Adding a Trust to your Estate Plan is smart if you want to protect your family and assets. But which type of Trust is the right fit for you?
Trusts help ensure your loved ones receive your assets quickly and efficiently. They can also save time and reduce estate taxes.
Revocable Living Trust
A revocable living trust (RLT) is one of the most common estate planning options. It enables people to manage their assets during their lifetime and gives them control over their property even after they’ve died. It also helps avoid the costs and time of probate, which can be a significant problem for families.
RLTs are an excellent choice for people who want to keep their details private after they pass away. The probate process is a matter of public record, meaning that prying eyes can learn details about the size and recipients of a person’s estate. A trust, conversely, can prevent nosy relatives from snooping on family details.
Another advantage of a revocable living trust is that it can help ensure that a person’s property is distributed following their desires after death. Other options, such as wills, can result in confusion or delays in administrating a person’s estate. A revocable living trust can prevent these issues by ensuring that the estate’s trust holder is familiar with the wishes and needs of the beneficiaries.
Despite the many benefits of a revocable living trust, it is essential to note that it does not provide any protections against creditor claims or estate taxes. Therefore, having an estate plan that utilizes multiple comprehensive planning tools is still wise.
An irrevocable trust can’t be amended or canceled once set up. It also allows the grantor to transfer assets into it during their lifetime that can be kept away from personal taxation. This may be beneficial if you have assets prone to significant capital gains taxes, like your home.
An irrevocable trust offers significant benefits, including reducing estate taxes, providing asset protection, and enabling multi-generational planning. It also shields the grantor’s assets from creditor attacks, as the assets no longer belong to the grantor or their beneficiaries once they are transferred into the Trust.
Irrevocable trusts can be difficult to change once established, so you must ensure that you’re comfortable with the terms and that they meet your current needs. Additionally, it’s essential to know that any income an irrevocable trust generates must be taxed at a different rate than your tax rate.
Grantor Retained Annuity Trust (GRAT)
GRATs are designed to reduce estate taxes by transferring assets at a discounted value, potentially reducing the size of your taxable estate. This strategy is particularly attractive during depressed asset values and low-interest rates.
To set up a GRAT, you transfer assets to an irrevocable trust for a specified period and retain the right to receive a series of fixed or increasing annuity payments for that term. At the end of the term, your beneficiaries will inherit all remaining trust assets. Depending on the structure of your GRAT, you can gift significant sums with minimal or no federal gift tax liability.
The key to making a GRAT work is that the Trust’s investments outperform an IRS-determined hurdle rate (usually around four percent). Any growth will pass to your beneficiaries if your assets outperform with no gift tax consequences.
Invest in assets likely to appreciate to maximize your GRAT’s benefits. Common examples include family business shares, pre-IPO stock, and individual equities. The timing of your GRAT is also essential. It would be best if you set up a GRAT when you have confidence that the value of your assets will increase significantly over the GRAT’s term. GRATs with shorter terms are often less effective because the hurdle rate is too low and can become costly to administer.
Grantor Retained Unitrust (GRUT)
This option is worth considering if you want to give assets to family members while reducing the amount of gift and estate taxes that might be due. With a GRAT or GRUT, you irrevocably transfer your assets into a trust for years. In return, the Trust pays you either a fixed dollar amount or a percentage of the original value of the Trust.
Once the term of the Trust has passed, any remaining assets are given to your beneficiaries. This strategy allows you to enjoy some assets while shifting future appreciation to your beneficiaries without tax consequences.
However, a GRUT has one drawback that can make it less attractive than a GRAT: The moment you create the Trust, you are considered to have made a taxable gift for tax purposes. The taxable value is determined by subtracting the value of the annuity interest (and any other retained interests) from the fair market value of the original assets transferred to the Trust.