Choosing the Right Trust to Meet Your Family’s Needs

Trusts are useful financial tools that provide legal protection for the trustor’s assets, provide detailed instructions about how those assets are to be distributed, and in many cases, help the trustor reduce or avoid inheritance or estate taxes. But there is no one-size-fits-all trust. They come in a variety of specialized forms and it’s important to understand all of the various options so that you can select the particular type of trust that is the best fit for your family’s unique needs.

Four Different Types of Trusts

A revocable living trust is, as its name suggests, a trust created while you are alive. You can continue to make changes to the trust or revoke it in full at any point during your lifetime. This type of trust is considered a grantor trust for tax purposes, which means that it is identified using your Social Security number, and that any profits or losses generated from trust assets will need to be reported on your personal tax return.

The grantor typically acts as the initial trustee of the trust. Since assets of the trust are included in the grantor’s estate, a step-up in basis on appreciated assets is allowed upon the grantor’s death. That means that heirs will not be taxed on any appreciation in the value of the trust to that point. After the grantor’s death, the revocable living trust becomes irrevocable, which means the trust can no longer be altered or amended. It will require its own tax identification number because the grantor’s Social Security number can no longer be used, and the trust will now be responsible for paying its own taxes. 

Irrevocable trusts can also be established during your lifetime if you do not anticipate any changes to your estate plan in the future, but you will not be able to alter or amend the trust or change any provisions once it is executed. Some irrevocable trusts, such as Intentionally Defective Grantor Trusts (IDGTs), Qualified Personal Residence Trusts (QPRTs), and Grantor Retained Annuity Trusts (GRATs) are also considered to be grantor trusts if you still control the assets during your lifetime.

When a grantor gives away all beneficial interest in assets transferred to a trust, then the grantor may not serve as trustee of that trust. This is commonly seen in Irrevocable Life Insurance Trusts (ILITs), which are another type of irrevocable trust that only holds life insurance policies. A testamentary trust can be provided for within your Last Will & Testament, but the trust is not established until after your death. This trust is considered irrevocable as well because it is created at the end of the probate process and is usually set up to provide for minor children.

Charitable trusts are another option if you would like to gift money to support a certain charity during your lifetime or after your death to qualify for tax deductions. Common types of charitable trusts include Charitable Lead or Remainder Annuity Trusts (CLATs or CRATs) and Charitable Lead or Remainder Unitrusts (CLUTs or CRUTs).

Special Needs Trusts

If you have loved ones with special needs (physical or mental disability or a chronic or acquired illness), you may consider setting up a special needs trust to help support them financially. Leaving money directly to a person with special needs could potentially disqualify them from receiving government benefits; however, if assets are left to them in a special needs trust, the funds can be used to improve their quality of life without jeopardizing their benefit eligibility.

Assets to Fund Your Trust

A trust can be funded with a variety of assets, including cash, investments, personal property, and real estate. For some assets, you will simply need to list the asset in your trust document, while other assets might require you to re-register accounts into the name of the trust. For personal property and real estate, you would need to re-title tangible property such as a car into the name of the trust and file a new deed in the name of the trust if any real estate is to be an asset of the trust.

You will need to work with your attorney, financial advisor, and/or CPA to confirm all assets have been moved or titled correctly into the name of the trust. Otherwise, the trust will not be funded correctly. Your attorney also might recommend you establish a pour-over will, which would allow any property that remains in your estate at death to be added to your trust without having to go through probate.

Naming Your Trust as a Beneficiary

If you would like to name your trust as a beneficiary of your retirement accounts or life insurance, there are a few things to consider, especially since the recent passing and implementation of the SECURE Act. The legislation passed changed the treatment of distributions from inherited IRAs. If you name your trust as the beneficiary of an IRA, then the funds must transfer into an account known as an inherited trust beneficiary IRA and the entire balance must be distributed within ten years of the original IRA owner’s death. The timing of those distributions is important – waiting to make a large distribution at the end of the ten-year period could result in higher taxes than making smaller distributions over the full time period.

Proposed Legislation

There is proposed legislation currently pending that would decrease the current gift and estate tax exemption to $5.85 million per person from the current $11.7 million. The proposed legislation would also significantly limit the use of types of grantor trusts because a distribution or contribution could be considered a gift that may result in the payment of tax.

We can help.

Whether you are considering establishing a new trust or you already have a grantor trust that may be affected by this new legislation, the first step should be to meet with your First Command Financial Advisor, a qualified estate planning attorney and your CPA. Working together, they can prescribe the best course of action and assist you in preparing the necessary documents to achieve your objectives.

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First Command does not provide legal or tax advice, and this article does not contain any legal or tax advice. Any recommendations provided to you in this article are strictly for financial planning purposes only. Should you require legal or tax advice, you should consult with your attorney or tax advisor.