09 Jul Trusts: Revocable vs. Irrevocable
Spring Lake. Fish Tacos. Asbury Park. Betty’s Icebox. The 4th of July was full of memories! Hope you and your family enjoyed the holiday, too.
Let’s get into this week’s topic.
“I Need a Trust”
I was talking to an entrepreneur about estate planning.
“I want an irrevocable trust,” she said.
“What are you looking to accomplish?” I asked her.
“My husband and I want to protect our children (ages 5 through 12) if something happens to us. My father also recently passed away and I’m the executor in his will. I’m dealing with probating his estate and it’s an expensive and time-consuming process. I want to avoid our kids having go through this. We also want to save on taxes, and we want protection so we don’t lose everything if we are sued.”
I explained to her that, based on her objectives, an irrevocable trust could accomplish some of those goals. But these trusts have important requirements and restrictions that may not be attractive to her.
Since I receive these types of questions so often, below is a useful overview for you to give you a very simplified and high-level overview of trust planning. As always with estate planning, the devil is in the details. If you think any of this planning is for you, reach out to us to explore specifics.
Is Trust Planning for You?
There is so much information (and misinformation) online and on social media about trusts. When someone I first meet tells me they need trust, my first instinct is to dig deeper to explore what they’re looking to accomplish.
It is useful to think of estate planning as a toolbox. Trusts are tools amongst many other tools in that toolbox. There are situations where you need a very specific type of tool (for example, a miter saw), but there are other situations where that same tool gets you nowhere. It all depends on what you’re looking to accomplish.
With that in mind, let’s get some basic context for thinking about trusts and situations where they are the correct tools.
Revocable Trusts: Help Your Family Avoid Court and Conflict
Revocable trusts, also known as living trusts, are widely used by people who want to save their loved ones’ expenses and frustration after their death. If you want to pass your inheritance to your family at your death in the most seamless and smoothest way possible, without them needing to struggle through a long, expensive, and time-consuming court process (i.e. probate), then this is the type of trust for you. This probate process can cost your family tens of thousands of dollars and stretch out to a year or more.
Unlike a will, a revocable trust allows your assets to bypass the probate process. A significant advantage of revocable trusts is their flexibility. As the settlor, you retain control over the assets within the trust and can modify, amend, or revoke the trust entirely at any time during your lifetime. This flexibility allows you to adapt to changing circumstances, whether they are personal, financial, or related to your beneficiaries’ needs. For these reasons, revocable living trusts are often considered part of foundational estate planning no matter what your family dynamics and net worth.
Irrevocable Trusts: Diverse Options for Specific Goals
Irrevocable trusts, while powerful, do not make sense for everybody. In contrast to revocable trusts, irrevocable trusts primarily focus on providing specific tax benefits and asset protection. Once established, an irrevocable trust cannot be changed or terminated (or it is often very difficult to make changes to this type of trust). This rigidity is what tax laws and regulations require for you to benefit from the powerful tax and asset protection powers of these tools.
Wealthy families utilize irrevocable trusts to minimize estate taxes they would be required to pay at death. Due to the federal estate tax exemption’s historically high threshold (for 2024, it is $13.6 million for individuals and $27.2 million for married couples), unless your net worth is at or above those levels, most types of irrevocable trusts probably do not make much sense for you. But that federal estate tax threshold is set to sunset to a much lower level (approximately $6 million per individual and $12 million per married couple) in 2026 unless Congress acts before then to keep the thresholds higher.
Another consideration when thinking about estate taxes is where you live. While the federal estate tax may not be a threat for you given its historically high threshold, your state may impose a much lower state-level estate tax. For 2024, multiple states impose a state-level estate tax. For example, New York’s threshold is $6.94 million per individual; Massachusetts’s is $3 million per individual; and Maryland’s is $5 million per individual, among other states having lower thresholds. Some of those state-level estate tax thresholds can be as low as $1 million per person so it is important to check your state’s laws to see whether you may be at risk.
Irrevocable Trusts and Tax Planning
If you are at or near the federal or state estate tax threshold, then there are various types of irrevocable trusts that can help you create, grow, and preserve generational wealth.
Below are some examples:
Irrevocable Life Insurance Trusts (ILITs)
If you are the owner and insured on a life insurance policy, then the death benefit will be included in your gross estate. This could trigger substantial estate taxes if you are at risk of triggering one of the estate tax thresholds referenced above. This type of trust can be structured to manage life insurance policies without the death benefit increasing your estate taxes upon your death. Like all trusts, it is critical that this trust be structured properly for it to work as intended and to reap the tax benefits.
Grantor Retained Annuity Trusts (GRATs)
When passing wealth from one generation to the next, gift and estate taxes can eat away large swaths of that wealth. To address that problem, these types of irrevocable trusts can be structured to transfer wealth to children with minimal gift tax consequences. You, the settlor, receive annuity payments for a set period, and at the end of the term, any remaining assets in the trust pass to the beneficiaries, often with significant tax savings. Again, it is paramount that this type of trust be structured and set up in strict compliance with tax laws and regulations, otherwise, the planning will fail.
Spousal Lifetime Access Trusts (SLATs)
These irrevocable trusts allow one spouse to create a trust for the benefit of the other spouse, providing potential income and access to trust assets while also removing those assets from the settlor’s taxable estate. This strategy, if set up properly, can help manage estate tax liability and offer some level of asset protection.
Charitable Remainder Trusts (CRTs)
These types of trusts provide a way to support charitable causes while also benefiting from income during your lifetime. You, the settlor, receive a percentage of the trust’s assets annually, and upon your death, the remaining assets go to the designated charity. This can provide income tax deductions and help manage estate taxes.
One Size Does Not Fit All
These are only a sampling of the many types of trusts that exist. The key takeaway when considering trusts is recognizing that not all trusts are created equal.
The key to determining whether this type of planning will help you is talking with your advisors (your financial advisor, lawyer, CPA, etc.) about what risks you are looking to avoid. You and your advisor team then work collaboratively to engineer an effective and holistic strategy.
Take Action
Ready to explore how to protect your family? Whether you’re looking to save your family from the cost and frustrations of probate or you’re looking to taxes and protecting yourself from lawsuits, we’ve got you covered. Reach out to us to get started getting your protections in place: Schedule a Call Now
