People add trusts to their estate plans for many different reasons. Some testators putting together an estate plan worry about an unstable beneficiary and want to protect someone from the burden of a lump-sum inheritance. Other times, protecting resources from creditors could be a primary goal for someone who creates a trust.
For some testators, a trust is a means of reducing potential tax responsibilities. Taxes can significantly diminish the value of someone’s estate after their passing. Federal estate taxes alone can consume 40% of someone’s property after their death. There are many different types of trusts that people can create.
What is the right type of trust to use if someone hopes to minimize tax obligations?
Irrevocable trusts offer tax protection
There are many ways to classify the different types of trusts that people create, but there are two main categories of trust. There are revocable trusts, which people can modify after creating. There are also irreversible trusts, which do not allow for any major changes or adjustments after their creation.
Irrevocable living trusts are the best option for those hoping to reduce or eliminate estate taxes. The trust becomes the owner of valuable property that might otherwise trigger taxes, thereby diminishing the value of someone’s estate. Irrevocable trusts can even help reduce the risk of capital gains taxes for beneficiaries in some circumstances.
Of course, the inability to adjust the trust after its creation and the loss of direct control over the trust’s resources make very careful and thorough planning crucial for those creating irrevocable trusts. Decisions including what assets to use when funding the trust and who to appoint as the trustee required careful consideration.
The grantor establishing the trust typically cannot serve as its trustee. They must choose someone else to administer the trust. The beneficiaries are typically also other people, making an irrevocable trust a powerful tool for those leaving a sizeable legacy for their children or grandchildren. An irrevocable trust can be a useful inclusion in a comprehensive estate plan.
Although people often find it challenging to create and fund a trust, doing so can help reduce the potential tax burden on an estate and someone’s beneficiaries.