Establishing a trust can help you achieve many different estate planning objectives, especially preserving wealth from estate taxes.
With the federal estate tax exemption exceeding $12 million for 2022, only a small percentage of Americans need to worry about having to pay estate taxes at the federal level. However, 12 states, along with the District of Columbia, impose estate taxes at the state level.
Setting up a trust is one of the most tax-efficient methods of protecting wealth from estate taxes. While you can’t avoid them entirely if you have an extremely large estate, you can use various trust vehicles to minimize your exposure to estate taxes.
How Certain Types of Trusts Can Help Reduce Your Estate Tax Burden
An estate planner and attorney can help you form these common trust instruments – and two may have the potential to minimize your exposure to estate taxes.
- Revocable Trust. Also called a living trust, a revocable trust allows the grantor (creator of the trust) to control assets placed under trust, as well as revoke or amend the terms of the trust at any time. With a revocable trust, the grantor acts as trustee and beneficiary while alive. When the grantor dies, the trust flows to a successor trustee, who distributes the assets held under the trust to named beneficiaries.
Revocable trusts can be essential to quickly transition assets held under trust to beneficiaries when you die since assets in a revocable trust bypass probate. However, because of the way this type of trust is structured, it offers no immediate tax benefits and won’t help the grantor avoid estate taxes.1
- Irrevocable Trust. Unlike a revocable trust, an irrevocable trust can be used to minimize exposure to estate taxes. That’s because assets that are placed into trust are removed from the grantor’s control, which reduces the gross value of the grantor’s taxable estate. Once the grantor relinquishes ownership of the assets placed under trust, and those rights are transferred to a named beneficiary, the value of any assets held in an irrevocable trust don’t count as part of the grantor’s estate – and the grantor isn’t liable for any taxable income generated by the assets held under trust as well. This type of trust instrument can be especially useful for people seeking to lower the value of their estates and thereby minimize their exposure to estate taxes.2
- Credit Shelter Trust. Credit shelter trusts (CSTs) are another common trust instrument used to help minimize exposure to estate taxes. This type of trust usually works best for very high-net-worth couples who know the value of their individual or combined estates exceeds the federal estate tax exclusion.
A credit shelter trust goes into effect when one spouse dies. Assets placed in the CST no longer count as part of the decedent’s estate and are managed by a trustee. Upon the death of the second spouse, the trust assets flow to the eventual named heirs of the trust without incurring any estate taxes.
The main purpose of forming a CST, also called a family or AB trust, is to transfer assets out of a spouse's name to lower the value of his or her estate. The surviving spouse does not control the assets but can conditionally access income from the trust while he or she is still alive. Due to the high exemption on federal estate taxes – which is double for married couples – this type of trust is a viable option primarily for ultra-wealthy couples whose estates surpass the estate tax exemption.
Putting it all Together
Working with a certified estate planner (CEP) can help you determine which type of trust may best meet your needs and objectives, especially if the goal is to avoid or minimize exposure to estate taxes.
1 Pros and Cons of Revocable Living Trusts, EideBailly, https://www.eidebailly.com/the-pros-and-cons-of-revocable-living-trusts
2 Irrevocable Trusts Explained, Investopedia, https://www.investopedia.com/terms/i/irrevocabletrust.asp
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