The living trust is the ideal estate planning centerpiece for many if not most people for a number of different reasons. We will provide an overview here, but first, we will address a common question that is asked about taxation.
Principal vs. Earnings
The Internal Revenue Service proceeds with the understanding that the principal that is held by a living trust was accumulated after taxes were paid on the underlying income. As a result, distributions of the principal are not subject to taxation.
Distributions of the earnings that are generated by assets in the trust are taxable. In some cases, the grantor of the trust will instruct the trustee to distribute all the assets in the trust as soon as possible. Under these circumstances, there would be little to no tax exposure.
It is also possible to arrange for the trustee to provide limited distributions over an extended period of time. This is necessary if a minor is a beneficiary, and people will sometimes take this approach to protect loved ones that are not good money managers.
In addition to the taxes that the beneficiaries would have to pay on distributions that are made to them, the trust itself would pay taxes on undistributed earnings.
Living Trust Benefits
Now that you understand the taxation situation, we can share some of the benefits. The fact that you can stretch out the distributions over time is certainly one of the positives, and there is an added layer of protection.
After your passing, the trust would become irrevocable. A spendthrift provision would keep the principal out of the reach of the beneficiary’s creditors.
This is not a very pleasant subject, but unfortunately, a very significant percentage of seniors become unable to make sound decisions at some point.
Alzheimer’s strikes about 10 percent of seniors, and the figure goes up to 32 percent for elders that are 85 and older. This is not the only cause of cognitive impairment, and there are other types of incapacity.
You would act as the trustee while you are alive and fully capable of handling your own affairs. When you establish the trust declaration, you can name a disability trustee to assume the role if you become unable to manage the trust yourself.
The estate administration process is streamlined when you have a living trust. All or most of the assets that comprise the estate would be consolidated, and this makes life easier for the successor trustee.
Plus, the distributions would not be subject to probate. When a will is used, it must be admitted to probate, which is expensive and time-consuming legal process.
The flexibility is another key benefit. Though you would probably never want to use it, you retain the ability to revoke the trust at any time. You can change the beneficiary and/or trustee designations, and you can convey property into the trust after it has been created.
With regard to assets that were never signed over to the trust, you can include a pour-over will to direct the assets into the trust after your passing. In California, a Heggstad petition can also be filed to ask the court to move personally held assets over to the trust.
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