"Estate plans encompass more than just a document that designates who gets what after somebody dies," says Fred Heinrichs, vice president and chief operating officer for the Fidelity Personal Trust Company. "Many people are establishing trusts or revising their existing trust documents."
A trust is a legal arrangement for the transfer of property by a grantor to a trustee for the benefit of a beneficiary. There are many types of trusts to consider, each designed to help achieve a specific goal. An estate planning professional can help you determine which type (or types) of trusts are appropriate for you. However, an understanding of the estate planning goals that a trust may help you achieve is a good starting point.
Take control with a trust
With the current high federal estate tax exemption, the purpose of a trust today is more about retaining control over assets during the grantor’s life and upon the grantor’s death than creating an estate tax saving plan. If you were to die this year (2023), for example, your estate would avoid federal estate taxes as long as it is valued at less than $12.92 million—and up to $25.84 million for a married couple. Given those parameters, it's likely that few in the US will be affected.
This exemption is currently set to “sunset” at the end of 2025 and revert back to $5 million, adjusted for inflation. It’s possible that may happen even sooner if Congress takes action.
"It's all about planning, planning, planning. You want to make sure you have the right pieces in place and that your plan truly matches your wishes, so your family isn't scrambling if anything happens to you," says Heinrichs.
Key reasons for considering a trust:
Control. A trust can control who will receive distributions, as well as when those will occur and on what terms. This can be especially important for surviving spouses and families with children from multiple marriages.
Protection. A properly constructed trust can protect your legacy from your heirs' creditors—or from the irresponsible ways of the beneficiaries themselves.
Privacy and probate savings. Depending on where you live or where your property is located, the process where the state settles your affairs, called probate, can be expensive and time-consuming and all the records will be public. In contrast, if you have a trust that you control, called a revocable living trust, the trust will generally avoid probate if funded properly.
State estate and inheritance taxes. More than a dozen U.S. states and the District of Columbia also impose some form of estate or inheritance tax with limits much lower than the federal $12.92 million amount, according to the Tax Foundation. Tax planning with trusts may make sense for individuals located in these areas.
Incapacity planning. Trusts can also provide instruction for how to handle trust assets if you become too ill to manage your own affairs. However, only assets transferred to a trust during your lifetime will benefit from the administrative and control features a trust offers.
Charitable giving. You can set up a tax-efficient long-range plan to donate your assets the way that you want through charitable trusts.
Life insurance ownership. Generally, without trust planning, the death benefit payout from a life insurance policy would be considered part of the insured's estate for the purposes of determining whether there are estate taxes owed. However, this is not the case if the policy is purchased by an independent trustee and held in an irrevocable life insurance trust (ILIT) that is created and funded during the grantor's lifetime, with certain limitations (please consult your attorney).1
Special needs planning. A family member may help a loved one with special needs while alive and set up a special needs trust to continue to provide financial assistance after the family member's death.
Large retirement account balances. The SECURE Act changed the rules for inherited IRAs by eliminating what was known as the "stretch IRA," a way to pass on a retirement account that allowed a non-spouse heir to take distributions from the account on their own timeline.2 If you think your heirs will not be able to handle a large windfall of cash within the 10-year time frame in which the IRA assets will need to be distributed, you may want to leave these assets to a trust so the trustee can designate when those funds can be distributed to the beneficiary, according to your wishes. However, this strategy could be less tax-efficient than leaving assets outright to your beneficiaries because of how income retained in a trust is taxed.
Read Viewpoints on Fidelity.com: SECURE Act rewrites the rules on stretch IRAs
Picking the right trust for you
The type of trust you consider creating—and particularly the language of the trust—will depend on your individual circumstances and goals. Working with your tax advisor and an estate planning attorney, you can decide if a revocable trust, irrevocable trust, or both, are appropriate.
A trust that is revocable can be altered or amended, and/or generally have assets pulled out of it, during the grantor's3 lifetime. After the grantor's death, the trust becomes irrevocable and, if properly funded, can act as a will substitute, enabling the trustee to privately and efficiently settle the grantor's estate without going through the probate process. It is critical that assets be retitled into the name of the revocable trusts in order for the trust to control their ultimate disposition.
With an irrevocable trust, in almost all circumstances, the grantor cannot amend the trust once it has been established, nor can the grantor regain control of the money or assets used to fund the trust. Typically, the grantor gifts assets into the trust, and the trustee administers the trust for the trust beneficiaries based on the terms specified in the trust document. A key planning benefit of irrevocable trusts is that they allow a grantor to remove assets and even any future growth of the assets from their estate—and avoid a potential estate tax with respect to those assets.
Remember that life happens—so review your needs as your circumstances change or evolve. As a general rule, it's a good idea to review your estate planning needs and existing plans every 3 to 5 years. In addition, review your plan when major life events occur, such as marriage, the birth of a child, divorce, the receipt of an inheritance, or a death.