ESTATE PLANNING TERMINOLOGY: TRUSTS
By: Jared Koch
Estate planning can be confusing, especially when special terminology is thrown in the mix. In particular, you might have heard that trust planning can be advantageous in an estate plan or broader tax planning but have no clue as to the difference between a revocable trust and an irrevocable trust, much less a testamentary trust versus an “ILIT,” “CRUT,” or “IDGT.” This article aims to help you sort through trust terminology so you can understand what plan may be best for you.
Revocable Trust. A revocable trust is just that—a trust that can be revoked. Think of a revocable trust as a glorified checking account: You can only establish a revocable trust while you are living. And like a checking account, you can freely move assets into and out of a revocable trust (and your creditors can access those assets to satisfy your debts). In addition, much like a transfer-on-death or pay-on-death designation on a checking account, the terms of the trust will control any assets in the trust at the time of your death.
It can be useful to use a revocable trust in many circumstances. Any assets placed in a revocable trust avoid probate. This can be especially helpful if you own real estate in multiple states. Without placing the land in a revocable trust, a probate will be necessary in each state where there is real estate. Using a revocable trust also helps protect your privacy. Court records of any assets that pass through probate are publicly available. In contrast, a revocable trust is a completely private structure, so any assets that are transferred into or out of the trust are protected from public view. A revocable trust can also be helpful to manage assets if you become disabled or incapacitated. When you are no longer able to manage assets in the trust, someone else named in the trust documents can step in to act as trustee and manage the property in the trust.
Irrevocable Trust. An irrevocable trust, as the name suggests, is one that is irrevocable. That means that any assets you place in the trust are permanently subject to the terms of the trust. An irrevocable trust may be created during your life (a so-called inter vivos trust) or at death by the terms of your will (a “testamentary trust”).
Testamentary Trust. As noted above, a testamentary trust is a type of irrevocable trust. You can use testamentary trust language in your will to automatically create a trust when you die to protect the persons inheriting from you. For example, a testamentary trust can be created to prevent young people from inheriting large sums of money. So rather than your grandchild inheriting a substantial sum at age 18, the assets can be held in a testamentary trust until he or she reaches a more suitable age that you designate—say, age 30. A testamentary trust can also be used to hold assets more permanently so that one of your heirs who is not financially responsible can’t waste their inheritance on frivolous purchases. By using a testamentary trust, the trustee has to approve many or all trust distributions so that the assets are used for appropriate purposes. And for spouses with a high net worth, testamentary trusts can be used to allow your surviving spouse to access your assets while still taking advantage of Minnesota estate tax exemptions.
Inter Vivos Irrevocable Trust. Inter vivos irrevocable trusts can be used in a wide variety of ways to reduce or avoid estate or income taxes. For instance, an irrevocable life insurance trust (“ILIT”) can own a life insurance policy on your life so that the life insurance proceeds are not included in the calculation of estate tax. A charitable remainder unitrust (“CRUT”) makes payments to beneficiaries for a certain period and then passes the remainder interest to charity, allowing you to take a charitable deduction and reduce the amount of your assets subject to estate tax. Other trust types you may encounter include a grantor retained annuity trust (“GRAT”), intentionally defective grantor trust (“IDGT”), and a qualified personal residence trust (“QPRT”). The terms of these and other inter vivos irrevocable trusts are quite intricate, so be sure to consult with your attorney and tax professional about how they can be helpful to you.
If you have questions or think that trust planning may be right for you, contact Blethen Berens at 507-345-1166 to schedule a consultation.