Have you started thinking about estate planning?

If so, you might have considered setting up a trust. If you haven’t yet, here’s a little overview. Essentially, a trust is a separate legal entity a person sets up to manage their assets. The assets are placed inside of a trust to be managed by a third party, known as a trustee, and the trustee decides how the assets are managed within the contexts of the trust. High-net-worth individuals in particular tend to use trusts instead of wills because a trust can reduce tax burdens and avoid assets going to probate. To break things down further, there are two types of trusts: revocable and irrevocable trusts. Each kind has its own advantages and disadvantages.

What is a revocable trust?

A revocable trust is also known as a living trust, and it can be changed at any time. The owner can remove beneficiaries, designate new ones, and modify stipulations on how assets within the trust are managed. There are a few important notes to make about revocable trusts that can make them less appealing to some investors. Revocable trusts do not shield assets from creditors. Therefore, if you are an individual who is subject to lawsuits in your line of work, this does not shield your assets. It also does not remove the implementation of state and federal estate taxes on the assets within the trust. Yet with the $12.6 million threshold before estate taxes, this is only a concern for high-net-worth individuals. However, there is added protection for real estate assets should it be granted to a minor as the trust can hold the real estate asset until they are of legal age. With this kind of trust, you will not have to name a guardian for the time until the minor reaches legal age. In the same way, if a minor is deemed unreliable with the money in a trust, the trust can set aside a distributed amount at recurring intervals. This will keep the minor from receiving all the money all at once.

What is an irrevocable trust?

An irrevocable trust is a trust that cannot be modified after it is signed. The main reason to select an irrevocable trust is for the tax benefit. Irrevocable trusts are not subject to estate taxes upon death. It also protects the benefactor from any taxes generated by income from the trust. The current allowance before having to pay estate taxes is $12.6 million per person. If you work in a profession where you could be subject to a lawsuit an irrevocable trust is a great way to protect your assets. The trust will hold your assets away from you so that they will not show in legal proceedings as personal assets. It is important to note that an irrevocable trust is harder to set up than a revocable trust. You will need a qualified trust attorney to establish the irrevocable trust. In the same way, it is difficult to dissolve an irrevocable trust, so if you are to create one keep in mind the binding nature of the entity. Another aspect to note is that with a revocable trust privacy is protected when it is established unlike an irrevocable trust that will be documented if it goes through probate court.

Why utilize a trust?

Both trust options are expensive to pursue, and they are geared more for high-net-worth individuals or those that have a potential for a lawsuit in their line of work. However, they can also be great options for eliminating the burden of estate taxes for benefactors. They can also help control assets on behalf of a minor benefactor. Before deciding to build a trust, talk to your financial advisor, attorney, and family to determine if it is the right pathway for you.

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Michaela Dowdy
Financial Planning Associate