By: Jose Roman
Estate planning is an essential aspect of personal finance. It involves planning for the distribution of one's assets upon death, as well as minimizing estate taxes and maximizing the value of the estate for your beneficiaries. Trusts are one of the most popular estate planning tools available, and they come in different types. In this blog post, we will explore the different types of trusts used in estate planning and the differences between a revocable trust and an irrevocable trust.
Types of Trusts in Estate Planning
Revocable Living Trust
A revocable living trust is a trust that can be changed or canceled during the grantor's lifetime. It is a popular estate planning tool as it allows the grantor to retain control over their assets while they are alive. The trust becomes irrevocable upon the grantor's death, and the assets are distributed according to the terms of the trust. Revocable Living Trusts are typically used as a Will substitute or as a way to gather all probate and non-probate assets so there is a uniform plan of distribution.
An irrevocable trust is a trust that cannot be changed or canceled once it is created. The grantor transfers their assets to the trust, and the trust becomes the legal owner of the assets. This type of trust is popular for estate tax planning, as the assets are no longer considered part of the grantor's estate for tax purposes. In 2023 the current estate tax exclusion amount is $12,920,000, meaning unless you estate is over this amount you won’t owe an estate tax. For this reason the average estate plan is unlikely to include irrevocable trusts, unless there is a specific reason for doing so.
A testamentary trust is a trust that is created in a person's will and takes effect upon their death. Typically, this type of trust is added to a Will and doesn’t go into effect unless one of your beneficiaries is a minor or someone who is disabled and unable to manage their inheritance on their own. Your executor will usually serve as the trustee of this trust or have the ability to name a trustee at their discretion. Two other types of trust that can be added to a Will are the Credit Shelter and Marital Trust. Both are used together and serve the purpose of avoiding the estate tax mentioned above, therefore in recent years they have become less common.
A charitable trust is a trust that is established to benefit a charity or a cause. The grantor can receive tax benefits for establishing a charitable trust, and the assets in the trust are used to benefit the designated charity. If structured properly the trust can avoid any gift tax consequences, while also paying the trust grantor with an annuity for a set period of time with the remainder going to the charity.
Differences Between Revocable and Irrevocable Trusts
The main difference between a revocable trust and an irrevocable trust is the level of control the grantor retains over their assets. With a revocable trust, the grantor can change or cancel the trust at any time during their lifetime. This means they can retain control over their assets and make changes to the trust if their circumstances change. However, upon the grantor's death, the trust becomes irrevocable, and the assets are distributed according to the terms of the trust.
In contrast, with an irrevocable trust, the grantor gives up control over their assets once they are transferred to the trust. The trust becomes the legal owner of the assets, and the grantor cannot make changes to the trust. This type of trust is often used for estate tax planning, as the assets are no longer considered part of the grantor's estate upon their passing for tax purposes.
Trusts are an essential estate planning tool that can help individuals distribute their assets, minimize taxes, and provide for their loved ones. Revocable trusts and irrevocable trusts are two of the most popular types of trusts, and they have different advantages and disadvantages. Your estate plan may require the use of one or more types of trusts, therefore it’s essential to consult with an estate planning attorney to determine which type of trust is right for your specific circumstances. When it comes to drafting a trust, I cannot stress to you the importance of not trying to do it yourself.
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