A living trust is a very effective estate planning tool that can be the right choice for a lot of people that assume they should use a will. We are going to explain taxes on living trust distributions in this post, but first, we will provide an overview of the advantages they provide.
Total Control and Flexibility
One of the reasons why many folks assume that they should not use a trust is because they are afraid of losing control of their assets.
There are irrevocable trusts that are used to accomplish certain goals, and if you create one of these trusts, you could not act as the trustee. Generally speaking, you would not be able to change the terms of the trust, so you would surrender incidents of ownership.
However, a revocable living trust is in a different category. As the name would indicate, you can revoke this type trust if you ever choose to do so, and you can act as the trustee while you are alive.
Nothing changes with regard to your ability to use assets that are technically owned by the trust, so this should not be a source of concern.
When you are creating the trust, would name a successor trustee to assume the role after you are gone, you would make your heirs the beneficiaries, and you would establish the terms.
These decisions are not set in stone after you establish the trust. If you want to change the beneficiary and/or trustee designations, you have that power. You can also convey property into the trust at any time after it has been established.
Asset Protection for the Beneficiaries
A living trust can be used to provide asset protection for the beneficiaries. The trust will become irrevocable after your passing, and the beneficiary would not have direct access to the assets.
Creditors of the beneficiaries would “step into their shoes.” Since the beneficiaries would not be able to reach the principal, the same dynamic would apply to their creditors.
In the trust declaration, you can stipulate the way that the assets will be distributed to the beneficiaries. For example, you could instruct the trustee to distribute a certain amount each month and approve additional need-based distributions at the discretion of the trustee.
You could go on to allow for larger portions of the principal to be distributed after the beneficiaries reach certain age plateaus. This is just one random example, but you can set any terms that you feel comfortable with when you establish a living trust.
Taxes on Trust Distributions
You pay taxes on your income throughout your life, and you acquire property and you make investments after you pay these taxes. If you want to give someone a cash gift while you are living, they do not have to claim the gift as income, because the money was left over after you paid taxes.
The same principle applies to inheritances. When a living trust beneficiary receives a distribution of the principal, they do not have to report the income. However, distributions of interest income are subject to taxation, and the trust is required to pay taxes on undistributed appreciation.
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