Trusts often get a bad wrap for creating the much maligned “trust fund babies,” and are often thought to only be for the wealthy or ultra-rich. The truth however, is that trusts are an important part of estate planning regardless of wealth or social/economic class, and as time goes on, revocable living trusts are becoming an important, nearly essential, part of even a basic estate plan.
In this article, we will provide a high-level overview of basic trust principals and functions. Specialized trusts that some attorneys call the “alphabet soup of trusts,” such as GRAT (grantor retained annuity trust), SLAT (spousal lifetime access trust), ILIT (irrevocable life insurance trust), CRAT (charitable remainder annuity trust), and CRUT (charitable remainder unitrust), fall outside the scope of this article.
What are Trusts?
Trusts documents establish a legal entity that creates a fiduciary relationship in which a trustee holds assets of the grantor (the person funding the trust) for the benefit of the beneficiaries.
The beneficiaries of a trust receive the property pursuant to the terms of the trust as desired by the grantor. A grantor can provide, for example, that the beneficiary can have immediate access to the income and/or principal of the trust, or that the contents of the trust will be distributed when the beneficiary reaches a certain age.
Any property distributed through a trust will, absent extenuating circumstances, avoid probate, though it may still be necessary to file a probate for such an estate for different reasons. For more on Massachusetts probate, check out our article Massachusetts Probate: What is it, and When is it Necessary to File.
What are Trusts Used For?
There are many different types of trusts which can accomplish a variety of goals for a grantor and/or a grantor’s family, including whether the grantor simply wants a trust to hold property for his or her spouse or children; provide future sources of income for a spouse or child(ren); whether they want to reduce or avoid taxes, among other things.
Depending on the specifics of one’s family, estate, and goals, trusts can be used, among other things, to:
- Hold property during lifetime;
- Avoid probate (for more on how to avoid probate in Massachusetts, click here);
- Receive property upon death;
- Plan around estate and other taxes;
- Plan for Medicaid/MassHealth (nursing home) needs
- Provide for a family member with special needs; and
- Ensure a level of privacy greater than a will as the schedule of beneficiaries of the trust usually remains private, with exceptions.
Revocable vs. Irrevocable
Trusts generally come in two forms: revocable and irrevocable. You may have heard financial advisors or attorneys discuss these general types of trusts on television or the radio, but what is the difference between them, and when would we use one or the other?
Revocable Trusts
A revocable trust, often times referred to as a “living trust” or “revocable living trust,” is a trust that can be amended or revoked by the grantor at any time during the grantor’s lifetime. Revocable trusts do not remove property from an estate for purposes of reducing or eliminating estate tax exposure. Further, revocable trusts generally do not provide any sort of creditor protection for a grantor, because the grantor still retains full ownership over the trust property until they pass away.
Revocable trusts are often used to hold, manage, and distribute assets and property to, and for the benefit of, the beneficiaries. A lot of times, revocable trusts are used as an estate planning tool to hold real estate for the benefit of ultimate beneficiaries. For example, if you own a home and intend to leave that home to a child, it may benefit the child beneficiary to place the home in a trust because the child would receive a step-up in basis for capital gains tax purposes, that they otherwise would not receive if the house was left to them through a will, or just outright gifted to them.
Upon the death of the Grantor, a Revocable Trust generally becomes irrevocable.
Irrevocable Trusts
An irrevocable trust is a trust which cannot be amended or revoked by the grantor. A grantor of an irrevocable trust is giving up ownership and control of the assets and property placed in the irrevocable trust. Irrevocable trusts may also be used to provide some creditor protection for the grantor, however it is important to beware of, and avoid, fraudulent transfers (i.e. transfers made to an irrevocable trust for the sole purpose of avoiding paying a creditor).
MassHealth/Medicaid Planning
Due to the nature of these trusts, they are generally reserved for MassHealth/Medicaid planning in order to qualify for benefits and remove assets from an individual’s name so that they are not “countable” – meaning Medicaid/MassHealth will not lien the property or otherwise require it to be used to pay for nursing home care. Timing is important with this planning as there is a five-year lookback period.
Minimize or Eliminate Estate Taxes
Further, with larger estates, irrevocable trusts can be used to try to minimize, or otherwise eliminate, estate tax exposure, both at the state (if applicable) and federal level. In this article, we won’t be getting into the different types of trusts that can be used for this purpose, their rules/requirements, nor different elections that may or may not be made. However, as an overview, for married couples, this tends to be a multi-trust plan to work in conjunction with the unlimited marital deduction.
This plan would likely including credit shelter/family and marital trusts, at the very least. The credit shelter trust will be funded with the then estate tax exclusion amount (if you are in a state with a state estate tax, there could be another CST funded with the then applicable state estate tax threshold amount), and the marital trust will contain the balance. The result here is the funds in the CST bypass the surviving spouse’s estate, and would therefore be shielded from estate taxes on the death of both spouses.
How is Trust Income Taxed?
Trust taxation is worthy of its own article, but for purposes of this trust overview article, it is important to understand that income that is kept in a trust at years end is taxed at a higher bracket than an individual.
| Taxable income | Tax rate |
|---|---|
| $0 – $11,000 | 10% |
| $11,001 – $44,725 | 12% |
| $44,726 – $95,375 | 22% |
| $95,376 – $182,100 | 24% |
| $182,101 – $231,250 | 32% |
| $231,251 – $578,125 | 35% |
| $578,126+ | 37% |
Compare the above 2024 individual tax brackets with the below 2024 trust income tax brackets.
| Taxable income | Tax rate |
|---|---|
| $0 – $3,100 | 10% |
| $3,100 – $11,250 | 24% |
| $11,150 – $15,200 | 35% |
| $15,200+ | 37% |
What we can see here is that you reach the highest tax rate for trust income much quicker than you would receiving this income as an individual ($15,200 vs. $578,126). This means is that when utilizing trusts for income generating property, it requires some thought (and math) to figure out whether placing that property in trust for purposes of, lets say, reducing state estate taxes, is ultimately offset by the increase in income tax due to the higher trust income tax bracket.
There are other tax considerations for trusts as well, including who is ultimately responsible for payment of the taxes, but those fall outside the scope of this article, and depend on many different drafting decisions.
Every plan contains pros and cons, and you will just have to make the best available choice. For a personalized review of your current estate, schedule a free consultation to discuss estate planning options, and determine what plan will be best for you and your family.
No information in this blog post is to be construed as, nor is intended to be, legal or tax advice. Consult with competent legal counsel and/or tax professionals prior to taking any action. Do not rely on any information contained in this blog post as the law changes from time-to-time and this blog post may not be updated to reflect those changes.
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