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The Advantages of Trusts: Securing Your Legacy and Wealth

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The use of trusts can be an effective way to avoid certain taxes and to control assets from beyond the grave. Trusts and wealth management are very complex situations, that require much deliberation when determining if to use a trust and what type of trusts to use. Each type of trust has potential tax benefits and tax consequences to be aware of.

Benefits of Trusts in GeneralThe Advantages of Trusts: Securing Your Legacy and Wealth

The main benefit of trusts is that they will avoid probate and minimize costs after an individual’s death. Avoiding probate also allows the assets to be distributed quicker to any beneficiaries. While a will can help with distributing assets upon death, it’s a public record. A trust document will be completely private. Probate and the death of a loved one can be a long and stressful process. The creation of the trust helps to close out the estate in a more seamless process. In addition to this, an individual can control how their wealth is distributed. This allows an individual to adjust for any personal family dynamics.

Depending on the type of trust selected, you can save on certain taxes. Most notably the estate tax on high net worth individuals (the net worth in excess of $13.61 million for 2024). Certain types of trusts are considered outside of a taxable estate. It is important to be aware that this exclusion may change in the near future. Currently, the exemption is set to decrease to around $6 million in 2026.

Two Main Trust Types

There are a plethora of different types of trusts that can be created. Each type has specific intricacies that need to be followed. During the creation process, it is important to communicate with a lawyer or wealth professional to determine which specific type of trust would work for the given situation. There are two main types of trusts: revocable and irrevocable. Think of this as the overall pools that specific trusts fall into.

Revocable Trusts

A revocable trust (sometimes called a living trust) allows an individual to make changes to the trust during their lifetime. This provides more flexibility for the creator of the trust. They can add and remove assets or beneficiaries to meet any changes in the individual’s life. While this is a helpful benefit during the lifetime of the individual, it can have adverse tax consequences down the road. Since the individual has control over the assets and can make any changes during their lifetime, the trust is not considered separate of the estate and will not be excluded from the estate tax mentioned above. Once an individual passes, the trust will turn into an irrevocable trust.

Irrevocable Trusts

When an irrevocable trust is created, the assets and beneficiaries are locked. There is usually no ability for an individual to make changes during their lifetime. Whatever the irrevocable trust agreement states when it is created is how the trust has to be administered. The bright side of irrevocable trusts is since the individual gives up the right to make changes during their lifetime, it is not subject to the estate tax mentioned above.

Items to be Aware of

Trust and estate planning are extremely complex. As such, there could be a heavy cost associated with the creation of trusts. Normally this amount largely consists of professional fees paid to lawyers for drafting of trust documents. The wording of the trust document is extremely important; the trust will be administered exactly as it is worded in the trust document. While the initial costs may be expensive. It could save money in the long run, avoiding costs that would be paid if the items went through probate.

Trusts are subject to the highest tax bracket extremely quickly. Income above $14,450 is subject to a 37% tax bracket. However, a trust can avoid paying the highest tax depending on the distributions made. Trusts can have three options for how the tax is paid. It can either be paid fully by the trust, fully paid by the individual, or partially paid by both. If fully paid by the individual, it will be taxed at the individual’s tax rate. If partially paid, only a portion of the income will be taxed in the trust. The other portion of the tax is paid by the individual. If an individual’s tax rate is less than the trusts applicable rate, then there will be less overall tax paid.

The amount of tax paid at the individual or trust level depends on the amount of asset distributed and its relation to total taxable income. For instance, if a trust has $14,000 of income and no distributions were made in the year. The full tax on the income is paid at the trust level. Instead, if the trust distributed $15,000. The $14,000 of income is deemed to be fully distributed to the individual and the full tax is paid at the individual level. The excess $1,000 given to the individual is not taxable. For the final scenario, the trust distributed $8,000 to the individual. In this situation, $8,000 of income is treated as being distributed to the individual and the tax is paid at the individual’s tax rate. The remaining $6,000 will be taxed in the trust at the applicable rate.

There are many different types of trusts that can be used for an individual’s specific situation. Consult with your tax advisor, lawyer, and wealth management advisor when contemplating creating a trust.

Written by Bryce Tarletsky, In-Charge Senior Accountant