Should a trust be part of your estate planning?

Trusts are one piece of an estate plan that can help bring some structure to passing assets to the next generation. There are many different types of trusts, but the focus in this article will be around revocable and irrevocable trusts. Which is the “better” option will depend on the financial situation and estate planning goals.

Here are a few key definitions when referring to trusts/estate planning:

1. Grantor/executor- establishes trust and transfers property to a beneficiary through a trust.
2. Probate- legal process where an estate is settled through state law.
3. Trustee- acts as legal owner of trust assets and is responsible for handing any of the assets held in the trust, tax filings for the trust, and distributing assets to beneficiaries according to the terms of the trust.

A revocable trust (also known as a revocable living trust) is a trust that can be revoked, meaning it can be changed or updated at any time when the grantor is still living. This can be a good option if you want to establish a trust but want to have control over your estate and assets while you are living. Upon death, a revocable trust can become irrevocable, meaning it can incorporate protections that you want in place after death.

Here are some of the benefits of revocable trusts:

1. They are flexible since you can amend them while you are living.
2. They avoid probate, which means the estate is not settled by state law, and the assets remain private (vs public record if otherwise going through probate).
3. Money is still available while living. Money can be transferred in or out of a trust at the grantor’s discretion.
4. Since they can spring into an irrevocable trust at death, the assets in the trust can be protected from creditors after passing depending on state law.
5. Pre-set rules around when the assets can be accessed by the beneficiary can be made while living (age they can be distributed/what they can be distributed for/etc.).

However, there are also a few disadvantages of revocable trusts:

1. They are still included in the grantor’s estate (vs being excluded in estate if in an irrevocable trust).
2. There is limited asset protection while the grantor is living.
3. Assets included in a trust are still on the grantor’s balance sheet while living, which can impact getting government aid in case of a long-term healthcare event (generally need to be spent down first before qualifying).

Revocable trusts have their place in estate planning and are generally recommended for families that have a net worth under the federal estate exemption (currently $12.06 million per spouse in 2022).

An irrevocable trust cannot be easily changed or amended (very few instances that allow changes to be made) while the grantor is alive. In most cases, the trustee and beneficiaries must approve any changes.

Here are some advantages of irrevocable trusts:

1. There are tax benefits. Assets that are in the trust are not part of the grantor’s estate, which could save 40% on taxes if their net worth exceeds the federal estate exemption.
2. They are generally asset protected (from creditors and lawsuits) while the grantor is living.
3. ?Since the assets are owned by the trust and not included on the grantor’s balance sheet (after being in the trust for 5 years), they do not impact qualifying for government benefits in the case of a long-term health care event.

There are also a few disadvantages:

1. They are subject to higher tax rates. Income that is generated from the trust is generally taxed at a higher rate since it is separate from the grantor.
2. An additional tax return is required to be filed each year for the trust, separate from personal tax returns.
3. They can be complex, and the rules can be hard to understand.

Assets that are held inside of the trust should also be carefully considered. In 2022, any income generated by a trust over $13,450 is taxed at the highest federal tax rate of 37%. Because of this, it is not recommended to hold assets that have interest (such as corporate bonds). Instead, assets that are growth oriented, or permanent life insurance, can be the most tax efficient assets to hold inside of a trust.

When deciding on which one would be right for you, there are numerous factors that need to be considered, such as, net worth, estate planning goals, etc. Generally, if the grantor wants to maintain control over the assets, a revocable trust makes more sense. But if there is a larger estate, then an irrevocable trust can help save on estate taxes by using the trust as a mechanism to gift into each year.

As always, you should consult with a trusted estate planning attorney before implementing any trusts to your estate plan.

Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.

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