For the average person, knowing how a revocable, irrevocable, and testamentary trust work will help you start thinking of how a trust might help achieve your estate planning goals. A recent article from The Street, “3 Powerful Types of Trusts that Can Work for You,” provides a good foundation for the benefits of putting money into a trust.
The Revocable Trust is one of the more flexible trusts. The person who creates the trust can change anything about the trust at any time. You may add or remove assets, beneficiaries or sell property owned by the trust. Most people who create these trusts, grantors, name themselves as the trustee, allowing themselves to use their property, even though it is owned in the trust.
A Revocable Trust needs to have a successor trustee to manage the assets in the trust for when the grantor dies or becomes incapacitated. Transfer of ownership of the trust and assets from the grantor to the successor trustee is a way to protect assets in case of disability.
At death, a revocable trust becomes an Irrevocable Trust, which cannot be easily revoked or changed. The successor trustee follows the trust document’s instructions to manage and distribute assets.
The revocable trust provides flexibility. However, assets in a revocable trust are considered part of the taxable estate, which means they are subject to estate taxes (both federal and state) when the owner dies. A revocable trust does not offer any protection against creditors, nor will it shield assets from lawsuits.
If the revocable trust’s owner has any debts or legal settlements when they die, the court could award funds from the value of the trust, and beneficiaries will only receive what’s left.
A Testamentary Trust is a trust created in connection with instructions contained in a last will and testament. A good example is a trust for a child outlining when assets will be distributed to them by the trustee and for what purposes the trustee is permitted to make the distribution. This trust fund is usually used for health, education, maintenance, and support, often referred to as “HEMS.”
A trust can be a valuable tool for families with relatively modest estates to protect children’s futures. Assets held in trust for a child’s lifetime are protected in the event the child’s going through a divorce because the child’s inheritance is not subject to the equitable distribution when not comingled.
Many people buy life insurance for their families, but they don’t always know that proceeds from the life insurance policy may be subject to estate taxes. An insurance trust, an ILIT (Irrevocable Life Insurance Trust), is an intelligent way to remove life insurance from your taxable estate.
Whether you can have an ILIT depends on policy ownership at the time of the insured’s death. In most cases, the insurance trust must be the owner, and the insurance trust must be named as the beneficiary. If the trust is not drafted before the application for and purchase of the life insurance policy, it may be possible to transfer an existing policy to the trust. However, if this is done after the purchase, there may be some challenges and requirements. The owner must live more than three years after the transfer for the policy proceeds to be removed from the taxable estate.
Trusts may seem complex and overwhelming. However, an estate planning attorney will draft them properly and ensure they are used appropriately to protect your assets and your family.
Reference: The Street (May 13, 2022) “3 Powerful Types of Trusts that Can Work for You”