When putting together an estate plan, trusts are commonly brought up as an alternative or complement to wills. One of the greatest benefits of trusts is avoiding probate, the court process of administering a deceased person’s estate, which can be long and costly depending on the make-up of the estate and the location where the deceased person resided. Other benefits include more flexible estate tax planning, privacy, and avoiding family conflicts.
Despite these benefits, trusts are not always the best choice, and there is often a lot of confusion as to how they function. Notably, many people are unaware that there are different kinds of trusts, each of which has unique benefits and trade-offs. You can speak with an estate planning attorney to know which trust, if any, is right for you.
For this Alert, we’ll focus on the most common trust type used in estate planning, living trusts. A living trust, also known as an intervivos trust, is called so because it is created during your lifetime and then assets or control of the trust are transferred to designated beneficiaries after you pass. There are two types of living trusts, as explained below.
Revocable Trusts
As the name implies, a revocable trust is flexible, and assets can be added or removed while allowing you to retain control of the assets during your (the grantor’s) lifetime. Revocable trusts can also be dissolved should your circumstances change. Assets in a revocable trust pass to beneficiaries outside of probate. These trusts generally become irrevocable upon the death of the grantor.
Although a revocable trust may help avoid probate, the assets in the trust are still typically subject to estate taxes. During your lifetime and after you pass, those assets are treated like any other asset you own, including being reachable by creditors.
Revocable trusts are, therefore, usually best suited for those looking to maintain control of their assets, but who still want the benefits of avoiding probate.
Irrevocable Trusts
An irrevocable trust allows you to move your assets out of your estate and potentially out of the reach of estate taxes and probate. Unlike a revocable trust, however, an irrevocable trust cannot be altered by the grantor after it has been executed. Therefore, once you establish the trust, you cannot remove assets from the trust and you cannot change any beneficiaries or terms or dissolve the trust. Though assets cannot be removed, you can generally add assets later on.
In exchange for these restrictions, the grantor may be relieved of direct tax liability on the income generated by the trust assets, though keep in mind that the trust itself and distributions may have income tax consequences depending on how the trust is structured. In addition, assets may also be protected from creditors in certain circumstances.
An irrevocable trust is generally preferred over a revocable trust if the primary goal is to remove assets from your estate, especially when attempting to reduce potential estate taxes.
Common Misunderstandings
Medicaid
One of the most common reasons people seek to establish a trust is to reduce an estate’s value when applying for Medicaid. This, however, is no longer an acceptable practice. You may have heard these trusts referred to as “Medicaid Qualifying Trusts,” but this is actually a misnomer, as such trusts will only serve to disqualify an applicant from being approved for Medicaid.
This is because even with an irrevocable trust, any asset in an irrevocable trust that the trustee can choose to give to the beneficiary will be treated as a countable resource by Medicaid. In addition, any asset that the applicant is not a beneficiary of can still be counted as a resource if the asset was moved into the trust within 5 years of applying for Medicaid.
Ultimately, you would have to relinquish both the control and benefits of an asset in order for it to no longer be considered a resource, and then only so long as you gave up the asset more than 5 years before applying for Medicaid.
Need for a Will
Another misunderstanding is that having a trust makes having a will unnecessary. This, however, is not the case, because there are certain things a will can do that a trust can’t. A will can also function to further protect your estate and your trust.
One of the limitations of trusts is that they control only the assets that have been added to them. Should you forget or neglect to add certain assets to your trust, they would then be subject to probate and, without a will, they would be distributed according to the law, and not your wishes.
To avoid this, a trust should be accompanied by a “pour-over will,” which is designed as a backup in the event you pass with assets that have not been transferred to your trust. When you die, the pour-over will transfers any leftover assets in your estate to the trust.
If you have minor children, a pour-over will allows you to name a guardian for them. You are not able to do so with a trust. You can provide financially for your children through a trust, but designating those who will actually care for them must be done through a will.
With a pour-over will it may still be necessary to go through the probate process, but with the only beneficiary being your trust, the process is usually much faster and cheaper. In addition, in Oregon, if an estate is small enough, a likely possibility if you have a trust, your estate could qualify as a “Simple Estate,” which would allow the estate to go through a significantly shorter version of probate.
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Please feel free to contact us if you have questions about or need assistance with your estate planning. Remember, it’s important not to put off your estate planning, and it’s important to keep your existing estate plan up to date.
You may also be interested in obtaining a copy of Estate Planning (in Plain English)®, written by members of this law firm and available through Skyhorse Publishing, Amazon, Barnes and Noble, and Bookshop (an online bookstore that allows you to support your favorite independently owned bookshop.)
Photo by Tyler Nix on Unsplash
