Estate Planning Basics – Trusts

Published On: May 26, 2020

Written by: Ben Atwater and Matt Malick

This is the fourth installment of our Estate Planning Basics series.  We began discussing the core documents you need for an estate plan, examined the differences between probate and non-probate assets, addressed life insurance and now we turn to trusts. 

Although we still use trusts for tax planning reasons, it is less common than years ago due to the high federal estate tax exemptions.  For a married couple to have a federally taxable estate, their net worth must reach $23,160,000 in 2020 (a threshold that applies to very few families).  That said, this large exemption runs through 2025 when Congress will need to write new legislation, or the exemption will drop back to the pre-2018 level, as indexed for inflation. Current estimates are that the exemption may be approximately $6,000,000 per person at that time (or $12,000,000 for a married couple). 

Today, we commonly employ trusts to control assets and give directives after incapacity or death.  For example, we use trusts to manage assets for minors, special needs beneficiaries, spendthrifts, etc.  We use trusts to avoid probate, including property we own in other states; to give us more privacy; and in certain circumstances to reduce taxes. 

As you might imagine, trust planning can get quite nuanced and complex, so this essay will take a basic and high-level approach to the subject. 

At a base level, there are two types of trusts: revocable trusts and irrevocable trusts.  A grantor, one who creates a trust, can change the terms of a revocable trust at any time, up to and including terminating the trust.  With an irrevocable trust, the trust cannot change after the grantor creates it without some hurdles, some major (like court approval) and some relatively minor (like grantor and beneficiary consent). 

With a revocable trust, the grantor is typically also the trustee, which means the grantor maintains control over the assets, whereas with an irrevocable trust the grantor typically must appoint an independent trustee, which means that the grantor loses ownership and most control of the assets.  As a general example, someone might use a revocable trust to hold ownership of a vacation home in another state to avoid probate in a second state upon death.  Or someone may own a vacation home in a more complicated irrevocable trust in order pass the property to heirs in a tax-efficient manner and also to avoid probate.  In this case, the grantor will ultimately lose absolute control over the property.

In addition to revocable and irrevocable trusts, you have other broad classifications of trusts like inter-vivos and testamentary.  An inter-vivos trust (which is routinely revocable) is simply a trust that is established during the lifetime of the grantor. Revocable trusts (also known as living trusts) are inter-vivos trusts that are set-up during a person’s lifetime to manage assets and to ultimately avoid probate. 

In Pennsylvania, beware of those promoting moving all your assets into living (revocable) trusts to “avoid probate.”  Much of the record keeping and tax filing that death requires is needed for both probate and non-probate assets. Additionally, a revocable trust must be attached to the Pennsylvania inheritance tax return, which is available for public inspection and which negates the “privacy” benefit often touted for revocable trusts.  The “shortcut” people often presume results from avoiding probate is generally misunderstood and overstated.  For most, a living trust is simply unnecessary. 

A testamentary trust is a trust that comes into existence upon the death of the grantor. Your last will and testament stipulates the creation of this trust after your death.  In this case, you would need to name a trustee.  This could be an individual or individuals with whom you have great confidence.  You could also designate a corporate trustee which takes the form of a bank or trust company, or some combination of individual and corporate trustees.  The list of pros and cons in this department is long.  Finding the proper trustee is sometimes the most difficult decision you will need to make in the creation of a trust. 

At death, your executor guides your assets through probate and then your assets fund the testamentary trust.  The purpose of the testamentary trust is oftentimes to manage assets for minors or for special needs beneficiaries.  Considering a disabled child who will need some degree of lifetime support, your will would create a testamentary trust (even a specific type called a special needs trust) to help provide financial assistance.  Or if you die leaving minor children you might set-up a trust under will providing for their support, education, health and welfare while also balancing the interests of a spouse whose support you may also need to provide for. 

Wills often create testamentary trusts for spendthrift beneficiaries, people who spend money in an irresponsible way, or for people lacking financial acumen who do not know or do not have an interest in the fundamentals of financial management. 

For testamentary trusts like those we just described, beneficiary designations for non-probate assets, like retirement plans and life insurance policies, will name the testamentary trust as the beneficiary in order that the trust collects the bulk of the decedent’s assets and the trust can best carry out its purposes.  With the passing of the SECURE Act at the end of 2019, you should consider reviewing previously drafted trusts that will receive retirement accounts to ensure that the tax code changes will not adversely impact your plan.

There are all kinds of trusts for all kinds of purposes.  In addition to revocable, irrevocable, inter-vivos and testamentary, which we briefly discussed, there are asset protection trusts, charitable trusts, life insurance trusts, dynasty trusts, qualified personal residence trusts, qualified terminal interest property trusts, marital trusts, bypass trusts, etc.  The list is long. However, every trust should have a purpose, and if you are unsure of the purpose of an old or outdated trust, you should have it reviewed.

By virtue of this kind of specificity and complexity, it is vital to have highly qualified legal assistance in your trust planning.  Finding an attorney who focuses his or her practice on estate planning is particularly important in creating a trust. 

We are always happy to discuss your estate planning in broad strokes as well as coordinate with the appropriate estate planning attorney to help you realize your goals.  Please do not hesitate to call or email if we can be of further assistance. 

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