Stephen Ahern
There’s a common misconception that trusts are only for the wealthy. In reality, all kinds of people use trusts to achieve their estate planning goals. Trusts are highly customizable and can be used for many purposes. The key reasons people create trusts for estate planning include minimizing estate taxes, protecting minor children or other vulnerable family members, shielding assets from creditors and transferring assets to the next generation without going through probate.
Using Trusts for Estate Planning: How Trusts Work
While many kinds of trusts exist, there are generally three parties involved. Say you want to use a trust to transfer some money and property to your kids. You would create a written trust document stating the terms of the trust. For example, do you want the kids to receive distributions from the trust when they reach a certain age, or are there other benchmarks you want them to hit before they can receive money from the trust?
As the person creating the trust, you’re the grantor/trustor. Your kids are the beneficiaries. You would also name at least one trustee in the trust document, who’s responsible for overseeing and administering the trust and its assets. Trustees may be trusted individuals or entities like your wealth manager or a private bank/trust company. They have a responsibility to manage the money in the trust and distribute it to beneficiaries in keeping with the terms you lay out in the trust document.
Basic Types of Trusts for Estate Planning
Depending on what you’re trying to accomplish, your estate planning advisors might suggest creating one or more of these types of trusts:
Irrevocable trusts generally can’t be changed or terminated once they’re in effect. People commonly use irrevocable trusts for estate planning as a way to to minimize estate taxes. Assets that you move to an irrevocable trust no longer legally belong to you but to the trust. That means they’re not counted toward your taxable estate for estate tax purposes, nor can they be seized by any creditors you may have.
Revocable trusts are also called living trusts. As the name implies, you can revoke or alter a revocable trust throughout your life. Assets that you hold in a revocable trust are still legally your property, so they’re vulnerable to any creditors you may have and they’ll add to your estate tax burden when you die. A revocable trust becomes irrevocable and unchangeable once the grantor dies. At that point assets can be passed to heirs outside of the probate process in accordance with the grantor’s wishes. A revocable trust is typically used to avoid the public probate process and ensure your wishes are carried out privately after your death.
Special needs trusts are often used by parents and grandparents of disabled children. SNTs allow grantors to put aside money for the future care of a beneficiary with special needs. By creating this kind of irrevocable trust, you can make sure that your loved one with special needs will have a trustee overseeing their financial wellbeing if you’re unable to do it. SNTs need to be established carefully to ensure that assets held in the trust are never legally the property of the beneficiary. That could affect their ability to qualify for any governmental benefits they need in the future.
Irrevocable life insurance trusts (ILIT) are a special kind of irrevocable trust that’s specifically used to own the trust grantor’s life insurance policy. Without such a trust, your life insurance’s death benefit could be considered part of your taxable estate when you die. Payouts provided by the policy can be distributed to beneficiaries through the trust.
Generation-skipping trusts are typically used by grandparents as a way to pass assets directly to grandkids. This strategy is generally used to minimize transfer taxes. Passing assets to your children and then having them pass their inherited assets to their own children means the same assets may be taxed twice as they go through two estates. The idea with using a GST is to skip that first round of taxation. If the skipped generation is financially comfortable and doesn’t need the inheritance, this strategy can work well for all parties.
Note that a generation-skipping trust doesn’t have to be set up to benefit relatives. A grantor can designate anyone who is at least 37.5 years younger than themselves as a beneficiary of this kind of trust.
Charitable trusts can be used to transfer assets to charitable organizations in ways that are tax advantaged for the donor. There are even ways to structure charitable trusts so the grantor receives an income stream from the trust during their lifetime.
Have more questions about estate planning? Take a look at our recent ebook, “Estate Planning for Every Stage of Life,” for more, and reach out to our estate planning advisors for help with specific issues like creating trusts for estate planning purposes. If using trusts could help you achieve your specific estate planning goals, contact us today.