Estate Planning Basics – Trusts

Published On: May 15, 2024

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 $27,220,000 in 2024 (a threshold that applies to 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 $7,000,000 per person at that time (or $14,000,000 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, beneficiaries with special needs, and spendthrifts. We use trusts to avoid probate, including property we own in other states; to give us more privacy; and in certain limited circumstances to reduce taxes. And we also frequently employ trusts in blended families to protect children and stepchildren.

As you might imagine, trust planning can get quite nuanced and complex, so this essay will take a 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 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 significant control of the assets.

As a general example, someone might use a revocable trust to take ownership of a vacation home in another state to avoid probate in that 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 to avoid probate. In this case, the grantor will lose absolute control over the property.

In addition to revocable and irrevocable trusts, there are other broad classifications of trusts like inter-vivos and testamentary. An inter-vivos trust (which is routinely revocable) is simply a trust that the grantor established during his lifetime. 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 avoid probate.

In Pennsylvania, beware of those promoting moving all your assets into living (revocable) trusts to “avoid probate.”  The government requires much of the same record keeping and tax filing for both probate and non-probate assets. Additionally, filers must attach a revocable trust to the Pennsylvania inheritance tax return, which is available for public inspection, and which negates the “privacy” benefit often touted for revocable trusts. People can misunderstand and overstate the “shortcut” of avoiding probate. 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, and upon your death, the trust is created and irrevocable. 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 to naming corporate trustees 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. If you have minor children who are beneficiaries, you should set up a trust under will providing for their support, education, health and welfare until such time as the beneficiary reaches an age where they are mature enough to manage their inheritance.

If you have a beneficiary with a disability and who will need some degree of lifetime support, your will would create a testamentary trust (a specific type called a special needs trust) to help provide financial assistance to the beneficiary with special needs so that the beneficiary is not disqualified from receiving public benefits and assistance.

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, should likely name that testamentary trust as the beneficiary so that the trust collects the bulk of the decedent’s assets, and the trust can operate effectively. Trusts that will receive qualified retirement assets like IRAs and 401(k)s must contain certain language to comply with IRS rules for these trusts to work properly.

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, spousal access 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 call or email if we can help. As a rule of thumb, you should review your estate plan when you have a major life change, and if things are status quo, then at least every five years.