Trusts are an important part of estate planning because of their ability to minimize estate taxes and potentially avoid probate. A trust is essentially a fiduciary agreement, one based on trust and confidence, between the person making the trust (trustor) and the trustee. This agreement gives the trustee the authority to manage the assets of the trust and distribute those assets to the beneficiaries as specified in the trust agreement. There are several different types of trusts with their own objectives. The two primary types of trusts are revocable and irrevocable. Revocable trusts are not the only type available.
The primary benefits of a trust
Trusts, like wills, are used to control your assets, including when and to whom your assets are distributed. A trust can also provide protection in situations where your beneficiary may not be as skilled at managing their own money. Having a trust can also mean that your estate will not need to go through the lengthy, public, and expensive probate process.
Revocable trusts and their benefits
All trusts are categorized as either revocable or irrevocable, which is an important distinction based on how the trust operates. A revocable trust, more commonly referred to as a living trust, provides the grantor with the ability to make changes to the terms of the trust, or revoke the trust altogether, at any time while they are still alive. After the grantor’s death, the trust becomes irrevocable. A revocable trust is flexible because it can be modified to account for changes in your circumstances or intentions. With a revocable trust, the trustee does not take control until after your death or incapacity.
Irrevocable trusts and their benefits
On the other hand, an irrevocable trust cannot be altered by the grantor after it has been executed. This characteristic can be very helpful. Once an irrevocable trust has been created, the trust assets are in effect out of the reach of creditors and the probate court. They are not subject to estate taxes either. Although you relinquish control over your assets when they are placed in an irrevocable trust, you gain favorable tax consequences. An irrevocable trust is commonly preferred over a revocable trust if the goal is to reduce estate taxes.
A and B Trust Structure
Spouses can choose to establish the A and B trust structure when creating their estate plan. The A Trust, referred to as the marital trust, provides benefits to the surviving spouse while including the trust assets in the taxable estate of that spouse. Then the B Trust, or bypass trust, effectively bypasses the surviving spouse’s estate for the benefit of the children. By using this A-B trust structure, married couples can benefit the most from the federal estate tax exemption for each spouse. That exemption amount is currently $5.45 million per person, or, $10.9 million for married couples with a properly structured A-B Trust. A new tax planning strategy, called “portability”, may be an alternative to an A-B trust plan for married couples.
A charitable trust is simply one that names a charity as a beneficiary. There are two types of charitable trusts: a Charitable Lead Trust and a Charitable Remainder Trust. The difference in these two types of trusts is who receives what and when. With a Charitable Lead Trust, specific assets got to the charity you choose, and the remainder goes to your designated beneficiaries. A Charitable Remainder Trust works the other way around. The trustor of the trust receives a certain amount of income from the trust for a specific period of time. Then any remaining assets will go to the charity you choose.
Other trust options
There are other types of trusts used in estate planning. For instance, an Irrevocable Life Insurance Trust (ILIT) is designed to remove proceeds from life insurance policies from your taxable estate. They also provide liquidity of assets for the estate and the trusts’ beneficiaries. Generation-skipping trust, in combination with the generation-skipping tax exemption, permits trust assets to be distributed to the future generations while avoiding the generation-skipping tax being imposed.
A Qualified Terminable Interest Property (QTIP) trust is most commonly used to provide income for the surviving spouse. When the surviving spouse dies, the remaining assets go to the beneficiaries named in the trust. This type of trust is most common when there is a second marriage. A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that is funded by gifts from the grantor. The purpose of this type of trust is to shift future appreciation on assets that appreciate more quickly to the next generation.
If you have questions regarding trusts as part of your estate plan, or any other estate planning needs, please contact the Northern California Center for Estate Planning and Elder Law, either online or by calling us at (916) 437-3500.