Types and Benefits of Trusts

Study Notes

Trusts

Trusts are legal arrangements that enable people to transfer assets to a third party for the benefit of another party. They are an essential aspect of estate planning and can serve various purposes, from asset protection to tax planning. In this article, we will discuss the different types of trusts, their uses, and the benefits and drawbacks of setting up a trust.

Types of Trusts

Grantor Trusts: These trusts are created by individuals who want to transfer their assets to beneficiaries while retaining control over the income generated by those assets. They can be either revocable or irrevocable, with the latter providing greater asset protection from creditors. The ability of a grantor's estate to receive a step-up in basis of the assets in a grantor trust upon death has been put into question by Revenue Ruling 2023-2, which determined that the assets in an irrevocable grantor trust do not receive a stepped-up basis upon the grantor's death.
Special-needs Trusts: These trusts are designed to provide for individuals with disabilities, ensuring that they have the resources they need without jeopardizing their eligibility for government benefits. They are typically funded by a financial planner and can be used to generate current income to support the individual while preserving their financial well-being.
Domestic Asset Protection Trusts (DAPTs): DAPTs are created to protect assets from creditors while minimizing transfer taxes. They are only available in states that have authorized them, and some of the biggest states (California, New York, and Texas) have not yet done so. The trustee may be required to maintain or arrange for custody of the assets in the trust's state of formation, and the trust must be irrevocable to protect the client's assets from creditors.
Trusts for Solo 401(k)s: These trusts allow business owners to set up a trust as part of their solo 401(k) plan, which can provide significant tax advantages and help build a retirement nest egg. The business owner can act as the trustee of the solo 401(k) and take advantage of the retirement plan's tax benefits.
Living (Revocable) Trusts: These trusts are created during an individual's lifetime and allow them to maintain control over their assets. They are appealing because they are revocable, meaning the individual can change or dissolve the trust while they are still alive. However, assets in a living trust are not protected from creditors, and the individual is subject to taxes on income earned by the trust.
Irrevocable Trusts: Unlike living trusts, irrevocable trusts cannot be changed or dissolved once they have been created. They can be valuable for tax planning, asset protection, and charitable giving. However, the individual cannot remove assets from the trust, change beneficiaries, or rewrite the trust's terms once it has been established.

Benefits of Trusts

Estate Planning: Trusts can be used to ensure that assets are distributed according to the individual's wishes after their death, avoiding the public and potentially lengthy probate process.
Asset Protection: Certain trusts can shield assets from potential creditors or legal claims, as placing assets in an irrevocable trust effectively removes them from the individual's personal ownership.
Tax Planning: Trusts can help minimize estate taxes and shift income tax burden to beneficiaries in lower tax brackets.
Protection in Case of Illness or Disability: Living trusts can be used to help manage assets if the individual becomes incapacitated, allowing the trustee to manage their property on their behalf.
Charitable Giving: Charitable trusts can support causes the individual cares about while potentially enjoying tax benefits.

Drawbacks of Trusts

Cost: Setting up and maintaining a trust can be expensive, with trustee fees, professional fees, and filing fees to consider.
Loss of Control: Depending on the trust chosen, the individual may give up some control over assets placed in the trust.
Time and Effort: Maintaining the trust and complying with its requirements can take considerable time, and income generated by trust assets may be taxed at a higher rate if not distributed to beneficiaries.

In conclusion, trusts can be a valuable tool for estate planning, asset protection, and tax planning. By understanding the different types of trusts, their benefits, and drawbacks, individuals can make informed decisions about whether a trust is right for their planning needs.

Description

Learn about different types of trusts, such as grantor trusts, special-needs trusts, and domestic asset protection trusts, along with their benefits and drawbacks. Explore how trusts can be used for estate planning, asset protection, tax planning, and charitable giving.