What is the Purpose of a Trust?
By: Ingrid Johnson
There are two main types of trusts—Revocable/Living Trusts, and Irrevocable Trusts. This article provides a very short overview of the different purposes of a trust and why you would set one up.
Trusts can provide privacy, coordination of assets, asset protection from third-party creditors, gift and estate tax savings, protect beneficiaries from irresponsible spending habits, avoid or minimize the costs of probate, avoid or minimize the costs of probate in multiple jurisdictions, plan for special needs individuals to avoid jeopardizing their eligibility for public assistance benefits, provide flexibility and control in asset distribution, and streamline asset management upon incapacitation and death, among other things.
However, different trusts provide different benefits—no trust does it all. For example, a Living Trust can avoid probate and provide privacy but unlike Irrevocable Trusts, it generally does not provide any asset protection during your life. Let me explain some of these benefits further.
Do Trusts Provide Asset Protection?
Some trusts provide protection from creditors, and some do not. A basic estate plan will often include a Living Trust. A Living Trust does not provide asset protection during your life. However, upon your death, you can build in a Marital Trust within your Living Trust, which can provide some asset protection. For example, the Marital Trust can distribute income to your spouse during his or her life but hold the principal in trust to ensure it is distributed to your children upon your spouse’s death. If your spouse remarries, the Marital Trust will prevent his or her second spouse or any stepchildren from being able to reach the trust’s principal. A Living Trust can also hold assets in trust for your children or more remote descendants for the same purpose of providing protection from creditors. Keep in mind, anything your beneficiary can reach, their creditors can likely reach too.
Irrevocable Trusts can provide asset protection during your life as well as after your death, subject to certain fraudulent transfer laws. However, there are tradeoffs to asset protection. If you put assets in an Irrevocable Trust, you will have to relinquish control and other rights over those assets. If you are looking to purchase rental properties but would like to be protected from personal liability if anything goes wrong, you may be better off forming a limited liability company (LLC) or other similar entity instead of relying on a trust to protect you from liability. However, there are reasons to layer in an LLC along with a trust that you may want to discuss with an estate planning attorney.
Do Trusts Avoid Probate?
Another key benefit of trusts is that they avoid probate. Both Living Trusts and Irrevocable Trusts can avoid probate but typically, you would set up a Living Trust to avoid probate and an Irrevocable Trust to do some more advanced tax planning. See my article on Wills v. Trusts for a more in-depth discussion on the benefits of avoiding probate.
Do Trusts Avoid Death Taxes?
Another difference between Living Trusts and Irrevocable Trusts is their tax implications. Living Trusts are included in your gross estate upon death, so they do not provide any tax savings. Irrevocable Trusts allow you to gift assets during your life and potentially avoid paying any estate or gift taxes on the amount the assets appreciate after being gifted into the Irrevocable Trust. Irrevocable Trusts are not included in your gross estate upon your death so amounts in an Irrevocable Trust are not subject to estate tax upon your death. However, the tradeoff is that you do not get a step-up in basis on the assets within your Irrevocable Trust upon your death. Typically, assets within your gross estate will get a step-up in basis upon your death. This can be a big perk if your beneficiaries want to sell that asset because it can minimize or eliminate capital gains tax. However, if the asset is expected to appreciate greatly during your lifetime, it may be a better option to transfer it to an Irrevocable Trust so it can appreciate gift and estate tax-free. This is just one example of strategic tax planning with trusts. There are many mechanisms and types of trusts estate planners can use to distribute your assets in a tax-efficient manner.
The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship.