Trusts are often thought of as a financial tool of the very rich, but you don’t have to have millions to benefit from what a trust can do for you.
The ultra-wealthy set up trusts so they can pass on significant sums of money to family members, charities and other entities after they die. Why not just have a will instead of a trust?
A trust is very similar to a will, but allows you even more control over what is going to happen to your property and possessions after your death. Say for example you want to leave money to a family member, but are worried about how them being irresponsible with a lump-sum of cash.
In this case a trust would be more beneficial than a will. A trust allows you to put conditions on certain assets and how they are distributed. You can specify in a trust that money only be given to a recipient at certain age or time intervals, or only for education purposes. A will cannot do those things.
Trusts are also a favorite of the ultra-wealthy because they can be used to minimize estate taxes, which is why they are useful if you have a lot of property, even if not a lot of cash.
Trusts may be revocable or irrevocable. In a revocable trust, you still have control over the assets. You may still do anything you like with the property, and you may change the conditions of the trust at any time.
Irrevocable trusts actually remove the property from your control – it is in a trust and does not belong to you anymore in a sense. Changes cannot be made without the beneficiary’s consent.
While that may sound scary and counter-intuitive to what you are trying to do-there are benefits to an irrevocable trust. The main benefit being tax exemptions.
Since the assets you put in the irrevocable trust no longer belong to you, you don’t have to pay income tax on any money made from the assets, which is common with real estate and investments.
This is also a great benefit for retirement planning purposes-the removal of these assets from your net worth may move you into a lower tax bracket, thus reducing how much you pay in taxes.
Irrevocable trusts also allow you to avoid estate taxes. The estate tax is levied upon the estate of the deceased taxpayer and the government requires payment before any estate assets are distributed to heirs.
But since the irrevocable trust takes those assets placed in it away from taxpayer, they are not subject to the estate tax.
Another savvy way to avoid paying the dreaded estate tax is to set up a generation skipping trust. This sounds like a trust for people who do not like their children, but that’s simply not true.
If a person passes assets onto their children, they will be taxed at the standard 45% estate tax-taking a rather large chunk of money away from a person’s heirs. Later on, when the children pass on money to their heirs, the money would be taxed again at the same overly high tax rate, essentially taxing the same money over and over again.
The generation skipping trust avoid double taxation. Your children also don’t get completely left out. You can set up the trust so that any income generated by the trust’s assets, such as dividends, or rent from commercial properties is available to your children, while protecting the asset for your grandchildren.
The federal estate tax levies against estates greater than $5.45 million for each spouse. So essentially if your estate is less than $10.9 million you’d be safe from federal estate taxes. This high figures makes most people think they don’t need a trust to avoid estate taxes.
But that’s not necessarily true. Each state also has an estate tax and it is usually much lower than the federal tax. Many middle class people’s assets are greater than their state’s minimum taxable amount, but don’t find out until it’s too late.
In this case a credit shelter trust is a good idea. With this one you put a certain amount into a trust, and then pass on the rest of your estate to your spouse and do not have to pay taxes on that amount. It is also called a bypass trust, and that money is never subject to estate tax.
If you have a sizeable life insurance policy, you may be subject to your state’s estate taxes. In this case you should set up an irrevocable life insurance trust.
This removes your life insurance benefit amount from your estate. In this trust you surrender ownership of the policy, but it can be used to pay estate costs and gives your heirs tax free income.
In cases of blended families, where step children or other complicated family matter exists, it’s prudent to use a qualified terminable interest property trust. This allows you to leave your assets to your spouse, and to then leave the rest after your spouse dies, to only the ones you specify, such as children from a first marriage.
One great advantage of a trust is that it helps you avoid probate court. When a person dies, the probate court must verify the will and distribute the assets.
If there is no will, the probate court makes rulings. This is expensive and can take a few months or even a few years. The good news is, anything that is in a trust, will not have to go through this legal process.
A trust is like a will, but better, because it gives you more specific control over how your assets are distributed after you die. The trust also reduces taxes the beneficiaries have to pay when they receive your property. It would not have to be a lot of property for the taxes to be a burden on the ones receiving your property.
For instance, if you owned 200 acres of land that had a good value, the estate tax there, and the probate court costs, could get into thousands of dollars quickly. With a trust, you would have some up front expense, but it would eliminate the probate and tax problems your beneficiaries would face after your death.
Regards,
Ethan Warrick
Editor
Wealth Authority
