FAQs About Trusts
Few financial topics create the confusion that trusts do. From avoiding probate to protecting heirs, and saving estate taxes to benefiting charities, a trust serves almost any purpose. But trusts are complicated, can be expensive to set up, and require professional advice. Here, the Michigan Association of Certified Public Accountants answers some frequently asked questions about trusts.
What is a trust?
A trust is a legal entity created to receive certain property from the owner, called the grantor or donor. A trust instrument names your beneficiaries, a trustee or trustees, and spells out the rules for paying out the assets to the trust’s beneficiaries. A trustee holds legal title and manages the property for the benefit of the trust’s beneficiaries.
In general, trusts fall into one of two categories. A testamentary trust is created by a will and takes effect after you die. A living trust, on the other hand, is created and takes effect while you are still alive. Living trusts may be revocable or irrevocable.
What is the advantage of creating a testamentary trust?
A testamentary trust can help ensure that an inheritance is used wisely. Instead of transferring assets outright to beneficiaries who may not be ready to handle them, you leave it in a trust to be managed by a trustee until a predetermined time.
What are the main features of revocable and irrevocable trusts?
When you create a living trust, you must decide whether the trust will be revocable or irrevocable. With both types, you re-title all your assets in the name of the trust. If you choose, you can serve as the trustee yourself, retaining control of your assets while you are alive and naming someone to succeed you when you die or if you’re unable to act as trustee.
With a revocable trust, you can change beneficiaries, replace the trustee, remove assets from the trust or dissolve the trust entirely. Because you still obtain control over the trust assets, revocable trusts do not remove assets from your estate. You must report your trust’s taxable income on your regular Form 1040, and those assets remaining in the trust at your death become part of your potentially taxable estate. Revocable trusts, in and of themselves, offer few tax benefits.
By contrast, an irrevocable trust permanently removes assets from your estate. Any property transferred to the trust is no longer yours. The trust becomes a separate entity that pays taxes on the assets’ earnings and, when you die, generally, assets in the trust are not subject to estate taxes. However, the price you pay for this tax savings is significant. Once created, an irrevocable trust cannot be altered in any way.
Can I avoid probate with a trust?
When you die, the assets titled in the name of your living trust pass directly to your beneficiaries, avoiding probate (the legal process for administering a will) and its inherent costs. While a will makes the amount of the assets you leave behind and your wishes for the distribution of those assets a matter of public record, a living trust avoids probate and therefore maintains the privacy of your estate. In addition, a living trust can be useful in naming someone to administer your affairs in the event you become unable to do so. Hhowever, avoiding probate does not avoid estate tax.
What should I consider in choosing a trustee?
It is important to consider the health, age, and financial intelligence of any trustee or successor trustee. Unlike someone with a durable power of attorney, who can act for you only while you’re alive, a trustee of a living trust will manage the property after you die, for as long as the agreement remains in force. For this reason, people setting up large trusts sometimes choose to name an institutional trustee, such as a trust company with a qualified family member to act as co-trustee.
You seek the expertise of CPAs at tax and audit time, of course. But CPAs also promote personal and professional financial security year round. Visit the CPA Referral Service on the MACPA Web site to search for a CPA in your geographical area or specific area of expertise.
This article was submitted by the Michigan Association of CPAs.
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