Pros and Cons of Trusts

Trusts are used for planning during lifetime and after death. They can be used to protect assets, avoid probate, manage money for children who are too young to handle money themselves. In addition, they can shelter assets if VA aid and attendance or Medicaid are needed and can save on inheritance taxes for those who have taxable estates.

Revocable trusts during lifetime can authorize someone else to handle your assets if you become incapable. You can be in charge until you are no longer able to handle your affairs, and then, an adult child or other person can take over. Since it is revocable, IRS and Medicaid and VA will still consider the assets in the trust to be yours. If something bad or good happens to family members, you can change where your money goes. Oftentimes people with young children do wills leaving money to a revocable trust after they die. If circumstances change, the trust can be revised without changing the will. When you pass away the trust becomes irrevocable, so the provisions for children must be flexible enough so your trustee can use the money to the children’s best advantage. A somewhat humorous case many years ago was a trust set up for an adult son in his 50’s, because the parents knew money would quickly be wasted if it went directly to him. After a few years, the son asked to be given all the money in the trust because he was getting married. Asked where he met his intended, he said Online. He had never met her in person.

A key decision is who to use as trustee. The person should have good judgment in providing for your beneficiaries and have the fortitude to say “no” to a beneficiary who might waste money if given large amounts at once. It is critical to have a backup trustee if the original one dies or can no longer handle matters. Family trustees can be used, but in some cases can lead to anger or estrangement if a sibling or relative says “NO” to a requested distribution.

Irrevocable trusts are an entirely different matter. They cannot be changed, so they are used in specific situations where the elder person needs to protect assets from inheritance taxes using a life insurance trust, or a special kind of trust to protect assets from VA Aid & Attendance, or Medicaid. These cannot be done at the last minute. For VA, assets must be put in the trust 3 or more years prior to applying, and for Medicaid, 5 or more years prior. The trust cannot under any circumstances return assets to the person who made the trust, because the assets are then still available to that person and count against them. For those who are candidates for such a trust, it is critical to evaluate all the downsides. For example, a person who needs all their income, plus some of their savings to live on, it may not be economically feasible to put savings into the trust. It may make sense however to put the house in the trust, as in many cases the house is not something you spend. It is where you live. Vacation property is a logical asset to put into the trust. A downside is it is unlikely a mortgage could be taken out by such a trust if a loan was needed.

One advantage of both types of trusts, if the irrevocable trust has tax provisions that treat the property as if it still belongs to the taxpayer is that income taxes will not change, whether property is in the trust or not. That is very important because as a homeowner you and your spouse each have a $250,000 exemption from capital gains tax, when you sell if you have lived in your house for 2 out of the 5 years before the sale. So, if you bought your house for $200,000 many years ago, add $500,000 to that and there is no capital gains tax on up to $700,000 for a husband and wife. And in today’s market, who knows? Then, if you pass away, the IRS still treats the property as yours and you get what is called a “step up in basis”. That means IRS raises the value of the house to the value on the day you died and when your heirs sell the house, they will not pay any capital gains tax on up to that value. So, if you bought your house for $50,000 in the early 1970’s. and when you die it is worth several hundred thousand, your kids can sell it, up to that stepped up value and not pay a penny of capital gains tax. That may not help you, but it sure helps them.

The key thing to remember, especially with the irrevocable trust, is to weigh the pluses and minuses and be realistic on what the goal is. Is it to protect assets while you are alive, or just to control assets after you are gone? Are you at an age where you no longer have to worry about children handling money, but are reaching the age where long term care may be needed? A careful evaluation with the assistance of an attorney who knows the pros and cons, will allow you to make sound decisions that can serve you and your family. One size does not fit all.