If you haven't stopped to consider how a trust may help you pass your wishes and wealth on, you could be making a critical estate planning mistake. Especially for individuals with substantial assets, protecting wealth for future generations should be top of mind.
"People often fail to appreciate the power a trust can have as part of a well-crafted estate plan, but that can be a costly mistake," says Rodney Weaver, VP, Advanced Planning at Fidelity. "Trusts are flexible and powerful tools that can be used to gain greater control over how they pass their wealth to future generations."
A trust is a legal structure that contains a set of instructions on exactly how and when to pass assets to trust beneficiaries. 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 most appropriate for you. However, an understanding of the estate planning goals that a trust may help you achieve is a good starting point.
Benefits of a trust
An effective trust begins with documentation carefully drafted by a qualified attorney with knowledge of your specific situation as well as current laws. Without the appropriate documentation, you and your beneficiaries may not reap the benefits of a trust, some of which are described below.
1. Pass wealth efficiently and privately to your heirs
Perhaps the most powerful and straightforward way to use a trust is to ensure that your heirs have timely access to your wealth. When you transfer your assets to your beneficiaries through a will, your estate is settled through a procedure known as "probate," which is conducted in state courts. However, probate is a public, legal process that can carry with it some unforeseen negative consequences for the administration of your estate, including:
With proper planning, the delays, costs, and loss of privacy can often be avoided.
You may be able to avoid probate and gain greater control over how your estate is settled by establishing and funding a revocable trust. Because the trust is revocable, it can be altered or amended during the grantor's2 lifetime. After a grantor's death, the trust acts as a will substitute and enables the trustee to privately and quickly settle the grantor's estate without going through the probate process with respect to assets held in the trust.
A grantor can also give the trustee the power to take immediate control of the assets held in trust in the event that the grantor becomes incapacitated (and the grantor generally has the ability to define what constitutes "incapacity" within the trust document). This provision can save heirs the time, financial cost, and emotional distress of going to court to request a conservatorship or guardianship over a loved one. Finally, revocable trusts are dissolvable, meaning the grantor can generally pull assets out of the trust at any point during the grantor's lifetime.
2. Preserve assets for heirs and favorite charities
If you have substantial assets, you may want to consider creating and funding an irrevocable trust during your lifetime. Because the trust is irrevocable, 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. 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.
Significantly, while the gift could use up some or all of a grantor's lifetime gift tax exclusion, any future growth on these assets generally will not be includable in the grantor's estate and therefore will escape estate taxes at the grantor's death. The individual lifetime federal gift tax exclusion is set at $11.40 million for 2019.
Irrevocable trusts can also serve several specialized functions, including:
Keep in mind, though, that irrevocable trusts are permanent. "The trust dictates how the funds are distributed, so you want to fund this type of trust only with assets that you are certain you want to pass to the trust beneficiaries, as specified by the terms of the trust," cautions Weaver.
3. Reduce estate taxes for married couples
For a married couple, a revocable trust may be used as part of the larger plan to take full advantage of both spouses' federal and/or state estate tax exclusions. Upon the death of a spouse, the assets in a revocable trust can be used to fund a family trust—also known as a "credit shelter," "bypass," or "A/B" trust—up to the amount of that spouse's federal or state estate tax exclusion. The assets held in the family trust can then grow free from further estate taxation at the death of the surviving spouse. Meanwhile, the balance of the assets in the revocable trust can be transferred to the surviving spouse free of estate tax pursuant to the spousal exemption. At the death of the surviving spouse, of course, these assets may be included in the surviving spouse's estate for estate tax purposes.
The estate tax-free growth potential for funds in a family trust can be significant. Say, hypothetically, that you and your spouse live in Florida, which does not have a separate state-level estate tax, and have a net worth of $20 million. If one of you dies in 2019, that spouse's revocable trust can fund the family trust with $11.40 million without paying any federal estate tax. Over the next 20 years, this $11.40 million could grow in value, all of which would remain outside the surviving spouse's taxable estate.
4. Gain control over the distribution of your assets
By setting up a trust, the grantor is able to establish ways that the assets are to be passed on to the beneficiaries. For example:
If you are charitably inclined, you may also want to consider establishing a charitable remainder trust, which allows the grantor, and possibly the grantor's spouse and children, to receive an annual payment from the trust during their lifetime, with the balance transferring to the specified charity when the trust terminates. The grantor may also receive an income tax charitable deduction based on the charity's remainder interest when property is contributed to the charitable remainder trust.
5. Ensure that your retirement assets are distributed as you've planned
You may be concerned that a beneficiary of a retirement account will liquidate that account and incur a large income tax obligation in that year as a result. To help alleviate that concern, by naming a properly created trust as the beneficiary of a retirement account at the grantor's death, the trustee can limit withdrawals to the retirement account's required minimum distributions (RMDs), required of each beneficiary.
6. Keep assets in your family
You may be concerned that if your surviving spouse remarries, your assets could end up benefiting their new family rather than your own loved ones. In this case, a qualified terminable interest property (QTIP) trust provision can be used to provide for a surviving spouse while also ensuring that at their subsequent death, the remainder of the trust's assets are ultimately transferred to the beneficiaries identified by the grantor in the trust document.
Building your legacy
The purpose of establishing a trust is to ultimately help you better realize a vision for your estate and, in turn, your legacy. Therefore, it's important to let your goals for your estate guide your discussion with your attorney and financial advisor as they help determine what kind of trust and provisions make sense for you. It is vitally important that the trust be properly drafted and funded, so that you and your beneficiaries can fully realize all the benefits available.
For help in picking an estate planning attorney, read Viewpoints on Fidelity.com: How to find an estate planning attorney.
Next steps to consider
Get organized with the Fidelity Estate Planner®.
Store important financial, legal, and personal documents safely.
Avoid common and potentially costly estate planning mistakes.