There are different types of trusts that can be used to satisfy various respective objectives. When it comes to the question of whether you can dissolve a trust, the answer is yes and no, and we will provide clarity here.
There is a legal concept called “incidents of ownership” that is the dividing line between the different types of trusts. Losing ownership of assets does not sound like a good thing, but under some circumstances, it can be beneficial.
You do in fact surrender incidents of ownership when you establish an irrevocable trust, and this can save your family a good bit of money if you are exposed to estate taxes.
On the federal level, the tax is applicable on asset transfers that exceed $11.7 million, and the maximum rate is 40 percent. This $11.7 million figure is called the credit or exclusion.
We have a state-level estate tax in Vermont, and the exclusion in 2021 is $5 million, which is a $750,000 increase over the 2020 exclusion.
Assets that are held in an irrevocable trust are not part of your estate. Taxation will be a factor when they are transferred to beneficiaries, but the transfers are discounted.
In addition to the estate tax efficiency utilization, people use irrevocable trusts to gain Medicaid eligibility. This program will pay for long-term care, and Medicare does not cover a stay in a nursing home.
You could continue to receive income that is generated by the trust’s earnings if you have an irrevocable Medicaid trust, but you would not be able to access the principal. If you fund the trust at least five years before you seek eligibility, the assets would not count.
These are a couple of different reasons why you may want to use an irrevocable trust, but there are others.
Modifying an Irrevocable Trust
In a general sense, you cannot modify an irrevocable trust, but there are some exceptions. A trust can include verbiage that allows for the engagement of an independent trust protector that would objectively evaluate a proposed change to the terms.
When an irrevocable trust is being created, the beneficiaries or the trustee can be given a power of appointment that would allow them to make certain changes. There are also modification provisions that allow for changes in response to specific triggering events.
Revocable Living Trust
In addition to the irrevocable trust, there is also the revocable living trust, and the name of the device is self-explanatory. You can revoke or dissolve this type of trust if you would like to do so for any reason, and the trust goes into effect while you are still living.
The power of revocation is an incident of ownership, and you would act as the trustee, so you would have total control of the assets. As a result, they would not be protected from your creditors, and they would count if you apply for Medicaid or file estate tax returns.
Why would you use this type of trust if it does not provide those advantages?
A living trust is a great alternative to a will for a number of reasons. The assets are consolidated, and this helps to streamline the administration process. Plus, the distributions are not subject to court oversight during the probate process.
Since we are on the subject of revocable versus irrevocable trusts, there is an interesting twist to highlight. After your passing, a revocable living trust would become irrevocable, and the assets would be protected from the beneficiary’s creditors.
This is one level of asset protection, and if you have concerns about the spending propensities of the beneficiaries, you can instruct the trustee to provide limited incremental distributions over time.
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