(Like all of our posts, this piece is for informational purposes only and should not be construed as investment, tax or legal advice)
When I meet with clients to discuss their estate plan, the topic of trusts often comes up.
The word itself conveys safety and security which I think is naturally why investors gravitate to trusts when talking about the passage of their assets.
Trusts aren't for everyone, however and should be understood at least at a high level to determine if establishing one is the right move for you and your family.
What is a Trust?
First, let's quickly define in layman's terms what a "trust" is.
A trust is a legal relationship between two parties whereby one party (the grantor) transfers assets to another party (the trustee) who has the fiduciary responsibility to hold and manage said assets on the behalf of one or more beneficiaries. This relationship is memorialized in a formal legal document that the grantor and trustee are required to sign.
Trusts are commonly used when the grantor wants control over how their assets are to be distributed/managed upon their death, to avoid probate, or to reduce or eliminate estate and gift taxes.
With the 2023 estate tax exemption currently sitting at $12.92 million per individual, high net worth investors tend to benefit most from trusts. However, lacking millionaire status doesn't preclude you from setting one up and receiving economic value.
But before you go out and have your attorney draft a trust agreement, let's first identify the different types of trust you may want to consider.
In general, trusts fall into two main categories: Revocable and Irrevocable Trusts.
Revocable Trusts
Often called a living trust, a revocable trust is an estate planning tool that allows the grantor the ability to make changes to the direction and management of their assets at any time.
For example, after your revocable trust agreement is established, you as the grantor may decide to add or remove a beneficiary, update beneficiary percentages, modify trust terms, etc.
Some of the more common reasons people setup revocable trusts are for:
Privacy & Avoiding Probate: Having a revocable trust allows the grantor's family and beneficiaries to bypass the expensive, time-consuming public probate process while maintaining privacy of the estate that would have otherwise been made public had a trust not been in place.
Flexibility: Revocable means, well, it can be revoked. The grantor has the ability to change or dissolve the trust should she change her mind about how her assets will be distributed and managed.
Asset Management and Distribution: In the event of the grantor's mental or physical incapacitation, revocable trusts can be used to guarantee that the assets are managed and disbursed in accordance with the grantor's wishes.
Out-of State Assets: If the grantor owns real property, or plans to own real property in multiple states, a revocable trust will avoid separate probate hearings in the other states and instead be governed by the state in which the trust was created.
What revocable trust won't do, however is save you money on estate taxes or protect your assets from creditors. This is critical to understand as some people hear the word "trust" and automatically think creating one will accomplish these things.
If minimizing taxes and asset protection are important to you, an Irrevocable Trust may be the better route to go.
Irrevocable Trusts
Unlike their revocable counterpart, these trusts cannot be changed or dissolved by the grantor and are utilized more for tax planning and asset protection.
So for someone with an estate worth $15 million and multiple beneficiaries under the age of majority, an irrevocable trust may be appropriate if the grantor wants to protect and preserve their beneficiaries' inheritance in the most tax efficient way.
Irrevocable trusts tend to benefit those looking for:
Asset Protection: Unlike revocable trusts, assets moved into an irrevocable trust are typically shielded against judgments and creditors.
Reduce Estate & Gift Taxes: If you have a large estate, using an irrevocable trust can help you reduce or even eliminate estate and gift taxes leaving more to pass to your beneficiaries.
Asset Management and Distribution: Should the grantor become disabled, irrevocable trusts can be utilized to ensure the assets are managed and distributed by a trustee in accordance with the grantor's desires.
Government Benefits: Being wealthy can actually impede your ability to collect Social Security and Medicare. Placing assets in an irrevocable trust can help you qualify for government benefits without having to deplete your assets.
Address Specific Needs: Should the grantor have beneficiaries with disabilities or specific needs, an irrevocable special needs trust can be created to support the beneficiaries without barring them from receiving government assistance.
Legacy Planning: Irrevocable trusts, such as generation-skipping trusts or GSTs are a useful tool for families with large estates to transfer assets to future generations without having to pay inheritance taxes multiple times on the assets.
Charitable Giving: Irrevocable trusts can also be used to make charitable donations, such as charitable remainder trusts, which can pay the grantor income while they are still alive and then donate to charity after their passing.
Clearly, there are many different structures to consider as well as benefits to setting up a trust whether revocable or irrevocable.
Similar to investing in the public markets, however, there's no such thing as a free lunch.
Trust Disadvantages
Attorneys have a fiduciary duty to always act in the best interests of their clients. As such, they should be talking to you as much about the pros as they are the cons of establishing a trust.
Here are some drawbacks you ought to be aware of:
Cost: The average hourly rate for an estate attorney in 2021 was between $250 - $310. The inflation rate in 2022 was over 6%. Do the math.
Setting up and maintaining a trust can be expensive! Be sure the benefits outweigh the costs.
Complexity: Trusts can be complex legal documents that are often difficult to understand and manage, especially when dealing with large estates, private businesses and multiple beneficiaries.
They often provide peace of mind knowing your assets are protected and intentions fulfilled, though do make your financial life a bit more complicated.
Not Always Necessary: I always fall back on the "KISS" acronym: Keep It Simple, Stupid!
Trusts may not be necessary for everyone, depending on their specific circumstances.
You may be able to accomplish your estate planning goals simply by updating your will and beneficiary designations listed on your retirement accounts.
How Do You Setup a Trust?
If establishing a trust is something you're considering, start by contacting your estate attorney and requesting an appointment. From there, the process involves:
Choosing Beneficiaries: The grantor must select one or more recipients for distributions from the trust in accordance with the trust's provisions. Beneficiaries can be people like your children, grandchildren or institutions like a 501(c)(3) non-profit.
Establishing Trust Terms: With beneficiaries established, the grantor will work with the attorney to outline the specifics of the trust including assets to be transferred, trustee responsibilities, rights of beneficiaries and how it's to be administered.
Selecting a Trustee: The grantor must select a trustee who will be in charge of overseeing and allocating the trust's assets in accordance with its provisions. While still alive, the grantor may serve as the trustee; however, they must choose a successor trustee to manage the trust's assets in the event of their incapacity or death.
Drafting the Trust Agreement: Once the terms are established, the estate attorney will draft the trust agreement. From there, the grantor must transfer the designated assets to the trust. The estate attorney and/or financial advisor generally assists with this process.
Should You Setup a Trust in 2023?
Like with anything personal finance-related, it really depends on your personal financial situation and what you're hoping to accomplish.
At the very least, I most certainly would consider sitting down with your advisor or estate attorney to review your estate plan and make updates as necessary.
Tax laws are constantly changing so even though a trust may not have made sense in 2015 for example, it might be something to consider moving forward.
