A basic distinction between the types of trusts would be revocable trusts versus irrevocable trusts. On the surface, the difference between them is self-explanatory: You can revoke or dissolve a revocable living trust, and you cannot dissolve a trust that is irrevocable.
Though the broad definition is self-evident, what are the implications? Let’s look at the answers to this question.
Revocable Living Trusts
There are those who assume that trusts are only useful for wealthy individuals, but this is not the case with revocable living trusts. These trusts actually do not satisfy some of the estate planning objectives of high net worth individuals.
This type of trust is primarily utilized to facilitate probate avoidance. If you use a will to transfer your personal property, it must be admitted to probate after your passing. This legal process is time-consuming, and your loved ones must wait out the process before they can receive their inheritances.
There are also a number of expenses that accumulate during probate, and these expenditures reduce the amount of the inheritances that will be going to the heirs eventually.
Property that has been conveyed into a revocable living trust can be transferred to the beneficiaries outside of probate after the death of the grantor, and as a result, timely and efficient asset transfers are facilitated.
You can also include spendthrift protections when you create a revocable living trust, and this is another part of the appeal. An independent trustee could manage the assets in the trust after you are gone, and you could instruct the trustee to distribute assets on a limited basis over an extended period of time.
A revocable living trust can be a good choice for a wide range of people. However, circumstances can exist that would call for the creation of a different type of trust.
Irrevocable trusts are used to satisfy more complicated objectives. When you create an irrevocable trust, you are surrendering incidents of ownership, because you cannot change your mind and take back the assets that you conveyed into the trust.
As a result, once you convey assets into an irrevocable trust, they become the property of the trust. They are no longer in your personal possession. Though it can sound counter-intuitive on the surface, this can be a good thing under some circumstances.
If you think that you could be the target of a lawsuit for one reason or another, asset protection will be important to you. Asset protection could also be a priority if you are concerned about the spendthrift tendencies of someone on your inheritance list.
There are certain types of irrevocable trusts that are used for asset protection purposes. Because the trust would own the assets, they would be protected from creditors and claimants seeking redress from an individual.
Estate Tax Efficiency
The federal estate tax looms large for high net worth families. This tax is potentially applicable on asset transfers that exceed $5.45 million (this is the figure for 2016). The death tax carries a 40 percent maximum rate, so its imposition could have a significant negative impact on the future of your family.
There are a number of different types of irrevocable trusts that are used for estate tax efficiency purposes. These would include grantor retained annuity trusts, charitable lead trusts, charitable remainder trusts, generation-skipping trusts, and qualified personal residence trusts.
Many elders seek Medicaid eligibility late in their lives, because Medicare does not pay for nursing home care. To qualify for Medicaid, you must have very limited assets in your own name, because it is a need-based program.
Irrevocable Medicaid trusts are sometimes used by people aiming toward Medicaid eligibility, because assets in this type of trust are not counted when program administrators are determining an applicants eligibility status.
Though you would not be able to touch the principal if you convey assets into an irrevocable Medicaid trust, you would be able to receive income that is earned by the assets in the trust. However, this income would go toward the cost of your care if you ever use Medicaid to pay for long-term care.
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Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.