Your Last Will and Testament (“Will”) is an important instrument to draft and have in place when starting your estate planning process. However, your Will is not the only document you can use to properly devise your wealth and assets in order to properly distribute them when you pass away and/or become incapacitated and are in need of physical and/or mental assistance during your last years of life.
Per the U.S. Internal Revenue Service (“IRS”), “a trust is a relationship in which one person holds title to property, subject to an obligation to keep or use the property for the benefit of another.” (available at Internal Revenue Service, https://www.irs.gov/charities-non-profits/definition-of-a-trust (last visited October 23, 2022)). In lay terms, think of a trust as a virtual vessel for your money and property. You, as the grantor, trustor and/or donor, may designate yourself as the trustee and beneficiary during your lifetime, depending on the type of trust. A trustee is the person who will manage the trust. However, upon your death and/or incapacitation, another person will have to manage such assets on your behalf.
There are different types of trusts depending on the goals you may have. Nonetheless, the main goal of all trusts is to transfer assets to heirs and beneficiaries and, at the same time, minimize or potentially eliminate estate taxes. As a general rule, trusts fall into four (4) categories: (1) inter vivos trusts or living trusts; (2) testamentary trusts; (3) revocable trusts; and (4) irrevocable trusts.
Types of Trusts:
Inter Vivos Trusts or Living Trusts
These types of trusts are created during the trustor’s lifetime. They may be revocable (which may be modified or completely revoked) or irrevocable (which means that control and ownership of everything within the trust is relinquished). You, as the grantor, may serve as the initial trustee and transfer property in and out of a revocable trust. However, upon your death, your revocable trust(s) turns into irrevocable trust(s) by operation of law. In addition, the trustee of an irrevocable trust is usually someone other than the grantor (e.g., a financial professional that is able to manage the assets).
Totten trusts are revocable trusts and are sometimes called: “poor man’s trust” since, technically, you do not need a written legal document in order to establish them. These trusts cannot be used for real property and, usually, a person utilizes bank accounts and certificates of deposits from applicable financial institutions when creating totten trusts.
Irrevocable Life Insurance Trusts
If you have a life insurance policy, as the grantor, you may create an irrevocable life insurance trust. In this case, the trust, that you as a grantor fund, pays the monthly life insurance premium. In one hand, your estate is reduced, however, depending on the terms of the trust, distribution of the funds may occur over a period of time, which could have a number of beneficial financial aspects depending on a case-by-case basis.
You may want to leave some of your assets to a charity or nonprofit of your choosing and, subject to its structure, a charitable trust may reduce income tax, estate taxes or gift taxes, as well as reduce or delay capital gains taxes. You may choose to create a Charitable Remainder Trust or a Charitable Lead Trust, which are the main two types of charitable trusts.
Special Needs Trusts
You may also want to leave a gift to a beneficiary with disabilities. In this case you need to be careful that you do so without jeopardizing other benefits said individual may have (e.g., Social Security benefits, government benefits, etc.).
Dynasty trusts or Generation-Skipping Trusts
Have you ever considered that your own children are not good wealth administrators? A dynasty trust or generation-skipping trust allows you to transfer assets to your grandchildren and skip a generation. It also has certain estate taxes benefits you may want to consider.
You may, or may not, be aware of the fact that an heir may use its interest on a trust as collateral for a loan. However, that is not permissible under a spendthrift trust. This instrument is most commonly used by grantors that know a specific heir may not have the maturity or capabilities of handling a large and sudden influx of money (e.g., having problems with gambling, drugs, alcohol, clearly mismanagement of money, etc.).
A surviving spouse may not always inherit everything from their late husband or wife. Therefore, it is important that, as a couple, you ensure the remaining spouse is taken care of. You could do this by setting up a joint marital trust, which will cover both spouses.
Qualified Personal Residence Trusts
Do you own a home or a vacation property? This type of trust removes the value of such properties from your estate and, therefore, reduces the amount of gift tax when transferring assets to beneficiaries. You should be aware that this type of trust is irrevocable.
Qualified Terminable Interest Property Trusts
If you re-married, have children from a previous marriage and/or have stepchildren, you may want to consider establishing a qualified terminable interest property trust. This type of trust will allow you to control where your assets and property go once your surviving spouse dies.
There are many other trusts that are less common, such as: pet trusts, asset protection trusts, gun trusts or National Firearms Act (“NFA”) Gun trusts, constructive trusts, etc. You should always remember that trusts are formed under state law, and therefore, you should seek local legal advice in order to ensure you are correctly establishing any type of trust depending on your circumstances, the state you live in and your ultimate goals for your estate planning needs.
Please note that this blog should be read for informational purposes only. If you have any questions or require additional information, please contact our office.
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