An Introduction to Trusts

Trusts are foundational tools in the estate planning process. They may be used to manage assets during life, control distributions after death, address taxes, reduce or eliminate probate, and provide asset control over multiple generations. In this article, we will discuss three of the main types of trusts; revocable, irrevocable, and Generation-Skipping Transfer (GST) trusts. While these estate planning vehicles share a lot of similarities, they each serve different purposes for both legal and tax purposes.

Revocable Trusts – Often called a “living trust,” a revocable trust is one that the grantor (the person who establishes it) may amend, modify or revoke at any point during their life. Often, the grantor also serves as the trustee (though this is not a requirement) and is the trust’s beneficiary while they are alive. This allows them to retain full control over any trust assets.

From a tax perspective, a revocable trust does not provide any estate or gift tax reduction. Because the grantor retains control over the trust assets, the trust is considered a grantor trust, and therefore all income will be reported on the grantor’s personal income tax return. At death, all assets owned by a revocable trust are considered a part of the estate for federal estate tax purposes.

Revocable trusts are generally best used to avoid probate, maintain privacy, and ensure a smooth transition of assets without giving up control.

Irrevocable Trusts – An irrevocable trust is one that once created and funded, cannot be changed or revoked, and assets cannot be taken back. By transferring assets into it, the grantor relinquishes total ownership and control. These are the requirements to be considered a completed gift for tax purposes.

The loss of control is what allows irrevocable trusts to provide significant estate tax and asset-protection benefits. If properly structured, an irrevocable trust can lock in the value of the assets for gift and estate tax purposes. Thereby any appreciation thereafter is excluded from the taxable estate. Creating an irrevocable trust may protect assets from future law changes since the assets would no longer be included in the decedent’s estate.

Additionally, because irrevocable trusts are treated as separate tax entities, they could be required to file their own tax return. However, they are often structured so that the grantor pays the income tax on the trust’s earnings. Since trusts reach the highest federal income tax bracket at much lower income levels than individuals, this increases tax efficiency while also reducing the grantor’s taxable estate.

Irrevocable trusts are commonly used for:

• Reducing estate taxes
• Asset protection
• Life insurance planning
• Charitable planning
• Generational wealth planning

These benefits, however, come at the cost of flexibility. Once the assets have been transferred to the trust, they generally cannot be reclaimed. As such, creating an irrevocable trust requires careful planning and is best used when the long-term benefits outweigh the need for control.

Generation-Skipping Trusts – A Generation-Skipping Trust is not a separate category of a trust, but rather a provision designed to address the federal Generation-Skipping Transfer (GST) tax. This tax applies to “skip persons,” typically a grandchild or younger beneficiary, and is an additional tax to any estate or gift tax liabilities. To be effective for GST tax planning, trusts must be irrevocable. Revocable trusts do not qualify for the GST exemption.

Generation-Skipping Trusts allow the grantor to allocate their lifetime GST exemption to the trust, which shields the assets and any appreciation from GST taxes. When structured properly, these assets may be passed to children, grandchildren, and future generations without being subject to federal estate taxes. The Generation-Skipping Trust is most effective for families with significant wealth who are focused on legacy planning as well as multigeneration asset preservation.

Selecting the appropriate trust ultimately depends on your individual goals, family dynamics, goals for future generations, and much more. When done correctly, these trusts help to make estate planning efficient and flexible, and balance present day needs with long-term legacy. Your JMG advisor can work with you and an attorney to determine the best trusts to utilize to meet your estate planning goals. We invite you to share this article with others who may also find it insightful.

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