By Contributing Legal Editor Robin Gorenberg, Esq.
As I mentioned in a prior blog post, everyone should have at least the “3 basic” estate planning documents in place: a Will, along with a Power of Attorney, and a Health Care Proxy for lifetime medical and financial decisions if you can’t make them.
In addition to the 3 basic documents, there are different types of trusts that may or may not fit your situation.
The 2 main types of trusts are Revocable and Irrevocable; each one has many purposes.
With a Revocable Trust (also known as Living Trust) the Donor (creator, also known as Grantor or Settlor) has the right to change or completely revoke the Trust during their lifetime. During your lifetime, this is known as a “grantor trust,” which means any assets you title into the Trust keep your Social Security number, and nothing changes for taxes. Typically you are the Donor (creator), Trustee (manager) and beneficiary during your lifetime. The Trust provides for a Trustee and beneficiaries after your death. Because you lose no control over your assets, this type of Trust does not protect your assets from creditors or lawsuits or long-term care costs (i.e. a nursing home).
Revocable Trusts are commonly used for the following purposes:
1. To provide for more mature ages of distribution to children or other beneficiaries after your death, also naming a Trustee after your death to be able to use or distribute assets for the beneficiary’s needs before the ages of mandatory distribution.
If you set up this type of Trust, after it’s signed, you would change the beneficiaries on assets such as life insurance and retirement plans, naming the Trust (instead of your children directly) as beneficiary, so that this money would be in the Trust, held until the later ages (otherwise if your children are named as direct beneficiaries, they would get that money outside of the trust). If you are married, you would still name your spouse as 1st beneficiary, but would name the Trust as 2nd beneficiary instead of the children directly.
2. To avoid the 1+ year probate process. Probate only applies to assets in your name alone (with no joint owner and no named beneficiary). You can set up a Trust and re-title your individually owned assets (i.e. real estate, financial accounts without beneficiaries) into the Trust, to avoid the 1+ year process at your death. You lose no control during your lifetime (since everything is revocable and amendable and all assets stay under your Social Security number), but it makes it simpler for your intended beneficiaries and quicker for them to receive your assets after your death.
3. To provide for 1 vehicle to own all your assets in case of your mental incapacity during your lifetime. You would remain the sole beneficiary during your lifetime, but the successor Trustee would take over all management of your assets.
The single Revocable Trust (be it for 1 person or for a couple) does NOT protect the assets from estate taxes at your death. Many married couples set up 2 Revocable Trusts to reduce the Massachusetts estate tax due at the second spouse’s death (plus the 2 benefits above). The federal estate tax threshold is $23 million combined for spouses, but Massachusetts’ estate tax threshold is only $1 million, and if the total estate is over $1 million, the entire estate (not just the excess) is taxed at the second spouse’s death. Two Revocable Trusts can save up to $160,000 at the second spouse’s death, passing more on to your intended beneficiaries. The 2 Revocable Trusts can also provide the same benefits as the single Trust (avoidance of probate, providing for later ages of distribution to children or other beneficiaries).
An Irrevocable Trust can’t be changed by the Donor once it is signed. Also, typically the Donor is not the Trustee. You can’t take back property you have placed into an irrevocable trust. You can’t act as trustee and manage the trust’s assets. You form the trust and step aside for all time. You can sometimes get income from the Trust but usually not principal.
Irrevocable Trusts require a separate Tax ID number, and depending on the assets in the Irrevocable Trust, annual Federal and Massachusetts income tax returns may be required.
Irrevocable Trusts are commonly used for the following purposes:
1. Irrevocable Life Insurance Trusts (ILITs) – This allows you to completely exclude the full death benefit of your life insurance from Federal and Massachusetts estate taxes at your death. While life insurance is non-income taxable to the recipient, it is part of your assets when added up to determine whether you are over the Federal or Massachusetts estate threshold.
ILITs cannot be changed (although you could let your policy lapse and then the Trust would be empty). Unlike Revocable Trusts, ILITs have lifetime requirements: separate bank account; deposit money into that account to pay premiums; changing owner and beneficiary of each policy to the ILIT; sending out a notice letter to each beneficiary each time you deposit money into the account for premiums). Also, for existing policies, the ILITs only work three years after you re-title the policy unless you are getting a new policy and name the ILIT as the initial owner.
2. Irrevocable Trusts to protect a person from losing government benefits – One common example is to put your assets into an Irrevocable Trust to qualify for MassHealth (The Commonwealth’s version of Medicaid) for long-term care costs (i.e. nursing home). You are effectively giving away your property for all time; you can receive the income from the Trust, but not the principal. You can ensure that your property ultimately will go to your beneficiaries vs. a nursing home when you place it in such a Trust. However, Medicaid currently has a five-year look back period, which means the value of property that’s put into the Trust within this time period still counts against the applicant for qualifying purposes.
3. Gifts to Minors – If you (or anyone) wishes to make gifts to minors, one option is to use an Irrevocable Trust. You can gift money to the trust and usually the minor must receive the money by age 21.
4. Charitable Trusts – There are several types of Irrevocable Trusts that allow you to make charitable gifts and take advantage of tax savings. The two most common are a Charitable Remainder Trust or a Charitable Lead Trust.
Talk with your attorney to determine which type of Trust best fits your estate planning needs.
Contributing Legal Editor Robin Gorenberg, Esq. is an award-winning attorney who specializes in estate planning, probate and estate tax preparation for individuals and law firms. She works with clients on both basic and complex estate plans, from Wills to all types of Trusts. Her goal is to communicate in a way that clients can easily understand, and to make them feel comfortable with the process and the ultimate documents.