When planning your legacy and thinking about your family’s future, you may want to consider a trust. If you’ve avoided this financial tool because it seems too restrictive, it might be time to reconsider. Trusts are popular when the beneficiary is incapable of handling asset management, but they can also be fairly flexible, depending on how they’re structured. Beneficiaries can be granted a decent amount of control while still enjoying the benefits of asset protection and tax savings.
Trusts can be set up during your lifetime (living trust) or in a will (testamentary). Let’s focus on living trusts, which are either revocable, where you retain control, or irrevocable, where the assets are no longer yours. With the former, you can change the terms of the trust at any time, but with the latter, only the named beneficiary can make changes.
While a lack of control might not sound appealing, irrevocable trusts have tax advantages: the appreciated assets aren’t subject to estate taxes.
There are many types of trusts — such as a qualified terminable interest property trust or a generation-skipping trust — that address specific situations. If you don’t have a blended family and don’t plan on giving to a generation younger than your children, you wouldn’t consider either option. Because of their complex nature and wide variety, it’s important to discuss your trust type(s) with a financial planner or estate attorney.
In the meantime, let’s dive into a few of the less specific and more widely used versions.
Irrevocable life insurance trusts.
If you own or plan to buy life insurance, you might consider a life insurance trust. Shifting life insurance ownership from yourself to a trust allows you to exclude it from your estate, meaning the death benefit the policy pays when you die won’t be considered part of your taxable assets. But you must live three years after the transfer. Usually the trust is also the beneficiary of the policy, which means the death benefit funds would roll into the trust, with periodic distributions to a spouse or children. This setup is particularly attractive if you’re trying to shield the money from your kids’ irresponsible spending or creditors.
Qualified personal residence trusts.
With this type of trust, you can transfer your home to the trust for a period of time, usually 10-15 years. It’s useful when you have a home (vacation or otherwise) that’s expected to appreciate significantly. That’s because when the trust ends, a home that might have been worth $250,000 when it was put into the trust could have a value of only $75,000 for tax purposes, reducing the amount of your assets subject to taxation. If it’s your primary residence, you can live in the home during the term. However, at the end, ownership is transferred to the beneficiary and you’d have to set up a rent arrangement if you remain in the home. One caveat to this plan is that it only works if you live to see the term fulfilled. If you die during, your home will be included in your estate just as if you’d never set up the trust in the first place
Credit shelter trust.
Also known as a bypass or family trust, credit shelter trusts are used to transfer assets while avoiding estate taxes. You simply specify the assets and, when you die, the beneficiary receives those assets tax-free. This is great for married couples because the spouse maintains rights to the trust assets and the income they generate during the remainder of his or her lifetime.
While trusts are a great financial planning technique, they do require the help of a professional. In preparation of trust planning, make sure to get your estate organized, with the help of LegacyShield. That way you’re familiar with all of your assets as well as where they reside, which will help you and your advisor decide which trust is most appropriate for you.