Wealth Transfer and Estate Planning: Unique Types of Trusts to Consider

Estate Planning

 Brian Watson By: Brian Watson

When you hear the word trust, you probably think of a revocable living trust that helps your loved ones avoid probate by establishing how your assets will be distributed after your death.

But an entire world of irrevocable trusts serves more specific estate planning needs.

A primary goal of an irrevocable trust is to reduce or eliminate estate taxes. Currently, the IRS estate tax exemption is $13.61 million per person. While this is more than double what it was just over a decade ago, thousands of high net worth families with complex asset portfolios may not be aware of the trust options available to protect their estate.

Estates valued below the IRS exemption limit aren’t subject to federal estate taxes. But if your estate exceeds the exemption threshold, the amount above the limit will be taxed up to 40% depending on the value of the estate.

An irrevocable trust can help you transfer assets from your estate to reduce or eliminate the taxes your beneficiaries must pay.

However, unlike a revocable trust, irrevocable trusts are far more difficult to modify once created. Understanding how the different types of irrevocable trusts work is essential before setting one up.

Before you consider these types of trusts, it’s also important to establish a relationship with a wealth manager you trust. They can work with you to design a full financial plan that incorporates these unique trust opportunities.

New call-to-action

Grantor Retained Annuity Trust or Unitrust (GRAT/GRUT)

Grantor retained annuity trusts or unitrusts allow you to transfer wealth to your heirs tax-free while minimizing the use of your lifetime estate tax exemption. The goal of a GRAT/GRUT is to remove appreciation of assets from your estate and create an income stream for you during retirement. They may be worth considering if:

  • You expect the value of your assets to increase significantly.
  • Interest rates are low (more on that below).

How a GRAT/GRUT Works

When you set up a GRAT/GRUT, you transfer assets into the trust. Those assets are used to make annuity payments to you during the term of the trust. The annuity payments return your original contribution plus interest based on a rate of return — known as the hurdle rate — set by the IRS. At the end of the term, the growth on the assets gets passed to your heirs tax-free.

But there are two catches:

  1. The trust assets must grow by more than the hurdle rate year-over-year. Otherwise, the trust closes, and you won’t reap the tax benefits.
  2. The grantor must survive the GRAT terms, meaning if they pass away before it completes, the tax benefits are also lost.

However, these catches aren’t a deal breaker as the grantor estate retains all assets and are no worse off than if they had not created the GRAT in the first place. For this reason, they are a favored wealth transfer strategy for those experienced with high-net-worth families like Plancorp.

You might also read in certain places that GRATs create a supplemental income stream during retirement. Although true, for those a GRAT is relevant to (those with estates over the exemption), that is rarely a motivating factor and typically a sign the advisor isn’t attune to the needs of wealth at scale.

How to Implement a GRAT/GRUT

  1. Work with a qualified estate planning attorney to prepare the trust agreement.
  2. Transfer assets to the trust. It’s a good idea to use assets that you expect to appreciate significantly.
  3. Receive annuity payments for a specific number of years.
  4. Track and document all payments disbursed from the trust. A wealth manager can help make sure you have this.

Charitable Remainder Annuity Trust or Unitrust (CRAT/CRUT)

If you think donations are tax free and that’s the end of the story or potential to maximize contributions, you’d be mistaken. Charitable Remainder Annuity Trusts or Unitrusts are similar to GRATs/GRUTs, but instead of passing the appreciation on your assets to your heirs, you leave it to charity. These types of trusts help reduce the taxes you would pay and maximize the donation to a cause you care about.

You get a large charitable tax deduction when you set up the trust, and your donation isn’t immediately subject to capital gains tax when sold within the trust. Instead, you get to spread the gain out over multiple years to defer the tax burden.

They may be a good option if:

  • You want to leave a sizeable sum of money to charity.
  • You have assets with significant unrealized capital gains.
  • You want a charitable tax deduction in the year you establish the trust.
  • You want additional predictable income in retirement.

How a CRAT/CRUT Works

After transferring assets into the trust, your original contribution amount plus the hurdle rate are used to determine your annuity payments for the term of the trust. After all annuity payments have been made, the remaining assets get donated to charity tax-free — as long as the remaining balance of the trust is at least 10% of its initial value.

How to Implement a CRAT/CRUT

  • Work with a qualified estate attorney to prepare the trust agreement.
  • Decide on the term of the CRAT/CRUT. This is how long you will receive income distributions from the trust. The term can be up to 20 years or the grantor’s lifetime.
  • Transfer assets into the trust. It’s best to choose investments with high capital gains since taxes on the gain are deferred.
  • After your death, the remaining assets are donated to the charities you chose.

Spousal Lifetime Access Trust (SLAT)

Spousal Lifetime Access Trusts help married couples lock in a significant portion of one spouse’s estate tax exemption by moving assets out of their estate and into the trust. You may want to consider a SLAT if:

  • You have significant assets in your name only, and you’re worried the value of your estate will exceed the exemption amount.
  • Your spouse might need access to the assets during your lifetime.
  • You have enough assets for retirement beyond what you’d transfer into the SLAT.

How a SLAT Works

When you fund a SLAT, you no longer have access to the assets in the trust, but your spouse does. Unlike GRATs/GRUTs and CRATs/CRUTs, SLATs don’t have ongoing payment structures. Your spouse can take distributions from the trust whenever they want — even if you’re still alive.

After your death, the remaining assets in the trust don’t count against your spouse’s estate tax exemption. And the appreciation of the assets is excluded from the value of both spouses’ estates.

How to Implement a SLAT

  1. Work with a qualified estate planning attorney to set up the trust properly.
  2. Transfer assets into the trust.
  3. The assets aren’t included in your spouse’s estate when they die.
  4. When the non-donor spouse dies, the remaining assets in the trust can be transferred to the trust’s beneficiaries.

Qualified Personal Residence Trust (QPRT)

A Qualified Personal Residence Trust removes the value of a home from your estate while allowing you to live in it, and allows any appreciation to pass to a beneficiary tax-free. This type of trust might be worth considering if:

  • Your home makes up a sizeable portion of your estate.
  • You want to stay living in your home.
  • You want to leave the property to your heirs after your death but don’t want the value to be included in your gift tax exclusion.

How a QPRT Works

When you establish a QPRT, your home is placed in a trust, but you the grantor retain occupancy of the property until the term of the trust expires.

Interesting to note that while the QPRT is in effect, the grantor can deduct the home’s real estate taxes and mortgage interest. Although mortgaged properties are rarely placed within QPRTs, this is worth understanding.

When the term expires, the residence passes to the named beneficiary, and you may no longer claim those deductions and will need to leave the property or enter into a lease agreement with the beneficiary.

You must be alive when the trust expires. Otherwise, the home’s value at the time of your death will be included in your estate, negating a major benefit of the trust.

Steps to Implement a QPRT

  1. Work with a qualified estate attorney to create the trust.
  2. Determine the term length.
  3. When the term is up, ownership of the property transfers to the beneficiary.
  4. If gift and estate taxes are assessed, the beneficiary only pays taxes on the value of the home at the time the trust was established — not the appreciated value of the house when the QPRT expired.

Irrevocable Life Insurance Trust (ILIT)

When you set up an Irrevocable Life Insurance Trust, the death benefit from the policy isn’t included in the value of your estate after your death. An ILIT may be a good option if:

  • You’ve taken advantage of other ways to reduce your estate taxes and still have a taxable estate.
  • You want to use the policy’s death benefit to cover your estate taxes and other expenses after your death.
  • You want your heirs to retain the full value of your estate.
  • You want to leave a set dollar amount as inheritance for your heirs.

How an ILIT Works

When you establish an ILIT, the trust is the owner of the life insurance policy, and the death benefit gets paid out to the trust. However, if an existing life insurance policy is transferred into the trust, the policy must be in the ILIT for at least three years before you die. Otherwise, the payout from the life insurance policy will be included in the value of your estate.

How to Implement an ILIT

  1. Work with a qualified estate attorney to properly set up the trust to adhere to all state and federal laws.
  2. Gift the life insurance policy to the trust.
  3. An interesting quirk of this trust type is that premium payments should come from an account owned by the ILIT. So if you are used to paying from a different checking account for an existing policy transferred into the trust, this will be a change of habit for you. Tracking all premium payments and ensuring they come from the correct account can help ease work afterward for your beneficiaries.

Next Steps for Your Needs

Tax planning is a critical component of a comprehensive wealth management strategy. Irrevocable trusts can be a powerful estate planning tool to help you reduce the tax liability your family members may face after your death. But they can be complicated, and if you don’t know and monitor the trust requirements closely, you’ll lose out on the benefits it could provide.

A financial advisor can review common types of trusts with you and take a deep dive into your finances to recommend the type(s) that may be best for you. Schedule a consultation today.

Related Posts

Brian joined Plancorp in 2020 as a financial planner. Prior to Plancorp, he worked at Edward Jones and had his own office in Litchfield, Illinois. His experience taught him how to build relationships and truly get to know clients as people first. He believes that is how you can truly impact clients' lives. Brian came to Plancorp because of the more collaborative and team-driven environment. He enjoys turning advanced financial concepts into easy to understand strategies for his clients. He especially enjoys helping clients navigate equity compensation! More »