We generally recommend that everyone obtain some basic documents for their estate planning, including a will, a financial power of attorney, a health care power of attorney, and a living will. And, it is critical for everyone to review how their assets are titled and how their beneficiary designations are named on certain type of assets such as retirement assets and life insurance. Beyond that, you may be wondering whether you need a trust. If so, what type of trust do you need?
Before we discuss whether a trust is needed for your estate planning, let’s briefly touch on the definition of a trust. A trust is basically an arrangement that a “grantor” establishes for one party (the “trustee”) to hold assets for a third party (the “beneficiary”). This arrangement is generally set out in a trust agreement which is either a stand-alone document or embedded in another document like a will.
Trusts can vary in a number of respects, including whether they are revocable or irrevocable, whether they come into existence during life (“inter vivos”) or at death (“testamentary”), and whether they receive a certain type of tax treatment (grantor v. non-grantor). More importantly, the trusts can be further explained and distinguished by the objectives of the trust. In working with your advisors, crafting an estate plan appropriate for you should begin with an understanding of your goals – only then can the advisor begin to recommend a trust – if at all -- that makes sense for your situation. We will review some of these characteristics while highlighting the objectives that these trusts may accomplish. This will barely scratch the surface of important issues, but we hope to provide some introductory educational material.
As stated, trusts can be revocable or irrevocable. A revocable trust is often referred to as a living trust, and this is a document that many argue is either over-utilized or under-utilized, depending on one’s point of view. A revocable trust is created during life and is often used by the grantor for the following purposes: a) minimize probate, b) provide for smooth administration of one’s financial affairs upon incapacity, and c) provide privacy. During the grantor’s lifetime, the grantor is often the trustee and beneficiary.
Although probate costs should be minimized whenever possible, the probate process can vary dramatically from state to state. In Tennessee, for example, probate is not too onerous so many attorneys do not always recommend a revocable trust. In Florida, however, probate can be cumbersome and costly, and thus revocable trusts are more common. While most attorneys will put their clients’ best interests first, some third party “trust factories” – with or without attorneys – market these trusts as an absolute must and overcharge for such services. Whenever you have firms stroll into town to provide nice steak dinners with the promise of solving all of your estate planning nightmares with a golden revocable trust, visit with a local attorney to ensure you are getting what you truly need.
Nevertheless, revocable trusts can help provide for a smoother administration of the financial affairs (to complement a financial power of attorney) and may provide more privacy as the terms of the trust are generally not available for public inspection. Revocable trusts, by themselves, do not help minimize income taxes or estate taxes nor do they provide asset or creditor protection.
In contrast to revocable trusts, irrevocable trusts are often created to minimize estate taxes or provide asset protection. Irrevocable trusts can come into being during life or at death. While the name implies that these documents are irrevocable and cannot be changed, trust law provides some leeway in making future changes to this document (e.g., decanting, judicial or non-judicial modification, trust protectors) and flexibility can be drafted into the trust document. Of course, there are many more restrictions on changing this document compared to a revocable trust so the grantor should be careful about creating this trust and funding such trust.
Irrevocable trusts were once quite popular for the wealthy to minimize estate taxes. By creating an irrevocable trust during life and funding the trust with assets that were expected to appreciate, wealthy grantors attempt to transfer appreciation out of their estate and to their heirs and thus minimize estate taxes. With the increase in the federal estate tax exclusion to $11.18 million in 2018 (or over $22 million per couple), the need for irrevocable trusts for estate tax minimization has lessened significantly. Nevertheless, one should consider this type of trust if their estate is large enough to warrant estate tax planning, if they live in a state that has a more onerous inheritance tax system, or if they fear the federal estate tax exclusion may decrease.
Some irrevocable trusts are created for asset protection and preservation. Although less common, pure asset protection trusts are created to shield creditors from the grantor’s assets. These can be domestic asset protection trusts or foreign asset protection trusts. In fact, Tennessee has favorable asset protection statutes when it passed the Tennessee investment Services Act in 2007. There are obviously a lot of hoops, factors, and costs that should be considered, but these trusts are becoming increasingly common for protecting assets for those that are in higher risk jobs or ventures.
Testamentary Irrevocable Trusts
The more common use of trusts for asset preservation – and, I would argue – the more likely use of trusts for the moderate to higher net worth individuals and families, are testamentary trusts. Testamentary trusts “spring up” at death, and are typically created through one’s will or through the revocable trust. These trusts become irrevocable at death, but the terms of the trust can be modified before death since they do not come into being until such point.
Individuals have their attorneys create these trusts to preserve the assets for their beneficiaries. The protection and preservation concern may arise from a few different concerns, and these trusts can name the spouse and/or the children and grandchildren as beneficiaries.
Some grantors are concerned about creditor protection. With appropriate language in place, creditors may be shielded from reaching the assets of the trust if the beneficiaries were to have a creditor (e.g., auto accident, bad contract) trying to reach the assets. Or, perhaps the grantor is concerned about the children’s work ethic being negatively impacted by inheriting too much money too soon. More commonly, however, there is a concern about their heirs’ inheritance being divided up between the heir and the heirs’ eventual ex-spouse. Thus, testamentary trusts should be strongly considered when one has such concerns.
When such a trust is created for primarily the surviving spouse, the grantor may have similar concerns. Moreover, the grantors want to protect the assets in the case of a subsequent marriage by the surviving spouse. Or, the grantor may have children from a prior marriage, and the grantor wants to provide for the surviving spouse while preserving a portion of the trust assets for the grantor’s children upon the surviving spouse’s death.
Those are just a few of the primary distinctions between types of trusts and the primary objectives. Trusts can be set up for other reasons such as Medicaid planning, charitable planning, and income tax planning. Regardless of where you are at on your estate planning journey, make sure you are working with an advisor that starts with a concern of your goals and can work with you on your financial plan and estate plan in an integrated manner. At Oasis Wealth Planning, we would be happy to help or to point you in the right direction. If you are in Jacksonville, Orlando, or Tampa, give us a call and we can begin the discussion.