over the responsibilities of managing the trust when the original trustee is no longer able to do so because of incapacity or death.
For example, if you would like to create a trust to benefit your children, you would work with an attorney to draft a trust agreement. Then, you would move certain assets into the trust, such as your home. These responsibilities would fall under the duties of the grantor. If you continued to manage the trust and the property within it, you would be acting as the trustee. Later, if you became incapacitated or died, the person you named as successor trustee would manage the trust and assets for the benefit of your children, the beneficiaries.
While this scenario is common, sometimes a bank or financial company acts as trustee. This typically occurs with complex and high-value trusts that need specialized knowledge to manage.
The Core Benefits of a Trust
There are many types of trusts and different structures that can be customized to your unique needs. These different types will be discussed later in this article, but first we’ll cover the reasons you may consider a trust in the first place.
Bypassing the Probate Process
When you leave assets to your heirs in a Last Will and Testament [Will], the property must move through the courts after your death – called the probate process. This has two main drawbacks, time and privacy, and both are addressed with a trust.
Assets in a trust move to beneficiaries and the management of trust funds move to successor trustees according to the terms of the trust document instead of probate. This means your heirs can receive the assets more quickly, without the hassle of court proceedings.
The probate process is also a matter of public record – meaning anyone can see the assets you had and which beneficiary received them. A trust, on the other hand, remains private.
Planning for Incapacity
If you become unable to manage the assets in the trust due to illness or injury, the successor trustee can step in to manage the assets according to the trust document. This avoids the need for court-appointed guardianship or conservatorship, which can be expensive and emotionally taxing for your family.
Protection From Creditors
By placing assets in certain types of trusts, you can shield them from future creditors and legal judgements. This separation protects your family’s safety net from unforeseen circumstances.
Reducing Estate Tax Exposure
For families with significant assets, estate tax is a serious concern. Fortunately, certain types of trusts remove assets from your taxable estate, potentially saving your heirs from the headache and expense of estate tax on those assets.
As you can see, trusts have many benefits that are not available with individually owned assets that pass to heirs through a Will. These additional safeguards and advantages make trusts an enticing option, but some of these benefits are only available with certain types of trusts.
Revocable vs. Irrevocable Trusts
The main differentiator between types of trusts is whether they are revocable or irrevocable. Revocable trusts provide more flexibility, but some of the benefits mentioned above are not available with them. Irrevocable trusts, on the other hand, are more rigid, but they can provide maximum protection.
Revocable Living Trusts
A revocable living trust is a common structure for simple estate planning needs. As the name suggests, you can change the structure, move assets in and out, or dissolve it entirely at any time.
Since you maintain total control of the assets within the trust during your lifetime, the IRS considers these assets to be yours. For this reason, assets in this type of trust are still included in your taxable estate. Additionally, assets are generally not protected from creditors during your lifetime.
A revocable trust generally becomes irrevocable upon the death of the grantor. In the case of two spouses creating the trust together, this change is often delayed until the death of the second spouse. There are also more in-depth options, such as an A/B trust which splits into 2 trusts at the death of the first spouse. An experienced financial advisor can help you understand these options and choose the one that matches your wishes.
The Irrevocable Trust
An irrevocable trust is common for high-value estates. Once the assets are placed in this type of trust, the grantor cannot reclaim them or change the terms without the express consent of the beneficiaries.
Because the assets are placed in the trust irrevocably, the IRS views them as separate from the grantor. This allows the assets in an irrevocable trust to be excluded from the taxable estate of the grantor. Additionally, the assets in this type of trust are generally protected from creditors.
The choice between a revocable and irrevocable trust often depends on your goals for the trust and the level of control you’re willing to concede. An experienced financial advisor can help you determine if you are likely to need protection from estate taxes or creditors in the future, so you can make a wise decision for your situation.
Specialized Provisions for Unique Needs
Trusts can be extremely flexible legal frameworks and can generally be tailored to your specific needs. Common needs like caring for heirs with money management issues, providing support for heirs with disabilities, avoiding tax on life insurance proceeds, and giving funds to charity are frequently addressed with the following specific types of trusts.
Trust with Spendthrift Provisions
If you are concerned that a beneficiary may struggle with money management or is at risk of a divorce that could deplete their savings, you can add a spendthrift provision to your trust. It limits the beneficiary’s ability to spend the trust’s assets or use them as collateral for debt.
Special Needs Trusts
Leaving assets directly to an heir with a disability can disqualify them from government benefits. A special needs trust allows you to provide support for them without jeopardizing their eligibility for public assistance.
Irrevocable Life Insurance Trust
Life insurance proceeds are generally free from income tax, but they are included in your taxable estate. An irrevocable life insurance trust allows the trust to own the policy, so the benefit of the policy goes to the trust when you pass. Since it is an irrevocable trust, it is excluded from your taxable estate and can provide income or assets to your beneficiaries without subjecting them to estate tax.
Charitable Remainder Trusts
There are several types of trusts that help fulfill your philanthropic desires, and one of the most interesting is the charitable remainder trust. It allows you to receive an income stream from the assets within the trust for a period of time, after which the remainder of the assets are donated to charity. This type of trust can provide a significant tax deduction while you are still living.
A trust can be an important part of your estate plan and your retirement plan. Now that you understand the basics, work with an experienced financial advisor to determine if a trust is right for your situation.
Integrate a Trust into Your Financial Plan with Meld
At Meld Financial, our team of tax, legal, and investment professionals work together to help you determine if a trust fits with your estate planning and retirement planning goals. We can also help you determine the right structure for your trust, and which provisions will benefit your unique family structure.
Trust and estate planning are just one part of our comprehensive wealth management program, Financial Fingerprint®. We developed this plan over decades of helping clients achieve their financial goals, and it is tailored to your specific needs while adapting to match changing circumstances.
Contact us today to discuss your financial situation and get started with Financial Fingerprint®.
