Many people do not understand the fact that there are multiple different types of trusts. They think that trust versus will is a choice between two possibilities.
In fact, there are multiple different types of trusts, and they fall under two main categories.
Irrevocable Trusts
An irrevocable trust is self-explanatory in a general sense. If you create this type of trust, you cannot revoke it at a later date. The trustee is the person or entity that will administer the trust, and you cannot act as the trustee of your own irrevocable trust.
Since you cannot revoke the trust or act as the trustee, you are surrendering incidents of ownership, and there are some reasons why this can be beneficial.
The federal estate tax is applicable on the portion of an estate that exceeds the exclusion, which is $11.7 million this year. People that have estate tax exposure use certain types of irrevocable trusts to mitigate the burden.
When you convey assets into an irrevocable trust, they are no longer part of your estate for tax purposes. A grantor retained annuity trust (GRAT) is one example of an irrevocable trust that can be used to gain estate tax efficiency.
To implement this strategy, you would convey highly appreciable assets into the grantor retained annuity trust. When you do this, you are removing the assets from your estate for tax purposes.
The IRS calculates the taxable value of the trust by applying the hurdle rate or Section 7520 rate, which is 120 percent of the federal midterm rate. Over the course of the term, the grantor will accept annuity payments from the trust are equal to the entire value of the trust.
This is the value that was calculated by the Internal Revenue Service using the hurdle rate. In fact, the assets may outperform the Section 7520 rate, and these rates have been very low over recent years.
If this takes place, there will be a remainder left in the trust after the expiration of the term, and it would be transferred to the beneficiary tax-free.
An irrevocable trust can also be used by a person that wants to qualify for Medicaid. If you convey assets into an irrevocable trust, they would not count if you apply for Medicaid eligibility.
Why would you need Medicaid if you will qualify for Medicare? The Medicare program does not cover long-term care for seniors, but Medicaid will pay for custodial care.
These are a two of the reasons why people use irrevocable trusts, but there are others that we will cover in a future post.
Revocable Living Trust
In addition to trusts that cannot be revoked, there is also the revocable living trust. You can in fact revoke or rescind this type of trust after it has been created, and if you establish a living trust, you would be the trustee.
Because you do not surrender incidents of ownership, the assets would count if you apply for Medicaid, and they would be part of your estate. However, there are other benefits that make living trusts useful.
One of them is the facilitation of probate avoidance. This is a costly and time-consuming legal process that would be necessary if you use a will as an asset transfer vehicle.
You can include spendthrift protections if you have a living trust. It can remain active for an extended period of time after your passing, and the trustee could provide limited distributions to the beneficiaries over time.
After your death, the trust would become irrevocable, and the principal would be protected from the beneficiary’s creditors. You can also account for incapacity when you have a living trust, because you can name a disability trustee when you establish the trust.
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