Revocable Living Trusts - Taxes on Reinvested Dividends

[24601NoMore]

Considering a Revocable Living Trust to hopefully simplify estate transition..

One thing I've run into is that Federal tax rates on income generated by a RLT and not paid directly to beneficiaries in the same tax year are way higher than the tax rates paid by individuals if the same assets were held outside of a trust.

For example - we have a number of CDs that we reinvest dividends back into. Assuming we're in the 12% marginal tax bracket, those dividends would be taxed (Federal) at 25% less (!) if those CDs were held outside of a Trust, vs inside of it. That appears to be because of the tax rates for income generate by a Trust and not paid out to the beneficiaries..

Am I missing something here, or is that indeed how income generated by a Trust vs. income generated by assets held in taxable accounts differs in terms of tax liability?

Other questions..

- What about dividends from a MYGA purchased with after-tax dollars held in a Trust? If those are re-invested, what rate is that dividend income taxed at?

- How about Qualified Dividends in a taxable account? Do they maintain the same 0%/15% rates if generated inside of a Trust vs. in a Brokerage Taxable account?

So confusing..

TIA for any/all help..

 

[teej1985]

Aren't RLT's just pass throughs for the individual? They don't get taxed as trusts?

 

[Dash man]

Yes, we pay taxes on any dividends or gains in the year we receive them. Our trusts are set up to pay out trusts to the beneficiaries each year. If a trust is set up to reinvest dividends or capital gains, they would pay a higher tax rates if not distributed to the beneficiaries.

 

[teej1985]

Yes, we pay taxes on any dividends or gains in the year we receive them. Our trusts are set up to pay out trusts to the beneficiaries each year. If a trust is set up to reinvest dividends or capital gains, they would pay a higher tax rates if not distributed to the beneficiaries.

You have your own RLT or something else?

https://burnerlaw.com/does-my-trust-need-an-employer-identification-number-ein/

Generally, revocable trusts do not need an EIN as they are grantor trusts and the trust’s income is reported on the tax return of the trust creator. If you have created a revocable trust, you may revoke the trust at any time and “regain” possession of the trust assets. Accordingly, a revocable trust is an extension of the grantor who created the trust. The grantor pays the income taxes generated by the revocable trust and uses the social security number of its grantor as its tax ID. Couples with a joint revocable trust both hold the power to revoke the trust, either person’s social security number can be used. A separate tax ID is necessary if they do not file taxes jointly.

A revocable trust becomes irrevocable at the grantor’s death. At that time, the trust requires an EIN, as the trust can no longer be associated with the deceased grantor’s social security number. The trust must file its own taxes.

 

[Dash man]

We own them, with each other as beneficiaries and our sons as contingent beneficiaries.. As long as earnings are paid out the taxes are ordinary and not at the rate trusts would pay.

 

[Slim11]

They may mean after they die? Idk. And who knows how they will change any of the tax laws in the future. I am curently setting up a trust to take care of ex spouse and minor child if i get hit by the proverbial bus. Not ideal, but the only way I can provide for my child. With a revocable trust I can change it when the kido gets older. As far as I know, as stated above, all accounts, and properties are taxed and filed with you while your alive.

 

[Sunset]

Considering a Revocable Living Trust to hopefully simplify estate transition..

.....

And you have already exhausted the use of TOD/POD on other accounts ?

Maybe I'm missing something, I have TOD/POD for example on my brokerage account, and it contains: CDs, Treasuries, Stocks, Stock funds.

So they all get spread to the beneficiaries when I die.

I have thought of a trust for real estate to remove the probate issue, but I'd like it to be perpetual until someone wants to dissolve it.

 

[SecondCor521]

@teej1985 is correct. If it is an RLT, the income is all reported under the grantor's SSN and is taxable on the grantor's tax return. Until they die, at which point the RLT, if it still exists, gets it's own EIN and starts filing trust returns and paying taxes at the trust rates and brackets, generally on any income that is earned by and retained in the trust. If distributed to the trust beneficiaries, then it's taxed on the beneficiaries' returns at their (presumably lower) rates.

The tradeoff is between the higher rates inside the trust and the benefits that the trust is providing (protection from creditors, ex-spouses, Medicaid maybe, keeping assets out of probate).

The only antidote I know of is to have the trust invest in assets that don't throw off income, like BRK.B or something.

And I echo the above: POD/TOD/beneficiary designations are generally easier/cheaper/faster to implement and maintain than an RLT and will similarly avoid probate. This assumes that the distribution after death wishes are simple. Mine are, so I use POD/TOD/beneficiary where I can and don't have an RLT.

 

[rk911]

Aren't RLT's just pass throughs for the individual? They don't get taxed as trusts?

that's exactly what was done with the trusts I am familiar with (mother, two BIL's and my FIL/MIL).

 

[OldShooter]

Yes, we pay taxes on any dividends or gains in the year we receive them. Our trusts are set up to pay out trusts to the beneficiaries each year. If a trust is set up to reinvest dividends or capital gains, they would pay a higher tax rates if not distributed to the beneficiaries.

Fairly routine on the forum here, "trust" is used but not defined.

An RLT (aka "rev" trust) doesn't really exist from a tax perspective. Everything goes through the grantor's tax returns. No requirement to distribute anything, no different tax rate.

A rev trust becomes an irrev trust upon the donor's death. This is where the 30+% tax rate comes into play if the trust income is not distributed in the year earned. The trust has to obtain an EIN and file a tax return.

It is also possible to establish an irrev trust while the grantor is alive. There are many kind of trusts used. ChatGPT just gave me a list of a dozen common ones. This is why it's important to hire expert help. Hopefully the OP is just trying to get educated here before consulting a specialist attorney for firm. An attorney could have quickly answered all of these questions.

 

[pb4uski]

that's exactly what was done with the trusts I am familiar with (mother, two BIL's and my FIL/MIL).

+1 DM is beneficiary of two trusts. One RLT where she is grantor, beneficiary and co-trustee along with my sister and I. Another RLT for my Dad that is now irrevocable because he passed where she is the beneficiary and she, my sister and I are all co-trustees.

For her trust I report interest, dividends, gains and losses no differently from if she owned those assets directly rather than indirectly through the RLT.

For my dad's trust I prepare a tax return each year and she receives a K-1 for interest, dividends, etc. and we distribute all income from the trust to her.

 

[PatrickA5]

+1 DM is beneficiary of two trusts. One RLT where she is grantor, beneficiary and co-trustee along with my sister and I. Another RLT for my Dad that is now irrevocable because he passed where she is the beneficiary and she, my sister and I are all co-trustees.

For her trust I report interest, dividends, gains and losses no differently from if she owned those assets directly rather than indirectly through the RLT.

For my dad's trust I prepare a tax return each year and she receives a K-1 for interest, dividends, etc. and we distribute all income from the trust to her.

How complex is the 1041 and K1s?

While I have no doubts that I would be able to handle Trust taxes, I'll be dead. The people left with the Irrevocable Trust will have to figure out what to do and how to do it. One of my kids, in particular, would probably just ignore Trust taxes completely, causing problems. Of course, the alternative would be to pay a corporate trustee to handle things, but that would cost a decent amount of money.

Currently, we have everything POD/TOD, including the house. Nothing should go through probate. I like what some of the protections that trusts might provide my kids, but I'm trying to figure out if I want to burden them with Trust Administration and tax reporting.

 

[24601NoMore]

Thanks for all the replies..so, to net it all out (let's see if I have this all right..)

Revocable Living Trusts are 'invisible' to the IRS while the grantor is alive. That means all dividends, cap gains, etc are taxed at the grantor's maginal tax rate, not the Trust's.

When the grantor(s) dies, the RLT become Irrevocable, at which time a new Tax Id Number is generated for the Trust. Dividends, Cap Gains, etc NOT paid out to beneficiaries and retained by the Trust are then taxed at the considerably higher marginal tax rates. All dividends, cap gains paid out to beneficiaries are taxed at the marginal tax rate of said beneficiary and reported on a K-1, while the Trust itself has to file a different form (1041).

 

[SecondCor521]

Thanks for all the replies..so, to net it all out (let's see if I have this all right..)

Revocable Living Trusts are 'invisible' to the IRS while the grantor is alive. That means all dividends, cap gains, etc are taxed at the grantor's maginal tax rate, not the Trust's.

When the grantor(s) dies, the RLT become Irrevocable, at which time a new Tax Id Number is generated for the Trust. Dividends, Cap Gains, etc NOT paid out to beneficiaries and retained by the Trust are then taxed at the considerably higher marginal tax rates. All dividends, cap gains paid out to beneficiaries are taxed at the marginal tax rate of said beneficiary and reported on a K-1, while the Trust itself has to file a different form (1041).

Correct, more or less.

When the trust becomes irrevocable, the trustee asks the IRS for an EIN. It's done on request; not automatically.

The K-1 is a form that the trustee has generated and sent to the beneficiaries for any distributed income. The beneficiaries take the income reported on the K-1 and incorporate that into their 1040s. A K-1 is similar in concept to a W-2 or 1099-INT.

And yes, the 1041 is what the trust uses to file it's taxes.

One addition: there may be a state income tax equivalent of the 1041. In Idaho, it's a Form 66. An Idaho trust would file a 1041 with the IRS and a Form 66 with the state tax agency to pay its state income tax.

 

[24601NoMore]

PS: we do have POD beneficiary designations on most all our accounts (aside from Vanguard, which is a real pain when it comes to beneficiaries on joint accounts - they basically won't do it for reasons that still don't make a lot of sense to me).

PODs aside, we have other reasons for being interested in a RLT:

- Complex financial situation. Maintaining a bunch of PODs as accounts come and go (eg: moving between brokerages, CDs and MYGAs maturing and getting replaced with others) and attempting to get reasonably "even" (50/50'ish) distribution between the 2 families once we are both gone is a GIANT PITA. Far easier to have one big bucket that basically gets split into two halves and distributed from there..

- Legacy: I'd like to setup my 50% of the Assets in the Trust to pay out a small portion (maybe 4%) each year to the beneficiary, and for the amount in the Trust to hopefully grow over time. When that beneficiary (who does not have children) eventually passes, I'd like the remaining funds to go to several worthy charities that I have in mind. I'd also prefer this to just giving her a large pile of $$ outright through POD because A) I doubt she could manage it well, so prefer a distribution of a small amount yearly instead and B) in the event she ever marries her long time (10+ year) boyfriend at which point the big pile of $$s would become community property that could be split in a divorce situation. I'd prefer those $$s to stay in my immediate family and to eventually go to charity instead after she eventually passes.

 

[pb4uski]

How complex is the 1041 and K1s?

While I have no doubts that I would be able to handle Trust taxes, I'll be dead. The people left with the Irrevocable Trust will have to figure out what to do and how to do it. One of my kids, in particular, would probably just ignore Trust taxes completely, causing problems. Of course, the alternative would be to pay a corporate trustee to handle things, but that would cost a decent amount of money.

Currently, we have everything POD/TOD, including the house. Nothing should go through probate. I like what some of the protections that trusts might provide my kids, but I'm trying to figure out if I want to burden them with Trust Administration and tax reporting.

Not very complicated at all (full disclosure: I'm a retired CPA and did some tax practice from 1977-1980). 1041 is 3 pages but basic, Sch D is 2 pages and K-1 is 1 page and many years I don't have a Schedule D. I have an Excel template that I input the 1099-DIV, 1099-INT and 1099-B numbers into that maps to the relevant lines on the tax return and I download that year's pdf for forms from irs.gov and fill them out, print them, sign and mail. I'm guessing 1-2 hours now that I've done it for 17 years.

Can you elaborate on the protections that trusts would provide for your kids? Similar to you we have virtually everything with beneficiary designations to the kids for financial accounts and enhanced life estate deeds for real property.

 

[pb4uski]

... - Legacy: I'd like to setup my 50% of the Assets in the Trust to pay out a small portion (maybe 4%) each year to the beneficiary, and for the amount in the Trust to hopefully grow over time. When that beneficiary (who does not have children) eventually passes, I'd like the remaining funds to go to several worthy charities that I have in mind. I'd also prefer this to just giving her a large pile of $$ outright through POD because A) I doubt she could manage it well, so prefer a distribution of a small amount yearly instead and B) in the event she ever marries her long time (10+ year) boyfriend at which point the big pile of $$s would become community property that could be split in a divorce situation. I'd prefer those $$s to stay in my immediate family and to eventually go to charity instead after she eventually passes.

My understanding is that if you don't pay out all income to the beneficiary then the income not paid out is taxed at trust tax rates. So if you don't want the trust to become a taxpayer then the only growth can be from unrealized gains and not from reinvested income.

But if you have all income and realized gains paid out to the beneficiary, then I think what you are thinking of would work, but consult your lawyer.

 

[OldShooter]

... - Complex financial situation. Maintaining a bunch of PODs as accounts come and go (eg: moving between brokerages, CDs and MYGAs maturing and getting replaced with others) and attempting to get reasonably "even" (50/50'ish) distribution between the 2 families once we are both gone is a GIANT PITA. Far easier to have one big bucket that basically gets split into two halves and distributed from there..

Agree. I think many of the POD advocates underestimate the maintenance aspects of this strategy.

... - Legacy: I'd like to setup my 50% of the Assets in the Trust to pay out a small portion (maybe 4%) each year to the beneficiary, and for the amount in the Trust to hopefully grow over time. When that beneficiary (who does not have children) eventually passes, I'd like the remaining funds to go to several worthy charities that I have in mind. I'd also prefer this to just giving her a large pile of $$ outright through POD because A) I doubt she could manage it well, so prefer a distribution of a small amount yearly instead and B) in the event she ever marries her long time (10+ year) boyfriend at which point the big pile of $$s would become community property that could be split in a divorce situation. I'd prefer those $$s to stay in my immediate family and to eventually go to charity instead after she eventually passes.

Be sure to get some expert advice on this plan. For example, the trustee should have some discretion on that 4% payout. What if the beneficiary becomes terminally ill and live-in help is needed? 4% doesn't do it but some trustee discretion could.

 

[PatrickA5]

Not very complicated at all (full disclosure: I'm a retired CPA and did some tax practice from 1977-1980). 1041 is 3 pages but basic, Sch D is 2 pages and K-1 is 1 page and many years I don't have a Schedule D. I have an Excel template that I input the 1099-DIV, 1099-INT and 1099-B numbers into that maps to the relevant lines on the tax return and I download that year's pdf for forms from irs.gov and fill them out, print them, sign and mail. I'm guessing 1-2 hours now that I've done it for 17 years.

Can you elaborate on the protections that trusts would provide for your kids? Similar to you we have virtually everything with beneficiary designations to the kids for financial accounts and enhanced life estate deeds for real property.

I'm also a retired CPA that prepared individual taxes (but not trusts) as a semi-retirement job. What you describe above sounds simple to you (and me), but for non-financial savvy people (like my daughter) it's a no-go. Might as well tell her to perform brain surgery.

The one protection that DW and I "might" consider a trust for the kids is in the event our kids get divorced and their spouses end up with half our money (that we intend for the grandkids to have). Or, our child dies leaving all of our money they inherited to spouse - which remarries.

Not sure we care enough about the above scenarios to go with a trust at this point. We're just studying up on our options.

 

[SecondCor521]

The one protection that DW and I "might" consider a trust for the kids is in the event our kids get divorced and their spouses end up with half our money (that we intend for the grandkids to have). Or, our child dies leaving all of our money they inherited to spouse - which remarries.

While trusts apparently work for this situation, in my state at least inheritances and gifts (and possibly separate property brought into the marriage) are considered separate property not subject to division as long as there has been no commingling.

If you leave money to your kid, then I think it's up to them to decide who to leave it to - either their kids, or their ex-spouse, or whomever.

Also in my state there is a law that says that in the event of a divorce, any POD/TOD/etc. to ex-spouse is automatically nullified.

 

[24601NoMore]

My understanding is that if you don't pay out all income to the beneficiary then the income not paid out is taxed at trust tax rates. So if you don't want the trust to become a taxpayer then the only growth can be from unrealized gains and not from reinvested income.

But if you have all income and realized gains paid out to the beneficiary, then I think what you are thinking of would work, but consult your lawyer.

That's my understanding as well. So, yes, dividends and cap gain distributions should be paid out from the Trust to the beneficiaries in order to have that income taxed at the lower individual (vs Trust) rates. Divvys and cap gain distributions can apparently stay in the Trust prior to it passing to a beneficiary and be taxed at individual marginal tax rates.

Agree. I think many of the POD advocates underestimate the maintenance aspects of this strategy.

Be sure to get some expert advice on this plan. For example, the trustee should have some discretion on that 4% payout. What if the beneficiary becomes terminally ill and live-in help is needed? 4% doesn't do it but some trustee discretion could.

Yeah, totally agree and do plan to hire Estate Planning people to advise/administrate all this. We tried a few years ago before going on an African Safari (just in case we didn't both make it back in one piece) to set POD/TOD on all of our accounts in a roughly, 50/50 split..damned near impossible given the differing $$ amounts in the various accounts. And there have been so many changes since then that I couldn't even begin to say with any certainty today what the split would be. It could literally be 10, 20 or even 30 percent off my original 50/50 split between the two families per the TOD/POD. Really a pain to administrate if you have a lot of moving parts/accounts.

I should have mentioned (but forgot to) that I did plan to have an "emergency access to capital" provision in the Trust for the reasons you mentioned. But primarily would want her to leave the principal mostly intact so that it could continue to generate dividends for her through end of life.

I'm also a retired CPA that prepared individual taxes (but not trusts) as a semi-retirement job. What you describe above sounds simple to you (and me), but for non-financial savvy people (like my daughter) it's a no-go. Might as well tell her to perform brain surgery.

The one protection that DW and I "might" consider a trust for the kids is in the event our kids get divorced and their spouses end up with half our money (that we intend for the grandkids to have). Or, our child dies leaving all of our money they inherited to spouse - which remarries.

Not sure we care enough about the above scenarios to go with a trust at this point. We're just studying up on our options.

This is another big concern of mine as well. If I just gave a big pile of assets to sister, she marries, and then either per-deceases new hubby or God forbid they divorce, either half (divorce) or all (death) of the $$s would go to him. Not what I want. I'd prefer the remaining $$s to go to a number of charities that I care passionately about.

Saw a webinar the other day that recommended you communicate your desires to your family. Was talking with Mom (80) about this just a bit ago, and my best efforts aside, she got a little argumentative with me about my plan. It was clear she prefers I just give sis the big pile of cash and then it's "her money". But there's a precisely 0.00% chance she'd have the first clue how to manage it, so would need "a guy" (just like Mom has today) who would up charging her 1% AUM or more, cutting 1/4th - 1/3rd into the 3-4% or so divvy/cap gain income stream I'm trying to setup. Pretty good chance she'd kill the golden dividend goose by spending a lot of it. So, I had to remind Mom that in the end, it's MY money to do with what *I* choose. It annoyed me enough to ALMOST say "well, I could just will all my assets to the cute little nurse that sees me thru my final days and leave nothing at all to you..would you guys like THAT instead?" Sigh...try to do a nice thing and even sometimes that isn't appreciated..ugh!

 

[OldShooter]

... I should have mentioned (but forgot to) that I did plan to have an "emergency access to capital" provision in the Trust for the reasons you mentioned. But primarily would want her to leave the principal mostly intact so that it could continue to generate dividends for her through end of life. ...

Slight rephrasing and that language can go straight into the trust. Search "HEMS" also.

 

[24601NoMore]

So I did some digging on Trustee costs..HOLY. COW! Even Vanguard is 55 basis points (25 bps Admin, 30 bps Advisory). That's $5,500 on every mil and would really cut in to $$ that our heirs would otherwise have available to spend.

It's looking more like a Trust isn't the best solution for us. But the POD/TOD Administration is an absolute nightmare with the # of moving pieces and parts we have going. I'm gonna try to take another swing at solving this problem that way and see if I can come up with an easier way to administrate it.

If I do that, I can't restrict little sis from just "blowing the wad" (via a Trust). But I'll put thousands of $$s more in her pocket every year, also, through cost avoidance.

Guess I'll just have to trust that she'll do the right thing..and if she doesn't, I won't be hear to care anyway (I guess!)

 

[Slim11]

So I did some digging on Trustee costs..HOLY. COW! Even Vanguard is 55 basis points (25 bps Admin, 30 bps Advisory). That's $5,500 on every mil and would really cut in to $$ that our heirs would otherwise have available to spend.

It's looking more like a Trust isn't the best solution for us. But the POD/TOD Administration is an absolute nightmare with the # of moving pieces and parts we have going. I'm gonna try to take another swing at solving this problem that way and see if I can come up with an easier way to administrate it.

If I do that, I can't restrict little sis from just "blowing the wad" (via a Trust). But I'll put thousands of $$s more in her pocket every year, also, through cost avoidance.

Guess I'll just have to trust that she'll do the right thing..and if she doesn't, I won't be hear to care anyway (I guess!)

Why not just make your sister the trustee, and release monies in increments? The trust will have to get its own number and do its own taxes, but she can higher an accountant for that? Does she have children? Whats her age? Trusts can live on for a long time like that.

 

[24601NoMore]

Why not just make your sister the trustee, and release monies in increments? The trust will have to get its own number and do its own taxes, but she can higher an accountant for that? Does she have children? Whats her age? Trusts can live on for a long time like that.

Mid 50s. No kids. Longtime relationship (10+ years) but unlikely to ever marry. Low income earner. So, I want to create an income stream for her via dividends and cap gains from the Trust - preferably where she can never touch principle - and have the remaining $$s go to charity after she passes (since she will not have kids and likely still be single). I also want to protect the principle from some unscrupulous guy who may say 'wow..she inherited some coin..I think I'll marry and divorce her and walk off with half"..heck, I'm not even 100% sure Mr. long-term relationship guy doesn't already have that in mind and isn't just playing the long game..

I'll definitely have to dig in more to what it would mean if she were the Trustee..