Estate planning is often a difficult subject since it involves envisioning what will happen when you’re gone. But one positive way to think about it is that good estate planning gives you control over what happens to your hard-earned assets after you die.
With the proper estate plan, you can control how and when your business and personal assets are disseminated to your heirs. Trusts are a useful estate planning tool to help you accomplish this.
What is a Trust?
A trust agreement spells out what you want to happen with the property or assets held in trust for your beneficiaries. There are many different types of trusts, and each has advantages and drawbacks.
Among the advantages are tax benefits and protection from creditors. Trusts also provide an efficient way to distribute assets to heirs without the cost and delay of probate court. In addition, trusts provide a degree of flexibility that your will alone cannot.
Drawbacks to trusts include the costs associated with drafting, establishing and maintaining them. Also, depending on the type of trust you choose, you may lose substantial control of the assets held in trust during your lifetime.
Types of Trusts
Two types of trusts are popular for estate planning purposes: grantor trusts and dynasty trusts.
A grantor trust is one in which the trust’s creator, or grantor, maintains some control of the trust. Many business owners create grantor trusts into which they put their S Corporation or partnership interests, thereby keeping the income from their business out of their estate.
Grantor trusts are generally revocable, meaning you can undo the trust if you choose. You can also amend and change these types of trusts and substitute assets in them as desired. This flexibility is quite appealing. For example, if you are concerned about the tax basis of the assets in the trust, you can swap low-basis assets for high-basis assets as needed.
Note that because the grantor maintains control over the trust’s income or assets, a grantor trust protects the business income from estate tax, but not from income tax.
A dynasty trust is designed to preserve wealth for future generations while avoiding transfer taxes. Because dynasty trusts can be set up with very long terms, they can theoretically last for a century or more and cover many generations.
Dynasty trusts are generally set up with the creator’s children as the beneficiary. After the children’s death, the grandchildren or great-grandchildren become the beneficiaries. Beneficiaries can receive distributions from the trust at the discretion of a third-party trustee, who is instructed as to your wishes.
Note that dynasty trusts are generally irrevocable. This means that you maintain no control over the trust’s assets, yet those assets are removed from your estate. Assets in the trust grow tax-free and as long as beneficiaries lack control over the assets, assets are excluded from beneficiaries’ estates as well.
Talk to Your Advisor
Be sure to discuss trusts with your estate planning advisor. He or she will know which types of trusts will be right for your family.