Many people do not understand what trusts are, how they can be beneficial, and whether they should have one. The following is a good overview from Kiplinger online, written by Deborah Yao in November. If you’ve wondered about trusts, this article should help.
“Your choice to set up a revocable vs. irrevocable trust could have a big impact on your heirs.
When deciding between a revocable vs. irrevocable trust, you should consider your net worth and what type of tax shelter your heirs may need. Although it may be tempting to set up a will and consider your estate planning complete, trusts are critical for organizing how your assets are distributed during your lifetime and after death. Both types of trusts have pros and cons that can significantly affect your estate and beneficiaries.
If you worry that a more sophisticated plan involving trusts only belongs in the heady realm of estate planning for millionaires, think again. There are plenty of ways to save money on estate plans include irrevocable trusts and other bells and whistles.
Revocable vs. Irrevocable Trust
How do you decide which trust is best for you and your family? Both types avoid the dreaded probate process when a court manages the distribution of your assets after death. Probate can be costly, lengthy and public. Both types also require a trustee to manage the trust, a legal entity that governs the treatment of your real estate, investments, cash, and other assets.
The type of trust to set up comes down to what you wish to accomplish.
Revocable Trust: The People’s Choice
As its name suggests, a revocable trust, also called a revocable living trust, gives you the right to make changes to or terminate the trust in your lifetime. Its biggest feature is the flexibility and control it gives the grantor — or you, the asset owner. The biggest drawback is that assets in the trust are still counted towards income and estate taxes. It also is not protected from creditors, legal judgments, liens and other obligations.
“To choose between a revocable or irrevocable trust will be based on their needs. If they want to maintain control of their assets, and they need those assets during their lifetime, then they would use a revocable trust,” said Lee McGowan, president of Monument Group Wealth Advisors in Concord Mass., which manages $550 million in assets.
Most people choose to set up revocable trusts unless they are high-net-worth individuals seeking to maximize their estate and gift tax exemption, said Betty Wang, president of BW Financial Planning in Denver.
For 2025, assets up to $13.99 million per person ($27.98 million for a married couple) are exempt from federal estate and gift taxes. So, if a person’s estate is worth $20 million, they might choose to put $7 million in an irrevocable trust. The remaining $13 million can be held in a revocable trust and is exempt from federal estate and gift taxes since it falls under the cap. However, they still have to pay income taxes on it. (Currently, 12 states and the District of Columbia also levy estate taxes.)
Typically, the owner or grantor is also the trustee of the revocable trust, although others can also be trustees. A married couple can be co-trustees so that when one spouse becomes incapacitated or dies, the other can carry on. When both have died, the trust becomes an irrevocable trust.
Irrevocable Trust: Is It Really a Tax Shelter?
An irrevocable trust is one in which the grantor gives up the ability to control or benefit from the trust assets once the trust is set up. People choose this type of trust if they have a specific purpose for the funds, such as controlling the payout to beneficiaries, designating the funds for a purpose, and protecting assets from liens, legal judgments, creditors, divorces and other obligations.
Due to state law changes in past years, it has become easier to change irrevocable trusts. “It’s a bit of a misnomer that an irrevocable trust can’t ever be changed,” McGowan said. “You can — it depends on the situation.”
One way is the designation of an independent trustee to make changes consistent with the grantor’s wishes. Another way is to give a beneficiary the power to appoint or redesignate the recipient of trust assets. The court also can order changes to a trust — or trustees can do what’s called “decanting,” moving assets from an old trust to a new one with better terms and conditions, as long as the changes are reasonably consistent with the original intent of the trust, McGowan said.
An attractive benefit of an irrevocable trust is that the grantor does not pay taxes on it; the trust can pay its own taxes without distributing its income. Alternatively, the trust can choose to give the income to beneficiaries, who will be the ones to pay taxes. This might be a better option if the beneficiaries fall into a lower tax bracket.
That’s because the taxes levied on the trust can be at par with the highest income tax rates. Within the trust, any ordinary income above $15,200 falls into the 37% marginal tax bracket, said Roger Stinnett, managing member of Stinnett Wealth Planning in Seal Beach, Calif. In contrast, the 37% rate doesn’t kick in for income taxes until $609,350 for a single taxpayer or $731,200 for joint filers in 2024 (and $626,350 and $751,600, respectively, for 2025 tax brackets).
Nevertheless, Stinnett sees a rush of people setting up irrevocable trusts by 2026, when the $13.99 million estate tax exemption (up from $13.6 million in 2024) will be cut roughly in half. That means they have less than two years to create and fund these trusts.
Related trusts
Beneficiaries with disabilities may need another type of trust, which can be revocable or irrevocable. These trusts provide for disabled beneficiaries without jeopardizing their government benefits.
Business trusts can help protect assets within LLCs, among others.
Life insurance trusts, which hold proceeds from insurance policies, are also fairly common but are irrevocable.
States with the most favorable trust laws
A trust created in one state is valid in all other states. However, each state has its own rules that apply to trusts. You can set up a trust in any state in which you have sufficient connections, such as having a vacation home in that state. In general, look at each state’s tax treatment of trusts, asset and creditor protection, privacy and modification rules.
The best states for trusts are Nevada, South Dakota, Delaware, Alaska and Wyoming, according to U.S. Bank. They do not charge state income taxes, offer perpetual trusts that are passed down through generations indefinitely, and provide asset protection and flexible decanting.
However, if the trust elects to shift the tax burden to beneficiaries, these favorable tax laws will be moot if beneficiaries don’t live in these states.”
I hope this article helped clarify things. I’d be honored to help with your estate planning and update or create your plan, whether that includes a trust or not. And this is the perfect time to take action. You can take advantage of having loved ones in town for the holidays to discuss your plans and get their input. Give me a call to schedule a consultation. I can be reached at 513-399-7526 or schedule our meeting on my website which is www.davidlefton.com.
Source: Kiplinger November 2023 by Deborah Yao