When it comes to Estate Planning, Living Trust is the best way to distribute your property among your loved ones as well as to avoid Probate and Estate Taxes. The Person who creates the Living Trust is called the Grantor or Initial Trustee. The person who acts on behalf of the Initial Trustee upon his death is called the Successor Trustee. And the person who inherits the property of the Initial Trustee upon his death is the Beneficiary.
Living Trust can be divided broadly into 2 categories:
- Revocable Living Trust
- Irrevocable Living Trust
What is a Revocable Living Trust
These are the most common types of Living Trust created by People. The reason behind this is the flexibility offered by these trusts. You can change its provisions anytime before your death when you want to.
- Add/remove beneficiaries
- Add/remove Trust property
- Sell trust Property, etc.,
Grantors of the Revocable Trusts make themselves the Initial Trustee and can change the provisions of the Trust easily till their death. The successor Trustee then takes the responsibility to distribute the assets among the beneficiaries but a Successor trustee has no right to change anything in the trust. Once the Grantor dies, the Revocable Living Trust becomes an Irrevocable Living Trust.
Revocable Trusts are also not immune to Estate taxes if applicable on the trust property and if any dues of the creditors are left, that also needs to be paid from the trust property after the grantor dies.
Advantages of a Revocable Living Trust
1. Avoids Probate
The most important benefit of a Revocable Living Trust is that it avoids probate. There is no involvement of the court in the distribution of assets among the beneficiaries.
2. Flexible in nature
Revocable Trusts can be altered or amended easily during the lifetime of the Grantor. You can add beneficiaries, and new properties whenever you want.
3. Operates in events of Incapacitation
In case you become incapacitated, your Revocable Trusts will still operate until it is funded. It can be used for your benefit, your treatment, etc. In case of incapacitation
Disadvantages of a Revocable Living Trust
1. No Tax Advantage
Revocable Living Trust does not provide protection against the Estate taxes payable on the trust properties put inside the trust.
2. No protection from Creditors
If the grantor has died without clearing the creditors’ dues, the trust property will be first used to pay the creditors and the leftover amount will be distributed among the beneficiaries.
3. Requires to be updated
Revocable Living Trust does not update automatically. Events like death, marriage, birth, etc. need to be updated in the Revocable Living Trusts,
What is an Irrevocable Living Trust
Irrevocable Living Trusts are not so common yet useful in their own ways. As the name suggests, the provisions of these Trusts cannot be changed easily. It is a complicated process to change the provisions of these Trusts which requires approval from beneficiaries or the court.
The process of transferring assets to an Irrevocable Trust remains the same as that of a Revocable Trust. The difference is that once an Irrevocable Trust is executed, the ownership of the trust property is transferred to the Trust itself.
Irrevocable Trusts are useful for wealthy individuals only as they help in avoiding Estate tax. This is the major advantage of an Irrevocable Trust. When a property is transferred to an Irrevocable Trust, the grantor loses full control over it and the Trust becomes the owner of that property. Since that property does not become part of the Grantor’s estate, it is not subjected to Estate tax.
Advantages of an Irrevocable Living Trust
1. Avoids Estate Taxes
Trust property of Irrevocable Living Trust is not liable to pay taxes. Wealthy people are the ones who have attained more benefits from these trusts.
The federal estate tax exemption in 2022 is as follows:
- For Individuals - $12.06 million
- For Married Couples - $24.12 million
2. Protection from Creditors
Since the trust becomes the owner of the property transferred to it and it is no longer a part of the Grantor’s estate; creditors cannot claim anything out of it.
3. Government Benefits
Benefits like Medicare and Supplementary Security Income provided by the government can be availed by creating an Irrevocable Living Trust since you do not have to deplete your assets for qualifying for these benefits. You can transfer your assets to Irrevocable Living Trusts and avail of these benefits.
Disadvantages of an Irrevocable Living Trust
1. High tax rates
Income from the Irrevocable Living Trusts is taxed at a higher rate than usual.
2. Additional Tax Returns
There will be a cost to prepare and file in an Irrevocable Living Trust while filing a Tax Return in it.
Read more about the different types of Living Trusts.