Estate taxes can significantly reduce the wealth you've worked hard to accumulate. Without proper planning, much of your estate may be lost to taxes, leaving less for your loved ones. Trusts offer an effective way to reduce estate taxes while giving you greater control over how your assets are managed and distributed.

Let’s explore how trusts can help lower estate taxes, key types of trusts to consider, and essential steps to create a trust-based estate plan.

What is a Trust?

A trust is a legal structure where you (the grantor) transfer ownership of assets to a trustee. The trustee manages these assets for the benefit of your chosen beneficiaries. Depending on your financial goals, you can establish trusts that provide protection, privacy, and tax advantages.

Trusts come in two primary forms: revocable and irrevocable. Revocable trusts offer flexibility because you can modify or dissolve them during your lifetime. Irrevocable trusts provide better tax benefits because the assets are no longer considered part of your taxable estate.

How Trusts Help Reduce Estate Taxes

As of 2024, the federal estate tax exclusion is $13.2 million per person. This figure represents the amount an individual can pass on to heirs without incurring federal estate taxes. However, this exclusion is scheduled to sunset at the end of 2025. It is expected to revert to the pre-2018 level of approximately $5 million when it sunsets, adjusted for inflation, which could be around $6.8 million in 2026.

Trusts can lower your estate’s taxable value in several ways:

Transferring Assets Out of Your Estate: Irrevocable trusts transfer ownership of assets from you to the trust. Since you no longer control these assets, they are excluded from your taxable estate, which reduces potential estate taxes.

Using the Gift Tax Exclusion: Trusts allow you to gift assets within the annual gift tax exclusion limit (which is $19,000 per recipient in 2025). Making regular gifts through a trust can lower your taxable estate over time.  Doing so gives you more control over the terms of the gift, may protect the assets from creditors, and can help systematically reduce your taxable estate over time.

Avoiding Double Taxation with Generation-Skipping Trusts: Generation-skipping trusts transfer wealth directly to grandchildren or younger generations, bypassing your children’s estates. This strategy avoids estate taxes at each generational level, preserving more wealth for future generations.

Leveraging Charitable Deductions through Charitable Trusts: Charitable remainder trusts provide income for you or your beneficiaries for a set period. The remaining assets go to a charity. This structure offers significant income tax deductions and reduces your estate’s taxable value.

Types of Trusts to Reduce Estate Taxes

Below are some of the most effective types of trusts for minimizing estate taxes:

Irrevocable Life Insurance Trusts (ILITs): When a life insurance policy is held in an ILIT, the death benefit is excluded from your taxable estate. This allows your heirs to receive all the policy proceeds without incurring estate taxes.

Grantor Retained Annuity Trusts (GRATs): GRATs are helpful if you expect your assets to appreciate. You transfer these assets into the trust and receive an annuity for a set term. Any appreciation in value above the IRS’s assumed interest rate passes to the beneficiaries with minimal estate tax.

Qualified Personal Residence Trusts (QPRTs): A QPRT allows you to place your home in a trust while retaining the right to live there for a specified period. Once the term ends, ownership passes to your beneficiaries, reducing the value of your taxable estate.

Charitable Remainder Trusts (CRTs): CRTs allow you to receive income during your lifetime, with the remainder going to a charity upon your passing. This setup reduces your estate’s taxable value while benefiting a cause you care about.

Additional Benefits of Using Trusts

While reducing estate taxes is a primary benefit, trusts also offer other advantages:

Bypassing Probate: Trusts avoid the probate process, ensuring your estate is distributed privately and efficiently. Probate can be time-consuming and costly.  

Protecting Beneficiaries: Trusts provide control over when and how assets are distributed. This is especially valuable if you have minor children, special needs beneficiaries, or heirs who may not be financially responsible.

Shielding Assets from Creditors: Assets held in certain trusts are protected from creditors. This ensures that your wealth remains intact for your intended beneficiaries.

Maintaining Family Harmony: Clearly defining asset distribution through a trust reduces the risk of disputes among heirs. This structure helps preserve family relationships and ensures your wishes are followed.

Key Steps to Establish a Trust-Based Estate Plan

Establishing trust requires thoughtful planning. Below are essential steps to help you get started:

Identify Your Estate Planning Objectives:
Clearly outline your goals. Whether you want to reduce estate taxes, protect assets, or support charitable causes.

Choose the Right Type of Trust:
Each type of trust serves a unique purpose. If your primary goal is to minimize estate taxes, irrevocable trusts are typically the best choice. A qualified estate planning advisor can help you decide which trust aligns with your needs.

Select a Trustee:
The trustee manages the trust’s assets and ensures your instructions are followed. You can choose a trusted individual, a professional trustee, or a financial institution. Make sure the trustee is someone who can handle the responsibility with integrity.

Work with Estate Planning Professionals: Estate planning involves legal and tax complexities. Collaborating with an experienced estate planning attorney and a financial advisor ensures your trust is structured correctly and complies with current tax laws.

Common Concerns about Trusts

Some misconceptions may prevent you from considering trusts as part of your estate plan. Below are common myths:

“Trusts are only for wealthy individuals.”: Trusts benefit estates of various sizes. Even if your estate isn’t subject to federal estate taxes, trusts offer control over asset distribution, privacy, and protection from legal challenges.

“Trusts are too complex to manage.”:  While trusts may seem complicated initially, estate planning professionals simplify the process by guiding you through each step. Once a trust is set up, its ongoing management is often straightforward.

“Trusts only take effect after death.”: Many trusts provide benefits during your lifetime, like asset protection and income generation. Trusts can be integral to your financial plan, not just an estate planning tool.

Final Thoughts

Trusts are versatile and powerful tools for reducing estate taxes, protecting assets, and preserving your legacy. Effectively using trusts gives you greater control over how your wealth is managed and passed on to future generations.

Establishing a trust-based estate plan today can provide significant tax savings, protect your loved ones, and support the causes you care about. Working with qualified professionals ensures your trust strategy is tailored to your unique circumstances and goals.

Disclaimer: Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through TOP Private Wealth, a registered investment advisor and separate entity from LPL Financial.