Trusts aren’t just for rich kids (although we highly recommend a trust with a ton of guardrails for the beloved spendthrift in your life.)
A trust is essentially a financial arrangement where assets or property is transferred from one person—the grantor—to another—the trustee—on behalf of a third party, the beneficiary. It’s true that there are many different kinds of trusts and some are quite complex, most trusts are simply a financial tool for holding assets. Verbal trust agreements are valid, but most are created by an estate attorney and filed at your local courthouse.
The relationship between the Grantor, Trustee, and Beneficiary
There are any number of reasons you may want to establish a trust, from estate planning to ensuring an errant child won’t squander their inheritance. The basic components of a trust are the same regardless of the purpose; you turn over assets to a trusted third party, for the benefit and use of another person at a particular time—it could be when they turn 35, or go to college, or when you die.
Some potential grantors are reluctant to set up a trust as they have doubts about transferring their assets to a trustee, but once they grasp the mechanics of the trust and realize that there is a distinctive difference in legal and beneficial ownership of the assets, and that there is codified trust law that governs the actions of the trustee, they are more likely to use trusts for estate and financial planning.
The trustee is someone who is independent and will make any decisions regarding the trust in the best interest of the beneficiary. The grantor and the trustee can be the same person, but beware—the IRS takes a dim view of grantors/trustees who do not actually act in the best interests of the beneficiary. In other words, don’t put all your kid’s college money in a sure-fire cigar bar—in these instances the trust may be deemed invalid. This is why trustees are often attorneys or bank officers—people who have no vested interest in how the trust is administered.
Types of Trusts
There are two fundamental types of trust, revocable and irrevocable. Both have certain advantages, but an irrevocable trust does have greater tax advantages if you are setting trusts up as part of your estate planning.
The trust grantor can change or completely cancel a revocable trust at any time, for any reason. The grantor and trustee are often the same in a revocable trust, and the assets are still owned by the grantor, which means any income gained must be reported on their personal taxes. If the trust is still in effect when the grantor dies, it automatically becomes an irrevocable trust because the grantor can no longer change the terms.
When most people think of what a trust is, an irrevocable trust is what comes to mind. This trust is common among wealthy individuals who want to pay for a grandchild’s education, for example. For the 2021 tax year, a grantor can transfer up to $15,000 in assets into an irrevocable trust, with few limits on how many trusts they can establish. As a side note, the IRS has scheduled that amount to drop to $14,000 in 2026.
Once established, this type of trust cannot be amended or revoked without the consent of the beneficiaries. Any assets listed in an irrevocable trust are transferred out of the grantor’s ownership and are the property of the beneficiary. There are tax advantages to an irrevocable trust; primarily that the assets you put into the trust are no longer taxable income to you. If you have a large estate, setting up irrevocable trusts for your heirs may put you in a lower income tax bracket, and give your heirs some financial security.
Irrevocable trusts are a legal entity, and are taxed as such. The trust beneficiary or guardian will have to file a tax return, claiming any income earned. Trust income is taxed at a higher rate than earned income. The rules on trust income taxes are complex; consult a tax attorney before you set up an irrevocable trust.
Trusts and estate planning
It’s a common misconception that estate planning and trusts are for those close to retirement; the opposite is actually true. You should start thinking about your golden years when you’re still in the first successful flush of youth, when the idea of setting aside money for a hundred years down the road seems ridiculous. Here’s the reality, and not to be morbid, but you never know when your family becomes your heirs, and you should be prepared. Of course you’re going to live to a ripe old age with lots of money and a low tax burden, so best start planning now for that rosy future.
A Living Trust is exactly that—one that you establish while you’re still living. It’s typically revocable, so you maintain control over the trust and its assets. This kind of trust is not a substitute for a will; rather it works in conjunction with your will so that the assets in the trust immediately become the property of the beneficiaries, sidestepping probate for those assets. Living trusts are also private, so if you’ve amassed rather more money than you’ve let on, this keeps that information private.
Even if you’ve yet to marry, a living trust isn’t a bad idea. If you fund the trust now and choose a trustee, then you can assure you’re taken care of if you become incapacitated. Bad things do happen, and this kind of trust ensures somebody will make the right decisions on your behalf.
Living trusts are the jack-of-all-trades in the estate planning universe; here are some of the things your living trust can do. After your demise, a third-party trustee should take over administering the trust.
Lower estate taxes—this is true on certain states, consult your tax attorney or CPA. This provision kicks in after the death of the surviving spouse.
Protect minor children—the trust can dole out funds as the kids becomes more responsible with money; you can stagger access to funds at various ages, like 21, 25, 35, and so on.
Protect unstable children—it’s a sad fact that some adult offspring can’t look out for themselves. The trustee can hold and allocate funds as needed through that child’s lifetime.
Maintain family wealth—you can draft the trust document so that family assets are protected, like in case a child divorces and you don’t want the ex-spouse getting half their assets—especially if you’re the one who gave them those assets. This is especially handy if Buffy loves Biff and would never insult him by asking for a pre-nup. Along those same lines, if your grieving spouse assuages their unhappiness with the tennis pro, the trustee will ensure that your kid’s college money doesn’t go to the Caribbean and Gstaad as therapy with the merry widow(er).
One final note: a living trust is not the same thing as a living will. A living will is a separate document that should be executed by your attorney, along with a health care power of attorney.
Irrevocable Trusts and Medicaid
The rising cost of health care, especially for seniors, can easily deplete a lifetime of saving and investment. Irrevocable trusts are one way to shield your assets while ensuring you have the income for your care and medical expenses.
An income-only trust pays you, as the grantor, any income derived from the trust for life. The principal is paid to your heirs when you die. When you apply for Medicaid, the principal is exempt from your assets for Medicaid purposes since you do not have access to the money. If you do move to an assisted living facility, the income is paid to that facility for your living expenses.
If you choose this type of trust, be sure you have other funds available should the need arise as the rules governing these trusts are quite strict.
Here’s why you should plan ahead. If you think you’ll need to enter a senior facility in the next few years, there’s a “look back” period of up to five years from the date you establish the trust to the date you are eligible for Medicaid. The ineligibility period is dependent on the amount you transferred to the trust.
A Testamentary trust is created via will rather than a separate document, and allows a deceased spouse to shield assets from the grim Medicaid reaper. This is called a “safe harbor” for the surviving spouse as the monies can be used to pay for expenses not covered by Medicaid. The spouse must reside in a defined community for this type of trust to be valid, that’s why the survivor is referred to as the “community spouse”. If you read the rules for a testamentary trust they are not terribly logical, but the end result is that this is a nifty way to protect your investments and ensure they go to spousal care in a perfectly legal way.
You don’t have to be wealthy to take advantage of the benefits of trusts. Establishing the appropriate trusts for your loved is the best way you can take care of them after you’re gone, and to ensure that as much of your hard-earned wealth as possible stays in the family. Keep in mind that revocable trusts have the flexibility to adapt to your evolving needs, while an irrevocable trust is the tool that you’d use in long-term estate planning.
You don’t need to be an expert on Trusts
Fortunately, you don’t need to be an expert on trusts. Here at Infinium, we take a holistic approach to helping clients. Although we are not estate planning attorneys and do not offer legal advice, we work in concert with the professionals who are trained and licensed to help in this important area of estate planning. Like many things in life, recognizing that you have a gap is half of the battle and the other half – and maybe the most important part – is to take proactive steps in the right direction to fill it.