Selecting the Trust That’s Right for You

Have you recently sold a business and received a windfall from the sale? Has a recently passed relative left behind a sizeable cash inheritance for you? Are you likely to be subject to estate taxes? These are just a few examples of financial situations that could warrant the establishment of a trust. However, many are hesitant to take that step due to a lack of understanding of how trusts work.

In essence, a trust is a legal document that spells out how you want your assets to be used and distributed, either during your lifetime or once you pass. A trust may allow you to avoid probate on certain assets and can help mitigate estate taxes. It also works in conjunction with your will and is one of the legal documents that may be included in your estate plan – which we covered in this issue of On Course. Looking a little deeper, there are different types of trusts that are suited for specific circumstances.

Types of Trusts

A legal document, which is typically part of your estate plan, creates your trust. The type of trust you choose will depend on the complexity of your financial situation and what you wish to accomplish.

  • Irrevocable trusts lock you into provisions on how your assets are used and distributed. Once you create an irrevocable trust, you cannot change its terms.
  • Revocable trusts allow you to revoke or amend the terms of the trust at any time you choose, thus providing more flexibility.

The primary difference between these trust types is the amount of flexibility they offer. Taxation is also a significant differentiator since irrevocable trusts are taxed at a higher rate, while revocable trusts are typically taxed at your personal rate. Additionally, irrevocable trusts are not generally eligible for a cost basis “step-up” (a tax benefit we covered earlier this year).

Selecting a Trust

The type of trust you set up will depend in large part on the amount of flexibility you need. Do you wish to specify how much can be taken out each year for beneficiaries, or how the funds can be used? This level of control is typically achieved with an irrevocable trust. If you’d like to allow more flexibility, a revocable trust may be a better fit.

The trust you select also depends on the estate tax laws in place. Currently, legislation has been proposed by Congress that could impact estate plans by decreasing the estate tax exemption amount. This pending legislation could lower the current $11.7 million threshold to anywhere from $3.5 to $6 million per person – a significant decrease with big implications. Since the assets they hold are not considered part of your estate, irrevocable trusts can help minimize estate taxes and protect assets from creditors; benefits offset by higher trust tax rates and a loss of flexibility.

The First Step

An attorney can help you determine if a trust is right for you and if so, what type of trust is best suited to your situation. While it’s not yet clear what Congress will do, if you’re in a complex financial situation or have assets exceeding the currently proposed $3.5 - $6 million estate tax exemption amount, the first step is to start a conversation with an estate attorney. Richard P. Slaughter Associates can refer you to an attorney, as well as provide education around trusts. We’ll also work to ensure all accounts in our care are in alignment with your estate plan, including assisting with retitling assets to your trust if appropriate.