While many people prefer not to think about it, death is an unfortunate reality that should be planned for accordingly. Estate planning includes necessary items such as a will, healthcare and property power of attorneys. Setting up a trust is a great start for you and your heirs to have peace of mind.
A trust is an effective estate planning tool that is often disguised in confusion. In reality, trusts can be quite simple depending on the wishes of the grantor, which is the person funding the trust. Some trusts are effective the second the grantor signs the documents and obtains a federal employee ID number, while others are only enforceable after the grantor’s death. If established correctly, a trust can easily have assets flow to the beneficiary—the person or people reaping the benefits of the trust. This proves to be an advantage as it keeps property away from the probate process and may even reduce or eliminate taxation upon the assets within the trust. A trustee is a person, often a sound-minded individual over the age of 18, who administers the trust.
Trusts are either revocable or irrevocable. A revocable trust can be changed or canceled at any time by the grantor, who often acts as the trustee. Oftentimes in a revocable trust, the grantor, trustee and initial beneficiary are the same person. The assets in the trust are still owned by the grantor and, therefore, any revenue generated by the trust must be reported on their personal taxes. Revocable trusts become irrevocable when the grantor dies. An irrevocable trust cannot be modified or revoked by the grantor without the permission of its beneficiaries. Irrevocable trusts are also generally more tax beneficent compared to the revocable trust because the grantor is giving up complete control of the property after the conveyance. In other words, they are at the mercy of their trustee.
A living trust is one of the most commonly used types of trusts. This type of trust is made by the grantor during their lifetime using assets that are intended for the grantor during their lifetime. Upon the death of the grantor, the assets are then passed to the beneficiary. A living trust can avoid any probate in court so long as the trust is funded and administered properly. Living trusts are almost always revocable for the lifetime of the grantor and will become irrevocable upon their death.
A testamentary trust, also known as a will trust, is set up through an individual’s last will and testament. This trust is used to appoint a trustee to manage and distribute the grantor’s assets upon their death. After the probate court determines the legitimacy of the will, the executor will then transfer assets by the will and into a testamentary trust. This allows you to set limitations and stipulations on when and how assets can be accessed by the beneficiaries.
A common trust, often known as a credit shelter trust, allows individuals to minimize or possibly eliminate any estate tax bills upon the death of a spouse. The assets that are transferred do not increase the value of the second spouse’s estate since the trust is owned and managed by a disinterested trustee. The surviving spouse can then access the assets of the trust by the terms of the agreement for things such as medical emergencies, education funds, etc. When the second spouse dies, the assets are not subject to estate taxes when transferred to the remaining beneficiaries.
Roman Basi is an attorney and CPA with the firm Basi, Basi & Associates at the Center for Financial, Legal & Tax Planning. He writes frequently on issues facing business owners. Ian Perry, staff accountant at Basi, Basi & Associates, contributed to this article.