Financial Literacy

The ABC’s of Trusts

As an estate planning attorney, one of the greatest confusions notice in my clients is in the understanding of the benefits of trusts. I often am encountered with a blank stare when I speak about trusts as an estate planning tool. We need to be comfortable with the use of all vehicles that build our economic strength.In estate planning, we work with individuals to accomplish three goals: 1) avoid probate, 2) minimize taxes and 3) protect assets for the creation of a legacy. Although each state has distinctive rules about trusts, there are several specific commonalities that are important to know.

Trusts, like corporations, are legal constructs. They are not something that you can actually see but they are effective in holding the title for property for the benefit of the beneficiary. The trustee can be the grantor, the person who owns the assets and transfers them into the trust or the trustee can be a person who will act on behalf of the best interest of the beneficiary.

Yet an important thing to remember is there is a “fiduciary” relationship requiring the trust is a legal duty. The duty requires that the trustee hold the primary responsibility act in the best interest of the beneficiary.

The two major categories of trusts are: revocable and irrevocable. As the name suggests, revocable trusts can be changed easily by the grantor. Irrevocable trusts are not easily changed once established. Each state, as well as the language in the trust, dictates how the trust can be changed. Typical provisions are made for the need, in circumstances where there is change in the law, for the trust to be modified. Revocable trusts become irrevocable upon the death of the grantor.

The primary benefit of the revocable trust is to avoid probate. Probate is the process that moves an asset out of your name after you have passed away. Probate is required when the primary tool for disposition of assets is through a last will and testament. The probate process requires months and sometimes years before assets are distributed. It may create challenges for the use of the resources within that time. Once the asset is retitled into the trust before death there is no urgency in transferring the asset (after death).

An irrevocable trust typically transfers your assets out of your (the grantor’s) estate and potentially out of the reach of estate taxes and probate, but cannot be altered by the grantor after it has been executed easily. Therefore, once you establish the trust, you will lose control over the assets and you cannot change any terms or decide to dissolve the trust.

An irrevocable trust is generally preferred over a revocable trust if your primary aim is to reduce the amount subject to estate taxes by effectively removing the trust assets from your estate. Also, since the assets have been transferred to the trust, you are relieved of the tax liability on the income generated by the trust assets (although distributions will typically have income tax consequences). The money in an irrevocable trust may also be protected in the event of a legal judgment against you. This tool is typically used to convert money from a countable to a non-countable asset when seeking asset-based benefits. So often people are told to “spend down” assets in order to qualify for benefits. Once money is transferred into an irrevocable trust for five years it is not countable asset in the “look back” period of eligibility for governmental benefits such as Medicaid.

There are many types of trusts that can be employed for the benefit of exercising control of your assets in order to build a legacy. Trusts are great tools and are not just for the wealthy. Just taking the opportunity to understand them and use them wisely provides the best opportunity for creating intergenerational wealth.

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