Asset Protection, Tax Planning

Trusts and Estate Planning: Are You Doing It Right?

Trusts and Estate Planning: Are You Doing It Right?

When most people think of estate planning, a simple will comes to mind. However, proper estate planning usually means more than just using a will, and it is certainly not a one-time event that you can check off your to-do list. Instead, your estate plan should evolve with your life and change as your needs change. Wills can be valuable for an estate plan, but they may not be enough in many circumstances.

Are you doing enough to protect your legacy? Maybe not, but learning the basics of various estate planning tools, like trusts, can be a helpful place to start.

What is a Trust?

Trust is a document that sets up a legal entity to hold your property for you. Technically speaking, it is an agreement between three essential parties:

  1. The Grantor. You, as the trust maker, are the grantor. You create the trust agreement based on your individualized needs and estate planning goals. Trusts can also be a valuable tool for asset protection in some circumstances as well.
  2. The Trustee. The trustee is someone that you designate to manage and be responsible for the property in the trust. This person is often a family member, but it does not have to be. Sometimes trustees can also be entities, such as financial institutions, as well.
  3. The Beneficiaries. Anyone who gains benefits or value from the assets within the trust is considered a beneficiary. Beneficiaries can be individuals or entities, including charities.

How is a Trust Different from a Will?

While trusts and will have the same goals—distributing your assets to loved ones or other designated individuals or entities—they are still different estate planning tools. There are a few ways that trusts are very different from wills.

  • When the Instrument Takes Effect. A will only applies when you pass away. Most trusts, on the other hand, will go into effect as soon as you sign them. There are, however, testamentary trusts that will only be effective after you pass, often because the will establishes them. Nonetheless, unless you specifically create a testamentary trust, most trusts will be active immediately after you create them.
  • The Property that the Document Covers. The trust can only deal with property that has been specifically granted to it. A will usually addresses all of the property that the testator owns in his or her sole name.
  • Wills Require Probate. One of the major reasons that individuals use trusts is because they do not require the probate process to be effective. Probating a will can take significant time, effort, and expense. A trust is much easier and faster to administer, even after your death.
  • Privacy Concerns. A will is a public document when it is probated. A trust, by contrast, remains private because it does not have to go through this probate process. Only those involved in the trust will know about its contents unless that information is deliberately shared with others.
  • Providing for Life and Death. Trusts can be used in life as well as in death. There are a variety of trusts that you can use as part of your estate plan that accomplish different goals that you simply cannot carry out with a will.

There are certain things that a will cannot accomplish that you should consider as well. For example, you may not be able to provide for loved ones with disabilities in a will properly. Instead, a special needs trust may be a better mechanism for that type of need.


Types of Trusts

Trusts are extremely flexible. While there are several that have designated names, they are really all the same type of instrument—they just have slightly different uses. You can create virtually any kind of trust that will suit your needs.

There are two over-arching attributes of trusts that have an effect on how the trust will function going forward. They are generally referred to as revocable and irrevocable trusts.

Revocable Trusts

A revocable trust is sometimes called an “inter vivos” trust or living trust. The trust is developed during your lifetime, and you can change or alter it, or revoke it entirely. The grantor, or trust maker, is the trustee during his or her life, and he or she also names a successor trustee. The successor trustee will take over after the grantor’s death.

Revocable trusts are a great way to maintain control of your assets while you are alive and also avoid probate. However, because of this control, revocable trusts are not a good asset protection tool. A creditor could access the property in the revocable trust without much more effort than reaching into your bank account.

Irrevocable Trusts

An irremovable trust cannot be changed, amended, or destroyed in most circumstances. Only in the rare event that the trust is determined to be invalid under the law can it be destroyed or modified. These trusts are often created while the grantor is living, but not always. A will can establish trust as well.

Irrevocable trusts are good asset protection tools because creditors cannot reach any asset that the grantor does not control. Because the grantor cannot change the trust or alter the items in the trust, creditors cannot obtain them either. Creditors can, however, often access the payments or distributions to beneficiaries from the trust.

“Named” Trust Options

Other trusts fall into either the category of revocable or irrevocable. These other “named” trusts simply have a particular setup that will help accomplish a specific goal. Nonetheless, knowing a few of the “standard” types of trusts can help you get an idea of how a trust may be used or what trusts can do.

  • Charitable Trusts. A charitable trust is set up to specifically benefit a charity or the public in general. These trusts are often part of an estate plan as a means to avoid estate taxes or gift taxes. This type of trust can be used both during the grantor’s lifetime and after death.
  • Special Needs Trust. The purpose of a special needs trust is to be able to provide for loved ones with special needs both during and after your lifetime. It accomplishes several goals: (1) allowing the loved one to have someone else control their finances; (2) allowing the loved one to remain qualified for particular government benefits like Social Security or Medicaid; and (3) providing for the loved one on a long-term basis. Special needs trusts are helpful for those who want to ensure that their special needs loved one will be financially sound after the grantor’s death.
  • Spendthrift Trust. Even if your loved one is not someone with special needs, he or she may not be able to handle money well. For example, you may be concerned that if you leave money to your daughter, she will just spend it on frivolous things and run out of funds quickly. A spendthrift trust restricts how a loved one can use the money provided to them. It is also protected from the beneficiary’s creditors as well, making it a helpful, although indirect, asset protection tool.
  • By-Pass Trust. When one spouse wants to leave money or property to the other, he or she could use a by-pass trust. This type of trust helps decrease estate taxes, which can save loved ones a staggering tax rate of up to 55 percent.
  • Totten Trust. A Totten Trust, named after a New York case from 1904, is a “payable on death” trust. Essentially, this trust is expressly set up to transfer to another individual upon your death. They are often used in bank accounts or similar financial instruments. You can use the money while you are living and even change the beneficiary, which means that this type of trust is revocable. Totten Trusts are much faster and more efficient than having to go through the probate process for a will.

You may also have trust and not even realize it. A constructive trust is not technically a trust that you set up yourself. Instead, it is an arrangement that the court deems to really be a trust, despite the fact that you likely are not calling it that. If you have an intention that certain property goes to a particular person, then you may have trust. For example, even where someone takes the title of a property, the court may determine that that person is really just holding the property in trust for someone else.


Trusts and Taxes

Although trusts can be helpful estate tax or gift tax avoidance mechanisms, they often must file and pay their own taxes as well. Taxes are usually paid at the beneficiary level or the entity level, instead of by the grantor directly. That means that the beneficiary may have to pay income taxes on the distributions that they receive from the trust. The trust itself may also have to pay taxes, particularly if the trust does not distribute all of its income every year or if the gross income for the trust is more than $600.00.

Like some business entities, trusts have their own income tax rate schedules. They have higher rates at lower incomes than individuals, so they do not make great tax shelters in most circumstances. However, if all of the income is distributed, then you generally do not have to worry about the higher rates because nothing will be taxed.

Learning More About How Trusts Can Help You

Trusts can have a lot of benefits for both estate planning and asset protection purposes. They can also cut down on estate taxes and gift taxes in some circumstances. You may want to incorporate trusts into your own wealth management strategies. You can learn more about trusts through our extensive library of wealth management tools. Sign up for a free membership.

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