Be aware of some common misconceptions about living trusts:
A living trust will help you avoid property taxes.
There are ways to lower your federal and state property taxes, but a living trust is not one of them. If your estate is large enough to potentially expose you to estate taxes, consult an estate planning attorney for strategies to reduce the size of your estate.
The federal estate tax threshold is $12.06 million in 2022 ($24.12 million for a married couple), but unless Congress acts, the exemption will drop to 5, $5 million in 2025. Additionally, 12 states and the District of Columbia impose an estate tax, and some have much lower exemptions than the federal level.
If you have a living trust, you do not need a will.
You are unlikely to include everything you own in your trust, and you can add assets between the time you set up your living trust and your death. Your attorney will likely recommend a document known as a “poured-in” will, which essentially transfers to the trust everything that you have excluded.
In addition to a will, you will need other estate planning basics, including a financial power of attorney and a health care power of attorney. If you have minor children, you will also need to appoint a guardian. Below is a checklist of documents you should include in your estate plan.
Documents you need for your estate
Keep these estate planning documents in a safe place, such as a safe or vault, and make sure your loved ones know where to find them. You may also want to give copies to your lawyer and to people who have been named to play a role in your estate.
– Financial/durable power of attorney. It gives someone the power to manage your money if you become incapacitated.
– Medical power of attorney. This appoints a person authorized to make health care decisions on your behalf if you become incapacitated.
– Directive to physicians/living will. This document allows you to specify the types of treatment and long-term care options you prefer.
– Funeral arrangements.
– Last will and testament.
– All the trusts you created, including your revocable living trust.
A charitable trust offers tax advantages
Are you looking for an additional source of retirement income? Do you want to leave behind a charitable legacy and reduce your tax bill now and when you die? If the answer is yes, a charitable remainder trust might be right for you.
A CRT is an irrevocable “shared interest” trust that provides income to you and any named beneficiary for a specified number of years (up to 20) or for the rest of your life or that of a beneficiary, with remaining assets donated to charity. Between 5% and 50% of the assets of the trust must be distributed at least once a year, and at least 10% of the initial value of the CRT must eventually be donated to charity.
Two types of CRTs
There are two types of CRTs. With a Charitable Residual Annuity Trust, or CRAT, a fixed amount is distributed each year to you or non-charitable beneficiaries. Once you’ve set up a CRAT, you can’t contribute to it later. With a Charitable Remaining Trust, or CRUT, distributions are based on a fixed percentage of the value of the trust, which is re-determined each year. You can also put more in a CRUT after it is created.
Both types of CRTs have tax advantages. According to Jim Ferraro, Vice President and Trustee Advisor of Argent Trust Co., CRTs are primarily an “estate tax reduction tool for the charitable inclined.” This is because assets paid into these trusts are generally not included in your estate upon your death. If they are not part of your estate, they will not be subject to federal estate tax.
You may even be able to avoid the tax altogether if the total value of the estate is reduced below the estate tax exemption amount for the year of death. This amount is $12.06 million in 2022. The exemption is doubled for married couples if portability is elected on Form 706 after the death of the deceased first spouse.
You can also claim an itemized charitable deduction on your tax return for the year you created a CRT. The deduction is for the projected amount that will go to charity. Since the amount of future contributions to the charity is not always clear when creating the CRT, a complicated formula is used to calculate it. The formula is based on your age or the age of any other beneficiary, whether a CRAT or CRUT is used, and the distribution rate, among other factors.
Additional fiduciary benefits
You can also defer paying capital gains taxes if you place valued capital assets, such as stocks or real estate, in a CRT. If you sell assets outside the CRT, the tax is due when you file your tax return for the year of the sale. But if you transfer the asset to a CRT, the trust can sell it tax-free.
However, as Ferraro notes, “the character of income or gain is trapped in the CRT” by IRS regulations that dictate how distributions are taxed. Although there is potential for tax-free income, portions of the distribution may also be treated as ordinary income, capital gains or other income and taxed accordingly. For capital gains, however, the tax bill will be delayed and you may not owe these taxes until you file your tax return for the years in which you receive a distribution.
CRTs can also be used as an alternative to “stretched” IRAs, which were phased out for most people in 2020. Under the old rules, non-spouse IRA beneficiaries could split distributions from an inherited account into their own life and leave the rest of the money to grow tax-free for decades. Now, all funds from an inherited IRA must generally be distributed to non-spouse beneficiaries within 10 years of the death of the IRA owner. To get around the new rules, you can name a CRT as the beneficiary of the IRA and set up the trust to provide lifetime income to someone other than a spouse.
While the tax benefits are attractive, Ferraro urges people not to “let the tax tail wag the dog.” If you’re not charitable, don’t go for a CRT.