Many investors have an idea how they would like their assets distributed upon their passing, but are not sure of the best way. Trusts are entities that ensure money and assets are handled according to the grantor’s instructions, keep the estate and its dealings private, and can be structured to a specific needs. "There are many types of trusts and just like the many types of tools in a toolbox, they each have their purpose," says Patrick Simasko, an elder law attorney and wealth preservation specialist at Simasko Law in Mount Clemens, Michigan. Each type has its own benefits and drawbacks. Here are eight things investors should know about trusts.
A choice: Revocable or irrevocable
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While revocable trusts are typically established for the benefit of a grantor during their lifetime and pass assets to the name beneficiaries at their passing, irrevocable trusts funded during a grantor’s lifetime cannot be changed or amended during that time, says Gerald Baker, executive managing director and chief fiduciary officer at Boston Private, a private bank and wealth management company. Types of trusts range from a "very simple" revocable family trust to an irrevocable trust fit to specific family situations, including generation skipping trusts, special needs trusts, credit shelter trusts and asset protection trusts, says Kevin Barlow of financial services firm Miracle Mile Advisors in Los Angeles.
Trusts can protect assets
Irrevocable trusts are commonly designed to protect assets when the grantors have to go into a nursing home, Simasko says, so that certain assets are untouchable. Keep in mind that this is because the grantors no longer have access to the money and have essentially already given it away. Putting assets into an irrevocable trust may also allow some people to obtain eligibility for Medicaid benefits, as long as they create and fund the trust five years before applying for benefits. Irrevocable trusts can also help grantors obtain veterans’ benefits that are asset-based, Simasko adds, with Veterans Affairs looking back three years for assets in order to determine eligibility.
Not for certain retirement accounts
Retirement accounts cannot be owned by revocable or irrevocable trusts. If they were, the retirement account would immediately become taxable, Simasko says. However, nonretirement bank accounts, life insurance policies, property and securities can be owned by a revocable or irrevocable trust, he says.
A trust can assist after death
A trust could help avoid probate upon death, ease the process for loved ones, and help them manage money they inherit. Revocable trusts are typically designed to avoid probate, Simasko says, which is the process of settling an estate through the court system. "With a trust in place, you are the one who controls that process to meet your financial objectives," Barlow says. And if you are concerned your beneficiaries may need help managing the funds, you can pick someone or an entity like a bank to manage the funds for them, Simasko says. You can also limit the beneficiary or direct them on how they’re to use the funds through the revocable trust.
Confidentiality is more certain
Trusts are not a matter of public record, unlike a will, ensuring confidentiality, says Chris White, regional fiduciary manager at PNC Wealth Management. A grantor could put real estate and other personal property in trusts that do not reveal ownership in their titles for privacy, Baker says. For example, a trust could even be used to hold an art collection and the liquid funds required to maintain the collection or to hold a grantor’s primary residence for asset protection and privacy.
Wealthy may save on taxes
The primary reason people put money in trusts is so that it can be transferred tax-free, says Steven Jon Kaplan, CEO of True Contrarian Investments, but with federal limits reaching record highs, that may not be necessary. Upon death, federal or state estate taxes can be avoided if money in the estate doesn't exceed the current federal ($11.4 million) or state limits. Those with more can transfer funds into an irrevocable trust to transfer it to others without making it part of a taxable estate, he says. Some states are far below federal limits, such as in New Jersey and Washington, and residents may be more likely to benefit from trusts, Kaplan says.
Trusts can be expensive
Trusts usually require careful administration and additional annual tax filings, which tend to be expensive, Kaplan says. You will usually also lose the advantage of long-term capital gains by putting assets into trusts, since they will be taxed upon withdrawal, usually based upon their current market value, Kaplan says. The marginal rates for trust income of all kinds apply at much lower levels, so that the highest marginal taxes are paid on very low levels of income. As a result, those who set up trusts often end up paying much more in annual fees and taxes in the long run than those who simply hold assets in ordinary taxable brokerage accounts.
Enlist the help of a professional
Because trusts can be complicated, it’s prudent to seek the assistance of an estate planning attorney or advisor. "An attorney specializing in estate planning is factoring the estate’s potential tax liability and the overall implications to the asset transfer needing to be accomplish," Baker says. "Additionally, each state has either statutory provisions or case law surrounding what is a valid and executable estate plan." Remember also to review your documents annually to be sure that they remain current, and contact your attorney to update as necessary, says Ken Stern, senior managing director of Lido Advisors in Los Angeles.
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