by Landon Buzzerd, CFP®
June 2024
Many people spend a lifetime accumulating investment accounts, real estate, and collectibles. Since you can’t take those assets with you when you pass away, where do they go? Some people informally promise to bequest a particular item or percentage of an asset to a friend or family member, however, once the owner is gone, there is no legal proof of that promise. Articulating your end-of-life wishes can be a challenging task and one that is often avoided. Planning for the eventual disbursement of your assets may be straightforward, or it may be complex with many personalities involved requiring detailed instructions.
A simple will & testament may accomplish your legacy wishes, however, it is important to note that a will does not:
Allow for the decedent to place guardrails on the assets left to the beneficiaries.
Shield the assets from the lengthy and expensive legal process called probate (during which the court oversees the distribution of assets).
Have protection against being contested by the beneficiaries, which can delay the eventual distribution of assets significantly.
Offer any avoidance of estate taxes at death, leaving less for beneficiaries to inherit.
To avoid any of the potential issues mentioned above and to ensure an efficient estate settlement process for your loved ones, creating a trust may provide you peace of mind. A trust is a legal agreement that details ownership of assets and provides instructions for distribution to the beneficiaries. This type of vehicle is often more beneficial for high-net-worth individuals and families because of its versatile and powerful estate planning solutions, such as tax mitigation, generational asset protection, and effective instructions on asset distribution.
Before we dive deeper into the different types of trusts and potential benefits, let’s review the basic roles involved in a trust agreement:
Who creates the terms of the trust agreement? -the Grantor, also known as the settlor or trustor, is the person who creates the trust and transfers assets into it. The grantor establishes the trust by executing a legal document known as the trust agreement, which outlines the governing terms and conditions.
Who will benefit from the assets placed in the trust? -the Beneficiary(s) is the individual or entity designated to receive the benefits of the trust. Beneficiaries are typically named in the trust document by the grantor and may include individuals, such as family members, friends, charitable organizations, or other entities.
Who controls the trust assets for the beneficiaries? -the Trustee is the individual or entity appointed to oversee the assets held within the trust. The trustee has a fiduciary duty, which means they are legally obligated to act in the best interest of the beneficiaries. The trustee is also responsible for ensuring that the trust assets are cared for in accordance with the trust document. A Successor Trustee is an individual or entity designated to take over the role of trustee when the current trustee is no longer able or willing to serve. The appointment of a successor trustee is a common provision in trust documents to ensure continuity in the administration of the trust.
Although there are many different types of trusts, on a broad level, all are categorized as either revocable or irrevocable. One of the most important distinctions between the two is the flexibility and control that the grantor has over the assets once the trust is established. The grantor of a revocable trust maintains control over the assets placed in the trust and can transfer property out of the trust as they wish. Alternatively, an irrevocable trust is essentially irreversible—meaning that it cannot be modified, terminated, or amended—except under rare circumstances.
Revocable Trusts
One of the most common trusts is a revocable living trust. In a revocable trust agreement, the grantor often names themselves as the initial trustee and beneficiary, retaining the right to amend or revoke the trust at any point. This includes naming a different trustee or beneficiary. When the grantor dies, their children are most often the successor beneficiaries. These trusts are often utilized to provide detailed distribution instructions for the assets in the trust upon the grantor’s death, bypassing the probate process. On the other hand, if the decedent did not execute a trust or a will before passing, they are considered to have died “intestate”, meaning without leaving legal instructions on the distribution of their assets. In this case, the intestacy laws of the state where they lived will determine how the assets are distributed, which may differ greatly from the decedent’s wishes.
Revocable trusts do not typically impact the grantor’s income taxes as the grantor will continue to claim the income and capital gains from the trust on their individual return. This also means that the assets in a revocable trust are still considered part of the grantor's estate for tax purposes, and they may be subject to estate taxes upon the grantor's death. Although the revocable trust can protect assets for the grantor’s successor beneficiaries, the grantor of a revocable trust is not protected from creditors.
As mentioned earlier, even if a will did exist, the assets would still be subject to probate, which could significantly delay distribution to the beneficiaries. By transferring assets into a trust, the assets will be distributed to the named beneficiaries efficiently and privately upon the grantor's death. The process of transferring assets into a trust involves retitling the assets you wish to be subject to the terms of the trust. For example, a taxable (non-qualified) investment account would no longer be titled to “John Smith” but rather the name of the trust, which the grantor would have the discretion to create. Typically, the name of the trust may read, “The John Smith Revocable Trust”. Most assets in the trust will still be eligible to receive a step-up in basis at the grantor’s death just as if the assets were held in personal name.
However, not all assets should necessarily be transferred out of personal name and into a trust. Retirement accounts, such as a 401(k) or IRA, allow for beneficiary designations. Therefore, upon the death of the account owner, these accounts pass directly to the named beneficiaries and are not subject to probate, allowing for a smooth and efficient transfer of assets. Beneficiary designations are one of the most important benefits of retirement accounts, and account owners are highly encouraged to name primary and contingent beneficiaries.
Irrevocable Trusts
Although a revocable trust can be an excellent planning tool for modest estates, only an irrevocable trust will protect assets. It is designed to shield them potentially from creditors and lawsuits during the grantor’s lifetime, while avoiding estate taxes at the grantor’s death. Irrevocable trust agreements should name a trustee other than the grantor, and they will often, though not always, name a beneficiary who is not the grantor. These terms are decided by the grantor at the creation of the trust but, unlike a revocable trust, the grantor cannot alter the terms after creation (with certain exceptions), hence the irrevocable nature of the trust.
Since the grantor of an irrevocable trust relinquishes control and ownership of the assets placed into the trust, the assets are typically considered separate from the grantor's personal assets and are not included in a grantor’s estate. An irrevocable trust can be an effective tool for individuals with a net worth that exceeds the federal exemption amount, which is currently $13.61 million per individual. This means, federal estate taxes are not levied until the estate exceeds $13.61 million. However, upon expiration of the Tax Cuts and Jobs Act of 2017, the federal estate tax exemption amount will drop from the current level of $13.61 million per individual to approximately $7 million. Individuals with assets in their estate totaling more than $7 million will be subject to rates as high as 40% for any assets over that $7 million threshold. Thus, it is crucial to maintain an updated balance sheet and understand which assets you own are considered part of your estate. There are a variety of irrevocable trusts that can be utilized to achieve your specific goals whether that be asset protection, tax mitigation, or philanthropy.
Various types of trusts exist under the umbrella of irrevocable trusts, including but not limited to:
Charitable Trusts are created by individuals who wish to make a positive impact on society by donating assets to charitable organizations and causes. The assets held in the trust are managed and invested, and the income generated is used to support the designated charitable activities. Charitable trusts offer several benefits to both the grantor and charitable organization, including the removal of assets from one’s estate to reduce any potential estate tax.
Special Needs Trusts are designed to provide for the financial needs of individuals with special needs without jeopardizing their eligibility for government benefits such as Medicaid or Supplemental Security Income (SSI). These trusts are typically established by parents, grandparents, or legal guardians of individuals with disabilities to ensure they receive the necessary care and support, while preserving their eligibility for government assistance programs.
Dynasty Trusts are powerful tools for wealthy families seeking to preserve their assets and provide for future generations in a tax-efficient manner. This trust is designed to provide long-term financial management and asset protection for multiple generations of a family. A dynasty trust can continue indefinitely, potentially lasting for several generations. One of the key features of a dynasty trust is its ability to leverage the generation-skipping transfer (GST) tax exemption.
Key Takeaways
The choice between a revocable and an irrevocable trust depends on the specific goals and circumstances of the individual establishing the trust. Both trusts provide detailed and contractual instructions for the distribution of assets that align with the grantor’s wishes upon their passing.
A parent or grandparent often wishes to leave their children and grandchildren an inheritance, but they worry that an adolescent may not be a prudent steward of the assets. A trust would allow the grantor to specify which assets are to be passed to certain beneficiaries, and it may determine the purpose for which assets are to be used (education, home purchase, living expenses, etc.). Some trust terms may not even grant the beneficiaries full access to the assets until they reach a pre-determined age.
There are many appealing benefits to creating a trust. The first step in exploring whether a trust may be a solution for your family is to have a discussion with your advisory team about your vision for transitioning wealth.
Over the course of Grant Street’s more than 30 years in business, we have assisted generations of clients in articulating their legacy wishes and coordinating communication of those wishes with their estate counsel. In our experience, the best estate planning strategies develop from a coordinated approach between client, wealth advisor, and attorney. That is why we have partnered with many attorneys across the country help clients put legacy wishes into a plan that can be realized for future generations.
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Disclaimer: This article is for informational purposes only and is not to be construed as tax or legal advice. Please consult your licensed tax professional and/or legal counsel for strategies that may be appropriate for you.
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