Reasons for Setting up a Trust?

[Janez]

Hello everyone,

I have appreciated the comments and help from my previous post about estate planning. Since then, I have set up all of our assets with transfer on death beneficiaries to both of my children (one an adult, one to be an adult next summer). This includes our house, our stock/brokerage accounts, and checking/savings accounts. We have the wills, POA, Advanced Medical Directives, Living Wills, etc. I even set up a "death binder" and have everything in one place.

I am still unclear as to why I would set up a trust at this time or in the future. Are there tax savings advantages to setting up a trust and what would they be? What is the limit of dollars that a trust would protect?

I can see that a trust is good if there are very young children, perhaps, or worries about extended family members (spouses you don't like) or worries that your children are not responsible in handling the money.

It seems that as circumstances change a trust could be set up.

Thanks for pointing out anything that I may be missing here, and thanks again!

Jane

 

[OldShooter]

Be a little careful with the language. A "living trust" (named by some sales-oriented lawyer, I'm sure) is a revocable repository for assets, the claimed benefit is that it reduces or eliminates the need for a probate. Probates seem to engender terror in customers and thickness in lawyers' wallets. YMMV depending on assets, state, and even county. Big city probates can be more expensive and time consuming than going to a small county courthouse.

Post-death, the rev trusts can convert to irrevocable ("irrev") trusts or can be created. A new irrev trust might be called a "testamentary trust."

Testamentary and irrev trust are typically used to manage assets for trust beneficiaries. We have one for a special needs grandchild and a couple for other grandchildren, primarily to manage college money. We also have one for 50YO DS who is a great guy but financially very naive. Possibly easy prey for a insurance salesman or a broker he knows from his church or social circle. He is happy that his money will be managed professionally.

The two types of trusts are often conflated here IMO.

 

[Dash man]

If any of your assets are in retirement accounts, an IRA Inheritance Trust may be useful. Since the funds in inherited IRAs can’t be stretched out anymore, funneling that money into an IRA Inheritance Trust, after necessary taxes are paid, can provide protection of those assets similar to the protection IRAs have from lawsuits and such. It also keeps assets protected if a child’s marriage goes bad.

 

[OldShooter]

... Since the funds in inherited IRAs can’t be stretched out anymore ...

Hmmm .... we just freshened our plans and our understanding is that the trust has 10 years to liquidate the IRA, with any $ the trust retains (vs being paid do beneficiaries) being taxed at the (high) trust rate. For that reason, we have directed that our special needs trust be funded from the Roths. They also have to be liquidated in 10 years but there are no tax consequences if the trust doesn't pay everything out. (Except trust taxes on future gains, of course.) We need the special needs trust to run longer than 10 years where the others will terminate when the IRA withdrawal period ends.

 

[ncbill]

If any of your assets are in retirement accounts, an IRA Inheritance Trust may be useful. Since the funds in inherited IRAs can’t be stretched out anymore, funneling that money into an IRA Inheritance Trust, after necessary taxes are paid, can provide protection of those assets similar to the protection IRAs have from lawsuits and such. It also keeps assets protected if a child’s marriage goes bad.

Inherited IRAs can be stretched out 10 years...with no need to take any distributions until that last year (no annual RMDs years 1-9)

Creditor protection depends on state law...here any type of IRA (including inherited) is protected...nor is an inheritance a marital asset in most states if kept separate.

 

[Jerry1]

We were in the same boat as OP and asked our lawyer the same question. We went ahead and did the trust to avoid probate and generally make it easier for the DD’s to wind down our estate. The cost was very reasonable especially compared to the aggravation of going to probate if something required it. Lawyer did acknowledge that we could get by without it but encouraged it. Given that we were doing all other estate documents and life care documents, the trust didn’t add much to the bill.

 

[Dash man]

Hmmm .... we just freshened our plans and our understanding is that the trust has 10 years to liquidate the IRA, with any $ the trust retains (vs being paid do beneficiaries) being taxed at the (high) trust rate. For that reason, we have directed that our special needs trust be funded from the Roths. They also have to be liquidated in 10 years but there are no tax consequences if the trust doesn't pay everything out. (Except trust taxes on future gains, of course.) We need the special needs trust to run longer than 10 years where the others will terminate when the IRA withdrawal period ends.

That’s correct and the IRA Inheritance Trust may not get funded until the end of those ten years and can be held pretty much indefinitely if the beneficiaries choose to. It used to be stretched out for a longer period based on the expected life expectancy on the beneficiaries. The point is to protect the funds for as long as the beneficiaries choose to. The taxes are paid, if owed, when the money moves into the trust, and continues to be protected from creditors and is separated from marital funds in case of divorce. They can withdraw any income the trust incurs to pay taxes on their own return. Trusts only pay taxes on retained income.
Special needs trusts are set up a bit differently to separate the income from affecting any government benefit they may receive.

 

[OldShooter]

... Trusts only pay taxes on retained income. ...

Our plan is that all income from the tIRAs will be passed through the trust in the year it is realized so there is never a need to pay the high trust rate (most at 37%) on the $$ coming out of the IRAs. That's why we see the trusts terminating when the IRA withdrawals are completed/10 years.

 

[Charlotte]

We set up a revocable trust about 4 years ago when both of our children were in high school. Now they are in college, and even though I consider them bright, hard-working and generally awesome young adults, I still don’t think it would be a great idea to drop many millions of dollars of them at age 19 and 20 if my husband and I were to die soon.

Our trust defines rolling the assets out to them over multiple ages (25, 30 and 35). If we find, after they’ve graduated university, that they are well set up in common sense, careers, and life partners, that we feel differently, then we’ll change the trust to a more direct inheritance.

 

[Poopycat]

I’m not an attorney so someone can jump in if what I write is incorrect. My understanding is that assets that are in an irrevocable living trust are generally protected from bankruptcy. I say “generally” because there are some confusing laws about fraudulent transfers that put irrevocable trusts at risk from creditors. I’m hoping I never go bankrupt, but if I do have medical/health issues that potentially drain my assets, I like the idea of those trust assets being protected.

My parents set up a revocable living trust because they didn’t want me to have to deal with probate. When my father passed away (my mother had died a few years before), it wasn’t too difficult for me to take control of the assets that passed on to me. Or I guess the better way to say it wasn’t difficult for me to take control of the trust’s assets.

I don’t remember if my dad set it up or whether the attorney did it, but upon my dad’s death the trust became an irrevocable trust. It was done so long ago that I don’t remember the details. But I think the assets from the revocable trust were transferred into the irrevocable trust. I had to get a new federal ID number set up for the irrevocable trust. I don’t have the flexibility to change the trust, but I do think it leads to protection from creditors.

Once I’ve settled on my new retirement state, I’ll visit an attorney because I have some questions about the trust and my will. As you can tell, trusts can be very confusing!

 

[Dash man]

Our plan is that all income from the tIRAs will be passed through the trust in the year it is realized so there is never a need to pay the high trust rate (most at 37%) on the $$ coming out of the IRAs. That's why we see the trusts terminating when the IRA withdrawals are completed/10 years.

Yes, but if kept in an IRA Inheritance Trust, you only have to distribute dividends and capital gains to avoid trust tax rates. The rest can be kept in the trust indefinitely for protection.

 

[MrsHaloFIRE]

Like others have said trusts can be a beast to understand. They can protect from big spending beneficiaries from running out of money (be they spouse, child, spouse of child). They can protect the underage and financially naive. Shelter from probate. In some cases shelter from liability. And protect those that are incapacitated or likely to become incapacitated. Everyone does not need a trust. A good estate attorney in your state should be able to walk you through what your death would look like on paper right now with and without a trust.

Please note, laws can and do change so one you setup today may look different if implemented many years down the road as say tax laws evolve etc.

 

[OldShooter]

.. Please note, laws can and do change so one you setup today may look different if implemented many years down the road as say tax laws evolve etc.

+1 Also families change, minor children grow up, etc. Grantors' intentions change. ...

 

[OldShooter]

Yes, but if kept in an IRA Inheritance Trust, you only have to distribute dividends and capital gains to avoid trust tax rates. The rest can be kept in the trust indefinitely for protection.

Yes, but "the rest" is the after-tax remains of any IRA withdrawals not distributed, so only about two thirds of the withdrawn amount. Any trust can keep IRA proceeds instead of paying them out, then live beyond 10 years holding "the rest ." Is an "IRA Inheritance Trust" somehow special or different?

 

[SecondCor521]

MrsHaloFIRE has listed what I think are the main reasons that people establish trusts in post #12.

As has been alluded to, trusts generally have worse tax rates and brackets compared to regular accounts. DSo whatever advantage is gained by anything on the list from MrsHaloFIRE, the potential increased taxes are an offsetting drawback. Of course, distributing the trust income can address this, but then that distributed income loses whatever benefit it had from being in the trust (such as asset protection).

The only other reason I know that trusts might be set up is in cases of large family wealth in order to avoid estate taxes. These would be things like grantor retained annuity trusts, intentionally defective trusts, etc. This is an advanced topic and I only know the barest bits about it beyond the fact that it exists.

 

[Dash man]

Yes, but "the rest" is the after-tax remains of any IRA withdrawals not distributed, so only about two thirds of the withdrawn amount. Any trust can keep IRA proceeds instead of paying them out, then live beyond 10 years holding "the rest ." Is an "IRA Inheritance Trust" somehow special or different?

It simply allows the beneficiaries to keep the IRA funds separate from marital assets and offers the same creditor protection an IRA would by earmarking them as retirement funds.

 

[pb4uski]

Our plan is that all income from the tIRAs will be passed through the trust in the year it is realized so there is never a need to pay the high trust rate (most at 37%) on the $$ coming out of the IRAs. That's why we see the trusts terminating when the IRA withdrawals are completed/10 years.

That is the way we operate my Dad's trust... KISS... in fact I have it set up that Vanguard automatically pays dividends in cash to the sole beneficiary's checking account.

 

[ncbill]

It simply allows the beneficiaries to keep the IRA funds separate from marital assets and offers the same creditor protection an IRA would by earmarking them as retirement funds.

Distributions from an inherited IRA would not still be considered retirement funds...they'd be protected if the beneficiary is a (presumably irrevocable) trust, ideally named beneficiary before the original owner of the IRA dies.

 

[RetireeRobert]

OP stated: "I am still unclear as to why I would set up a trust at this time or in the future. Are there tax savings advantages to setting up a trust and what would they be? What is the limit of dollars that a trust would protect?"

If you are talking "estate taxes", it does not matter whether you pass your assets to heirs via RLT's or via wills/beneficiary designations. "All" your assets values are totaled up and comprise your taxable estate. At federal level, the exemptions are quite high, so chances are you do not have to worry about federal estate tax anyway. I believe Colorado is a state without estate or inheritance tax, so no worry there (but double check this with your Colorado sources).

You do not state the worth of your house, but unless you are living in a tiny hovel chances are your estate would not qualify for probate under any "small estate" exemptions Colorado might have. So a house, cars, furniture, owned life insurance can create a sizeable "probate estate" and commensurate costs to go through probate. RLT would avoid probate costs. I live in Oregon, so consult your Colorado sources on details.

 

[Dash man]

Distributions from an inherited IRA would not still be considered retirement funds...they'd be protected if the beneficiary is a (presumably irrevocable) trust, ideally named beneficiary before the original owner of the IRA dies.

It doesn’t need to be irrevocable. The funds would be inherited funds in a trust providing protection from creditors and keeping separate from marital assets. The point of this trust is to provide protection equal to that of an IRA beyond the ten years where an IRA must be fully distributed so the government can collect its taxes.
Withdrawals can be over that ten year period where the beneficiaries can either withdraw and use the funds, or withdraw and put the funds into the trust to save for their future. Either way, taxes have to be paid, so after tax funds are transferred into the trust.
It’s an option we’re providing for our sons. Should they choose to blow the IRA funds, the trust isn’t needed. Should they choose to take advantage of it, it’s available. We’ll be dead.

 

[misanman]

I have been the personal representative for two estate settlements, one probated and one a trust. It's hard for me to understand, based on my experience in Michigan, why folks are so afraid of probate. I did not find the experience onerous or even very expensive. But, I understand that the process may be more difficult in other states. I'm under the impression that some lawyers push trusts. We have good friends who have a big trust document in a three-ring binder. It's gone through multiple revisions over the years (not unexpected, I suppose) and the lawyer gets a payday each time.

 

[Dash man]

I have been the personal representative for two estate settlements, one probated and one a trust. It's hard for me to understand, based on my experience in Michigan, why folks are so afraid of probate. I did not find the experience onerous or even very expensive. But, I understand that the process may be more difficult in other states. I'm under the impression that some lawyers push trusts. We have good friends who have a big trust document in a three-ring binder. It's gone through multiple revisions over the years (not unexpected, I suppose) and the lawyer gets a payday each time.

It depends on the state. My state, Pennsylvania, has a straight forward probate process that isn’t too difficult or costly. But we have trusts because of family complexity and real estate in three states. We also have a lot of assets and are using Schwab as a corporate trustee.

 

[ncbill]

Depends on the state...here probate is not normally a huge issue...BUT...

I missed getting a couple of things retitled into their trust with my recently-deceased relative...escrow balance once the home (in their trust) was sold went back to a personal account, and their vehicle which I was told had already been given away...hadn't been.

So I had to open a "small" (under $20,000) estate...$120 filing fee ($150 for a regular estate)...had it not been for the vehicle I would have let it go to unclaimed property instead & saved the beneficiaries that filing fee.

Plus it took weeks just to get the paperwork done since COVID meant no in-person meetings with the court clerks...everything had to be done by mail.

 

[Happyras]

MrsHaloFIRE has listed what I think are the main reasons that people establish trusts in post #12.
...

The only other reason I know that trusts might be set up is in cases of large family wealth in order to avoid estate taxes. These would be things like grantor retained annuity trusts, intentionally defective trusts, etc. This is an advanced topic and I only know the barest bits about it beyond the fact that it exists.

I would guess in general trusts have only specific advantages to some. In states with large estate taxes on small (relatively) amounts, you have to preserve your individual tax exemption or (in the case of WA) the estate will be taxed fully on the last surviving spouse. I have friends who swear by the intentionally defective trust structure. For most the Fed Estate tax is not too big an issue for now, but you can bet that will soon change. I know many lawyers sell trusts inappropriately, then upon death, they tell the heirs they have to go through probate anyway.

I hope we can figure out a way to gift the estate away over time, but for now, we have several trust structures to protect against unnecessary estate taxes or loss of exemptions.