In estate planning, trusts can be established to easily transfer assets to heirs. With the right setup, assets in a trust can avoid probate and taxation, and can immediately pass from the original owner to the heirs. The types of trust can vary depending on the type of assets you’re trying to protect or your goals in setting up a trust.
Living trusts vs. testamentary trusts
While all trusts are set up by grantors during their lives, not all trusts immediately go into effect. Depending on when the trust becomes effective, it’s either a living trust or a testamentary trust.
Living trusts: When a trust is created and then immediately becomes effective, it is known as a “living trust.” (Learn more: Living Trusts)
Testamentary trusts: This trust is often created within a will and doesn’t become effective until after death. The person who creates a testamentary trust is called the “testator.”
How do you fund a testamentary trust?
Testamentary trusts are generally funded only after a death with the assets of your estate. In order to fund a testamentary trust, language in the will must explicitly state which assets should be moved into the trust upon death. The estate assets can then be distributed and managed according to the terms of the trust. (Learn more: Testamentary Trusts)
You retain ownership and control of the property in the trust and can change the terms of the trust, including the trustees and beneficiaries.
How do you fund a revocable trust?
If you’re setting up a revocable trust, you’ll most likely be the sole trustee, which means you can move assets in and out of the trust at will, without too much hassle. Because of this, many people with revocable living trusts put a large portion of their assets to be held in trust, including real estate, financial accounts (stocks, bonds, etc.), and even bank accounts. (Learn more: Revocable Trusts)
You give ownership and control of the property in the trust to others (trustees) and no longer own or control the property, thus making you unable to enact changes.
How do you fund an irrevocable trust?
By putting assets into an irrevocable trust, you are essentially giving up ownership and control of those assets, so choose these assets carefully. Remember, there are gift tax limitations and implications to consider when funding an irrevocable trust.
Choosing a funding method that supports the goals of the trust is something you should decide with the help of a qualified estate planning attorney in your state. Transferring property to an irrevocable trust also requires that a formal transfer of property be completed, meaning that the property must be retitled in the trustee’s name. An estate planning attorney can help you complete and manage a retitling of property. (Learn more: Irrevocable Trusts)
Trusts are legal entities, and the trust itself is subject to taxation on the property that is being held. Because trust tax brackets are compressed, relatively small amounts of income will push the trust into the highest tax bracket.
Fun fact (that’s not really all that fun): All trusts are either revocable or irrevocable. Also, living trusts must be funded during your lifetime; testamentary trusts are funded after your death.
Reasons for choosing a revocable trust vs. an irrevocable trust
If the primary goal of the trust is to avoid future estate taxes, you'll likely want to set up an irrevocable trust, since you don't have to pay taxes on it.
If the primary goal of the trust is to maintain control of assets in the event of incompetence, you'll likely want to set up a revocable trust, since you'll want to retain control over the assets and the beneficiaries.
In addition, the rules of the particular trust may dictate whether a trust must be revocable or irrevocable. If you’re unsure whether you want to establish a revocable or irrevocable trust, consult a licensed estate planning attorney in your state.
Things to Consider
- What is the purpose of your trust and how it can help you? Is it to avoid taxes, pass assets seamlessly to heirs, or something else?
- It’s important to decide the type of trust you will need.
- Creating and managing a trust can get very complicated, so hire a qualified estate planning attorney.
This article is provided by Everplans – a life and legacy planning company dedicated to transforming the way people get their families organized. For more information, visit everplans.com.
Neither Transamerica nor its agents or representatives may provide tax, investment, or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding their particular situation and the concepts presented herein.