When considering your estate planning, trusts can be an attractive option. They allow you to pass your wealth on while potentially avoiding the probate process and the headaches that come with it. They also give you some control over how your assets are invested and paid out to your beneficiary or beneficiaries. There are many options when setting up a trust — from the payment schedule and trustees, to how taxes on your trust’s assets are handled. It’s important to understand your options before you sit down to add a trust to your estate planning.
The Three Most Critical Roles in the Trust
The most important parts of your trust are the people in it. Three critical roles need to be filled. When establishing a trust, you are the grantor. The grantor is the person who funds the trust and sets the ground rules for how it will be run. The trust’s assets will be given to the individual or individuals that you have chosen to receive the assets and wealth in the trust. These are known as your beneficiaries.
You probably have a good idea of who you want your beneficiary or beneficiaries to be. However, it may take you longer to determine how to fill the third role of trustee. The trustee is responsible for running the trust, investing its assets, and giving them to your beneficiary or beneficiaries in accordance with the terms of the trust. The trustee can be an individual or an institution like a bank.
Along with beneficiaries and trustees, you also have the option to choose successors for these roles. Putting successors in place allows for greater long-term planning of your trust fund. If you have established a trust for your children, you can establish that your grandchildren will be the beneficiaries if their parents pass away before the trust is fully paid out. If you name an individual as your trustee, the successor trustee can take over the management of the fund if that individual dies or can no longer act as trustee.
How to Structure Your Trust
There are two main types of trusts in the broadest terms: revocable and irrevocable. In a revocable trust, you can actively manage and move assets within the trust. You still own them, and the trustee only takes over management if you become incapacitated. If you die, the assets are subject to the estate tax. If you have any outstanding debts, the assets in the trust may be used to pay them off.
An irrevocable trust works very differently. Once an irrevocable trust is established, you no longer have control of the assets. You cannot change the terms of the trust, and you no longer own the assets in it. The assets are protected from the estate tax when you pass away, and your creditors cannot use the assets in the trust to pay off your debts.
Both revocable and irrevocable trusts avoid probate on the assets within them. You’ll decide who the beneficiaries are before you pass away. There are also many variations within these broad categories, so you’ll want to make sure you discuss your options with a wealth management professional.
How the Trust Pays Your Beneficiaries
When you establish your trust, you’ll be able to decide how your beneficiaries are paid from it. This can be anything from a single lump sum to a lifetime of support drawn from the trust’s assets. You will stipulate how the trust is formed when it is drawn up.
Many trusts give the beneficiary all of the assets when they reach a certain age or milestone. For example, if you establish a trust for your children, it may say they receive 25% of the proceeds immediately and the rest after they graduate college. The number of payments and the stipulations for receiving them will be up to you when you set up the trust.
Many trusts also provide for the beneficiaries between these lump payments. A typical distribution method is known as HEMS — health, education, maintenance, and support. You can give your trustee instructions to cover these costs for your beneficiary, including provisions to adjust those payments in emergencies. This can make the trust a longer-term source of support, but it does increase the period of time the trust needs to be actively managed by a trustee, which can increase administrative costs.
Who Pays the Taxes
The funds your beneficiary draws from the trust are considered income, and the government will tax it. You can stipulate in your trust that the taxes on that income will be paid out as part of the trust, saving your beneficiary the headache. Otherwise, it is up to the trustee, who may have your beneficiary pay the taxes on the income themselves.
The assets in the trust may generate income on their own. All of that income must be paid out to the beneficiaries in a simple trust. In a complex trust, the trustee can reinvest the income, distribute it to beneficiaries, or donate it to charitable organizations. Depending on how your trust is structured, your beneficiaries can be paid from the income, receive the principal, or some combination of the two.
Beneficiaries also receive an exemption to the estate tax on their inheritance of up to $11.7 million in 2021. Inheritance beyond that is subject to the estate tax. States also have their own estate tax rules, which can come into play.
How to Set Up Your Trust
A trust can guarantee support for your beneficiaries, but how they get that support is up to you. Establishing a trust requires careful planning and consulting with an estate planning lawyer. This professional can help you structure your trust to maximize its benefit. You’ll also want to sit down with a financial planner, like 3D Wealth Advisors, to help fit your trust into your larger financial and estate planning goals.
A trust fund will ensure your hard-earned wealth continues to benefit the people you care about, even after you’re gone. Contact 3D Partners Wealth Advisors to get started.