TRUST-BASED PLANNING
| Print this Article |
|
The Premature Demise of the Trust-Based Estate Plan
By Scott H. Levin, CFP®, ChFC®, CAP®, CEP®, MCEP®
As financial advisors, we have a variety of tools available to support our clients’ quests to achieve their financial goals. When it comes to estate planning—where we may work with other professionals engaged by clients—I find it surprising that trust-based estate planning is not more frequently used.
In 2025, the federal estate tax exemption is $13.99 million per person, affecting few Americans. Portability of the exemption enables the deceased spouse’s exemption to be used by the surviving spouse if elected on a 706 return. This allows the surviving spouse to use both their own and their deceased spouse’s exemption amounts. These factors have led many estate attorneys, CPAs, and financial advisors to abandon trust-based estate planning.
In this article, I will detail 18 reasons why it may still be a good strategy to consider implementing a trust-based estate plan.
1. Avoiding Probate. Using revocable living trusts (RLTs) can avoid probate, which involves costs, the court, creating a public record, and added time and effort. Funding an RLT and retitling assets to it is a way to avoid probate. Then assets will transfer privately to heirs in a safer manner.
2. Continuity in Managing Assets. An RLT provides asset management continuity for incapacity or death. While a payable on death/transfer on death account can avoid probate, it won’t help in the event of incapacity. A power of attorney (POA) can be used during incapacity but is not ideal because the account custodian may not accept an outdated version. A successor trustee assumes account management when the grantor becomes incapacitated.
3. Distribution Control. Irrevocable trusts provide distribution control and confidence that assets will pass to the intended heirs and not be redirected to an unintended beneficiary. This ensures that lineal descendants will benefit from the assets in the future.
Assume assets are left outright to a child; they die while married, then their surviving spouse gets remarried and dies; now the parent’s assets are owned by their child’s former spouse’s next spouse. Using a trust for the child can ensure assets will eventually go to grandchildren.
4. Creditor and Divorce Protection. Irrevocable trusts are considered the owner of the assets, not the beneficiary. As long as the trust rules are followed, trust assets aren’t available to financial or lawsuit creditors or spouses in a divorce settlement.
5. Spendthrift Protection. Irrevocable trusts provide spendthrift protection to combat the issue of a beneficiary who spends money recklessly or has a drug, alcohol, or gambling addiction.
6. Future Estate Tax Protection. Assets left outright to heirs, unless spent, will be included in the heir’s estate and may be taxed. Assets left in an irrevocable trust for heirs are owned by the trust, not the heir, so they are not taxed at the heir’s death.
7. Using a State Exemption Amount. At the federal level, portability allows a deceased spouse to port their unused exemption amount to the surviving spouse so both exemptions are available. Only Hawaii and Maryland allow for portability of the state exemption amount. Unless a bypass trust is funded at the first spouse’s death to use their state estate tax exemption, it is lost.
8. Multiple Marriages/Children from Prior Relationships. When a person has children from different relationships, they often want to care for the current spouse but also protect assets for the children. Assets left outright to the spouse could be redirected away from the children. An irrevocable trust can be used to ensure the assets will be available for children.
9. Protection from Taxation at Multiple Deaths. People may leave assets to parents or siblings. If the heir, who is older or close in age, dies soon after they inherit the assets, an estate or inheritance tax could apply at both deaths, causing taxes that could have been avoided by funding an irrevocable trust.
10. Estate Tax-Free Asset Growth. With portability, assets in the surviving spouse’s estate may grow over time, potentially resulting in an estate value exceeding the combined exemption of both spouses. If the deceased spouse’s exemption was used at their death to fund a bypass trust, all future asset growth would be out of the estate of the surviving spouse.
11. Using the Deceased Spouse’s GST Exemption. The GST exemption amount is not portable, so if it is not used at the death of the first spouse, it will be lost. If a GST-exempt bypass trust is funded, the assets will be exempt from the 40% GST tax.
12. Future Probate Avoidance for Heirs. Assets inherited outright may be subject to probate. Assets left in an irrevocable trust will not be subject to probate. If the estate includes real estate located in another state, ancillary probate could apply to it. If this real estate is owned by an irrevocable trust, the asset will avoid ancillary probate.
13. Protect Government Benefits for Special Needs Heirs. If special needs heirs receive government benefits, an outright estate distribution may cause them to lose those. A special needs trust can be used to preserve government benefits.
14. Care for Pets. Leaving assets outright for pet care doesn’t guarantee that money will be spent on the pets. A trust for the pets will name a trustee who has a fiduciary responsibility to care for the pets and use the assets for that purpose.
15. Incubate a Business. If an heir uses outright assets to start a business, the value of the business will be included in their taxable estate. Assets kept in trust for the heir, who then establishes a business entity funded and owned by the trust, will keep the business out of the heir’s taxable estate.
Assume Steve Jobs’ parents left him assets in an irrevocable trust that he used to create Apple. The business, owned by the trust at formation, would not have been included in Steve’s estate, saving $768,250,000 in federal estate taxes. If the Apple stock remained in trust for the lifetime of Steve’s future heirs, there would not be a federal estate tax at their deaths either.
16. Loss of the DSUE. If the surviving spouse ports over the deceased spouse’s unused exemption (DSUE), then gets remarried and the new spouse dies, they will no longer be able to use the DSUE of the first deceased spouse. This problem is avoided if a bypass trust is funded at the first spouse’s death.
17. Non-U.S. Citizen Spouses. An unlimited marital deduction exists for assets transferring between U.S. citizen spouses but not non-U.S. citizen spouses. They only receive a federal gift tax annual exclusion amount of $190,000 in 2025. For federal estate tax purposes, the non-U.S. citizen spouse can only receive the estate exemption amount minus any lifetime gifts over $19,000 annually before the estate tax applies. Funding a qualified domestic trust (QDOT) defers the tax until principal distributions are actually paid from the QDOT to the non-U.S. citizen spouse or at their death.
18. Protection from a Future Exemption Decrease. In the future, the $13.99 million exemption could be decreased. SLATs, DAPTs, and other trusts can be funded now to use the full exemption to address this concern.
In Summary
As you can see, there are numerous benefits to trust-based planning, even for clients with modest assets. Because of all the information presented above, you may want to consider using trust-based estate plans regardless of the size of a client’s taxable estate.
Scott H. Levin, CFP®, ChFC®, CAP®, CEP®, MCEP® is a Financial Advisor, Senior Estate Planning Specialist with Wescott Financial Advisory Group. Contact him at 215-209-4103 or slevin@wescott.com.
image credit: Adobe Stock Images
