Trusts to avoid estate tax

[SecondCor521]

Hi all.

A poster over on Bogleheads regularly recommends that inheritances are provided in trust rather than outright, asserting that doing so keeps those inheritances out of the beneficiary's estate. He also asserts that this helps with other things like bad spouses and Medicaid and bankruptcy.

I am interested in this idea for estate tax avoidance, but am overall dubious for various reasons which I can go into if it becomes relevant.

If it is a legitimate idea and not just the commentary of a single BH poster, it occurs to me that there must be others here on this board who are in a similar situation: an inheritance now from an 80-something or 90-something grandparent level added to what a FIRE-ish couple in their 50's or 60's now might accrue on their own, plus compounding for a couple more decades, could result in massive estate tax bills.

And surely (?) someone in those sorts of shoes has thought about that and thought that maybe that's a potential planning issue. Perhaps, like me, they have heirs that they might rather see the money go to.

So is anyone out there also in this situation? If so, what have you done about it? Do you provide in trust rather than outright? What kinds of trusts do you use if so? What have you learned along the way about the subject?

 

[luckydude]

Hi all.

A poster over on Bogleheads regularly recommends that inheritances are provided in trust rather than outright, asserting that doing so keeps those inheritances out of the beneficiary's estate. He also asserts that this helps with other things like bad spouses and Medicaid and bankruptcy.

I am interested in this idea for estate tax avoidance, but am overall dubious for various reasons which I can go into if it becomes relevant.

If it is a legitimate idea and not just the commentary of a single BH poster, it occurs to me that there must be others here on this board who are in a similar situation: an inheritance now from an 80-something or 90-something grandparent level added to what a FIRE-ish couple in their 50's or 60's now might accrue on their own, plus compounding for a couple more decades, could result in massive estate tax bills.

And surely (?) someone in those sorts of shoes has thought about that and thought that maybe that's a potential planning issue. Perhaps, like me, they have heirs that they might rather see the money go to.

So is anyone out there also in this situation? If so, what have you done about it? Do you provide in trust rather than outright? What kinds of trusts do you use if so? What have you learned along the way about the subject?

Yep, DW and I are in the situation you describe.

Right now our HHNW is well north of the current estate tax exemption amount for couples, and I am in line to receive another 8-figure inheritance in the future. So with the estate tax exemption amount expected to drop down to $5 million pp ($6.2 million adjusted for inflation) in 2025 and the estate tax rate expected to increase to 45% in 2026, both I and my heirs face massive tax hits.

Our situation is further complicated by the fact that about 80% of our HHNW is tied up in various forms of RE.

Our challenges are #1 how to provide liquidity to pay estate tax when the time comes, #2 how to pass control of our RE holdings to our heirs, and #3 how to minimize tax hits.

When our HHNW was more modest a decade ago, we set up a living trust to hold our RE and did the POD designation for our financial accounts, thinking the setup would be sufficient for our purpose. That's no longer the case and we're in the midst of trying to come up with a more comprehensive estate planning strategy.

To partially address #1, we set up an irrevocable life insurance trust which will provide $x million in liquidity to pay for estate tax if things go according to plan; we fund that by using part of our annual gift exemption amount. We are also planning to liquidate some of the non-core RE holdings in our lifetime to provide additional liquidity.

We've started to address #2 and #3 by setting up LLC for a couple of parcels for which we've signed up for wind farming. We're using remaining part of our annual gift exemption amount to transfer these parcels using their cost basis over multiple years to our heirs so they can receive a 6-figure lease payment annual from the wind farm (and thus keep the payment out of our estate). We plan to eventually set up additional LLCs to transfer other properties to them in the future in similar fashion once the irrevocable life insurance trust is fully funded and more annual exemption amount is freed up.

We are working with an estate planning attorney to explore other, possibly more esoteric strategies. Unfortunately, no strategy is perfect, and each has its pros and cons. In the meantime, the general idea is to try to transfer as much of our assets to our heirs as possible during our lifetime to minimize the expected massive tax bite.

As far as protections against bad spouses, bankruptcy, lawsuits, etc., frankly those are minor considerations for us at this point.

To be perfectly honest, it has become a real PITA to deal with this estate planning stuff

 

[DrRoy]

We have our assets in a living trust for the purpose of probate avoidance, not so much for taxes.

 

[jebmke]

The best way to deal with this is find a good law firm that has some depth in their estate practice including people (preferably at partner level) who have specific training and expertise in taxation. Normally this would be something like a masters degree in taxation in addition to their law degree.

State laws vary considerably so it needs to be someone who is deeply familiar with both the federal estate (tax) laws as well as state laws that govern both the estate tax as well as potential inheritance tax that the beneficiaries may end up paying.

If your assets are above the exemption levels, this isn't something you want to DIY or leave to random internet people.

 

[ERD50]

Not in your position, but became aware of some of this back when the brackets were far lower.

A poster over on Bogleheads regularly recommends that inheritances are provided in trust rather than outright, asserting that doing so keeps those inheritances out of the beneficiary's estate.

Not true, *unless* it is an irrevocable trust. Irrevocable trusts remove the money from your control, it is no longer yours. And it has to be done properly, I'd assume there is also a 'claw back' period. A revocable ('living') trust does not do this at all (it can help avoid probate, but not estate taxes).

But it's complicated. Read up (NOLO is a good source) and seek a real pro if you want to move forward. Most of these plans have gotchas, TNSTAAFL.

-ERD50

 

[Koolau]

Unless the minimums change, I'll never need this. I think I'd be tempted to BTD instead. YMMV

 

[ShokWaveRider]

No heirs don't care.

 

[socca]

... Our challenges are #1 how to provide liquidity to pay estate tax when the time comes, #2 how to pass control of our RE holdings to our heirs, and #3 how to minimize tax hits. ...

Another challenge: minimizing the tax on time (your time, your heirs' time, etc.) while maximizing tax savings. Before you get too excited about launching multiple entities (esoteric or not), consider the very real tax on time required to administer them. Estate planning lawyers have no trouble selling esoteric tax-minimization strategies as long as fat fees are available.

 

[Koolau]

No value judgment implied on anyone else, but I would be concerned about passing a large inheritance to (in our case) our children. I realize that inheritance of a business in which the children are already intimately involved is quite different. I'm thinking more in terms of a middle class 30+ year old, suddenly receiving $15mil in cash. Our kids are pretty responsible for the most part. I'd hate to mess them up with a big inheritance. (Likely we'll die with a nice stash, but nothing like the current inheritance tax minimums.) YMMV

 

[SecondCor521]

@luckydude, thanks for the perspective, and good luck with your situation. Just being reminded of the LLC route as another option helps tip my conclusion that the BH poster (who I think is a estate planning guy) is a "when all you have is a hammer" type of situation.

(As an aside, I think the basic exclusion amount halving happens on 1/1/2026 and simultaneous with the increase in rate, unless there has been a recent change to the law which I didn't notice.)

@DrRoy, yes, a living trust doesn't do anything for estate taxes AFAIK.

@jebmke, appreciate and agree with the comments. No state level estate or inheritance tax in our situation.

@ERD50, thanks for the comments. I know there are a lot of different kinds of trusts out there.

@Koolau, yep, you're way better at BTD than I am (as are most on this board!)

@socca, good point. This stuff is rapidly approaching PITA territory to echo @luckydude's comments - hard to optimize, hard to let go of apparent opportunities to optimize.

 

[teej1985]

The "one boglehead poster", bsteiner, is Bruce Steiner, a reputable attorney. He knows what he is talking about.

https://www.kkwc.com/attorney/bruce-d-steiner/

 

[SecondCor521]

The "one boglehead poster", bsteiner, is Bruce Steiner, a reputable attorney. He knows what he is talking about.

https://www.kkwc.com/attorney/bruce-d-steiner/

Yes. I didn't mention his name because this thread is about the idea, not the person.

I think Mr. Steiner is smart, well educated in relevant areas, has tons of relevant experience, and is generally well respected, including by me.

Given those stipulations, if his frequent recommendation of providing in trust is a generally good idea, particularly in the scenario I described in the OP, then I would expect others to either (a) agree with the recommendation, or (b) converge on similar solutions independently. I haven't yet seen much supporting evidence, but I'm still looking for it.

 

[tulak]

I live in WA, where estate tax starts after 2.2 mil. I’m less worried about the federal estate tax, since I might never hit that threshold.

I never thought about this until the other day, also after I saw something on Bogleheads. No idea what to do to minimize this tax, but I have time to figure it out.

 

[luckydude]

No value judgment implied on anyone else, but I would be concerned about passing a large inheritance to (in our case) our children. I realize that inheritance of a business in which the children are already intimately involved is quite different. I'm thinking more in terms of a middle class 30+ year old, suddenly receiving $15mil in cash. Our kids are pretty responsible for the most part. I'd hate to mess them up with a big inheritance. (Likely we'll die with a nice stash, but nothing like the current inheritance tax minimums.) YMMV

I share your concern.

I am a bit unique in that on DM's side, I am the 4th generation of inherited wealth, and on DF's side, I'm the 2nd generation. So, I have experience both as an inheritor when I was growing up, and now as the older generation planning to pass my wealth onto my heirs. Also in my extended families, I've seen literally dozens of examples of wealth transfers---some went off well while others failed spectacularly. So, I am drawing on both my personal experience as well as the experiences of my cousins, uncles, aunts, etc., in trying to come up with a wealth transfer strategy.

Based on what I've seen within my own family, if the parents are financially disciplined and responsible and passed those values onto their kids, the kids usually handled it well. They can either grow the pot or at least they can hold on to it and lead normal, productive lives.

But if the parents are financially irresponsible or ignorant, or worse are indulgent toward their kids out of a mistaken sense of "love" by giving them too much too early without proper guidance, the kids usually mimic their parents' behavior and flame out (e.g. a cousin lost his 8-figure inheritance through an affinity scam; a 2nd cousin inherited a trust fund at 18 in college, promptly bought a fancy sports car, crashed said car because speeding and became paralyzed from waist down).

For me, I think the key is to get my heirs educated on money management and financial discipline as early as possible and give them the opportunity to "test drive" a small amount of wealth under our guidance, so that they can learn from mistakes and get comfortable with managing wealth. Of course, it's possible that some kids just never learn no matter how much guidance parents provide them. If that's the case with my heirs, at least I'll be able to see it up front and put in some checks and balances through various estate planning mechanisms to rein in the worst of their impulses.

It's akin to teaching a kid how to drive a car. They need to learn all the rules of the road and do plenty of practice before they get their license and drive on their own.

 

[Souschef]

.


For me, I think the key is to get my heirs educated on money management and financial discipline as early as possible and give them the opportunity to "test drive" a small amount of wealth under our guidance, so that they can learn from mistakes and get comfortable with managing wealth. Of course, it's possible that some kids just never learn no matter how much guidance parents provide them. If that's the case with my heirs, at least I'll be able to see it up front and put in some checks and balances through various estate planning mechanisms to rein in the worst of their impulses.

It's akin to teaching a kid how to drive a car. They need to learn all the rules of the road and do plenty of practice before they get their license and drive on their own.

I agree. I divided the proceeds from the sale of my house among our 4 sons. I am also gifting them the $16K max every year. It is not a life changing amount, but enough to ease their financial burden.

 

[RetireBy90]

I think there are some really valid reasons to consider a trust. However I think lawyers can/may advise them when other options are available. DM paid over $3K for a trust because she was worried about passing her house but many states (including hers) allow transfer on death deeds. We paid $300 and $250 to prepare and file for 2 houses. We ended up selling her house when we had to move her to assisted living so that was a “tax” not needed.
As for saving on taxes, If you were to transfer assets to a trust say $5M worth and over the next 20 years they increase in value, you already gave them away so not your estate, no estate tax. I do believe there are taxes the trust would have to pay on realized gains so you need to consider that.
Another “trick” used to be buy whole life insurance paid up, and the policy will pay tax free upon your death. Life insurance distribution isn’t taxable, and not your estate.
Another option is a deferred single premium annuity for your heir. If it is 20 years away, you could purchase one a year with a gift from you and spouse for total of $14K to each heir each year. So if you wanted you could do one for heir and one for spouse, $28K. Over 4 years moving $112K to each heir. You just needs lots of heirs for $10M. I’m available if needed.
ETA - souschef provided updated $16K not $14Kper year. Thanks

 

[luckydude]

Another challenge: minimizing the tax on time (your time, your heirs' time, etc.) while maximizing tax savings. Before you get too excited about launching multiple entities (esoteric or not), consider the very real tax on time required to administer them. Estate planning lawyers have no trouble selling esoteric tax-minimization strategies as long as fat fees are available.

Thank you. This is very true. We're just going to set up one LLC for now and see how that goes. But you're so right about the time and effort and $ it takes to set up individual vehicles and then having to administer them. Estate planning is truly PITA.

 

[luckydude]

@luckydude, thanks for the perspective, and good luck with your situation. Just being reminded of the LLC route as another option helps tip my conclusion that the BH poster (who I think is a estate planning guy) is a "when all you have is a hammer" type of situation.

(As an aside, I think the basic exclusion amount halving happens on 1/1/2026 and simultaneous with the increase in rate, unless there has been a recent change to the law which I didn't notice.)

Thank you SecondCor521. Best of luck with your planning as well!

I don't venture over to BH much and don't know much about the BH poster your reference, but I actually think the concept of using living trust as default vehicle for estate planning is a sound one. Its benefits are avoiding probate and allowing a grantor to control the timing and distribution of his assets to heirs upon his/her death. Done right, a living trust can certainly offer some measure of asset protection against a beneficiary's bad spouse and creditors while assets remain within the trust. So I think a living trust is a great vehicle for estate planning in general.

What it doesn't do is "reduce estate tax" (other than the bypass trust setup, which was quite useful when exemption amount was much lower in the old days). So, for an estate that exceeds the estate tax exemption amount, other strategies are needed to minimize the estate tax bite. That's where strategies such as irrevocable life insurance trust, LLC, annual gift exemption amount, etc. come in. The idea is to try to transfer as much of one's assets out of one's estate (and thus out of one's living trust) as possible before death.

So, in my case, my main vehicle for estate planning is still the living trust that DW and I set up a decade ago (updated as needed). That still governs the timing and amount of distribution of our assets in the trust upon our demise. The LLC and irrevocable life insurance trust, etc., are simply additional strategies for reducing estate tax, but they don't replace the living trust itself. So when we kick the bucket, only those assets still remaining in the living trust will be subject to estate tax (if any) and distributed according to the terms of the trust.

Obviously I am no expert on this, so it's best to consult a professional

 

[mathjak107]

Before New York went to the federal level we were over the state threshold for the 1 million dollar exclusion .

Plus ny has a tax cliff .

Go over by 5% and you don’t pay on the overage , you lose the exclusion and pay from dollar one .

We found the most knowledgeable estate attorney to guide us .

He set us up with what are called disclaimer trusts .

These work great ..they are totally transparent if not needed .

The surviving spouse has 9 months to disclaim half the estate if need be .

The estate is split and-half goes in to an irrevocable trust ….

Last thing we would want is to deal with an irrevocable trust and the restrictions.

Today new York is at the federal level so so far we don’t need them

 

[OldShooter]

No value judgment implied on anyone else, but I would be concerned about passing a large inheritance to (in our case) our children. ...

Our estate plan creates a testamentary trust for our 50+YO son. It will hold very low seven figures plus he will receive a house with value approaching $1M. The reason for the trust is primarily to ensure proper management of the money as he is very financially naïve. It is also to protect the money as he is quite a gentle soul and would be vulnerable to hucksters that he might meet in "safe" places like his church. He knows about the trust and the reasons and he is grateful for it.

The trust will be funded with tIRA money, so will disburse based on the ten-year rule, then terminate.

 

[SecondCor521]

Our estate plan creates a testamentary trust for our 50+YO son. It will hold very low seven figures plus he will receive a house with value approaching $1M. The reason for the trust is primarily to ensure proper management of the money as he is very financially naïve. It is also to protect the money as he is quite a gentle soul and would be vulnerable to hucksters that he might meet in "safe" places like his church. He knows about the trust and the reasons and he is grateful for it.

The trust will be funded with tIRA money, so will disburse based on the ten-year rule, then terminate.

You may have mentioned this, but, and if you don't mind my asking, who is the trustee for your testamentary trust?

 

[OldShooter]

You may have mentioned this, but, and if you don't mind my asking, who is the trustee for your testamentary trust?

We've specified Schwab based more on faith than due diligence. That said, DW retired as an SVP in Megabank's Investments and Trusts division so she knows the landscape and has all the acronyms after her name.

We'll actually be scheduling a Zoom next month with the Schwab Trust region manager to understand more about what we're getting into. There are various ways of handling a small trust like we're talking about here and DW wants to get the Schwab details on that.

 

[ncbill]

I live in WA, where estate tax starts after 2.2 mil. I’m less worried about the federal estate tax, since I might never hit that threshold.

I never thought about this until the other day, also after I saw something on Bogleheads. No idea what to do to minimize this tax, but I have time to figure it out.

As I posted over on that thread, why not move assets into an irrevocable trust domiciled out-of-state?

There are costs to setting it up & running such but they're likely to be a fraction of the hefty estate tax that would be owed if the asset owner died now.

 

[tfudtuckerpucker]

As I posted over on that thread, why not move assets into an irrevocable trust domiciled out-of-state?

There are costs to setting it up & running such but they're likely to be a fraction of the hefty estate tax that would be owed if the asset owner died now.

I've been looking for options for Washington state also. One thing I found- a Washington credit shelter trust (also known as a revocation trust), which allows a married couple to transfer one $2.2 million exemption to a surviving spouse, effectively doubling the exemption to $4.4 million for state taxes.

 

[mathjak107]

Look into what we used , the disclaimer trust