From Trusts to Taxes: Is Your Estate Plan Ready?

An older couple go over paperwork with a financial adviser at their kitchen table.

(Image credit: Getty Images)

Congratulations! You’re well on your way to the retirement you envision for yourself. You’ve saved diligently, contributed to a 401(k) or IRA and have a good idea how much you’ll need to maintain your lifestyle or perhaps adopt a new one.

But what about after that?

Estate planning is a topic that some people wish to avoid … at least until they have no choice. But early planning can provide you with more choices and a greater likelihood that the legacy you leave someday will be used as you see fit and not be eroded by unnecessary taxes.

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How should you get started?

Do you have all the right documents?

A will, power of attorney, health care proxy — hopefully, you’ve worked with an attorney to develop these important documents. Even if you have, however, ask yourself whether these documents still reflect your wishes and current situation. For example:

Have you moved to a different state recently or are you planning a move in the future? Legal requirements for wills, powers of attorney and health care proxies vary from state to state, so what you had drawn up in your previous state may no longer be valid.
Does your will reflect your family as it is, not as it was when the will was created? If your children, for example, are now young adults, designating a guardian would no longer be the priority it was when they were toddlers.

Many trust and estate planning attorneys believe that you should review and update your will and other documents every five years.

Have you addressed potential conflicts?

You decide to leave a sizable portion of your wealth to a local not-for-profit organization with a mission you care about. Your children, however, don’t share your passion and wonder why they must now share their inheritance.

Or perhaps you own a successful business that you leave to a child who has already begun working with you. What about his or her siblings, who may or may not feel they were treated commensurately?

Estate planning requires the involvement of not only a knowledgeable attorney, accountant and financial adviser. It should also require the involvement of your heirs. By engaging them in the process, you can help them understand your intentions, priorities and apprehensions. You can also determine whether they have concerns that should be addressed in any plan you eventually formulate.

Do you know the ground rules?

Today, the lifetime estate tax exemption is $13.61 million per person or $27.22 million per married couple. In other words, only estates above those amounts are subject to estate tax.
As of January 1, 2026, the current exemption is scheduled to reset back down to $5 million per person or $10 million per married couple, adjusted for inflation. Assets over these limits can be taxed as high as 50%, so make sure you stay in touch with your financial adviser.
Currently, you are allowed to give up to $18,000 annually to any recipient you choose — $36,000 for a married couple. Gifts above that amount are subtracted from your lifetime estate and gift tax exemption.
Gifts used for medical or education expenses are not subject to gift tax, no matter how large they are. The key, however, is not to give these assets directly to a child or other recipient. Tax liability can be avoided only if you pay these expenses directly.

Should trusts be part of your estate plan?

Trusts are legal entities that are separate and distinct from the people who create them, the people who benefit from them and even the people or organizations who hold legal title to the assets in the trust. They are created for the benefit of a beneficiary, who may be a spouse, child or other family member, or even a charitable organization. Most important, trusts can help solve complex issues that stand in the way of building, preserving and transferring assets. For example:

They can ensure that assets are managed effectively and distributed according to the trust creator’s wishes.
They can shield assets from creditors, divorced spouses and unwelcome third parties.
They can provide numerous benefits for you while you’re still alive, including possible tax advantages and income streams.
A type of trust known as an irrevocable trust can be used to reduce estate tax liability in the event that the lifetime estate tax exemption really does decrease in January 2026 (or in the event that your estate exceeds the current exemption). By placing assets in an irrevocable trust, you remove them from your estate and, therefore, decrease your estate tax liability.

Is there any disadvantage to placing assets in an irrevocable trust?

In 2023, the IRS quietly changed the rules by announcing that investments placed in an irrevocable trust will no longer be eligible for a step-up in cost basis. What does this mean?

Imagine you place a stock in your trust that you bought for $20 per share.
Over time, the stock performs admirably, and at the time of your passing, it is selling for $40 per share.
Several years later, your trust’s beneficiary decides to sell the stock, which is now selling for $50 per share.

If the stock were still in your taxable estate, your heir would experience a taxable gain of $10 per share ($50 to $40). In other words, the cost basis of the stock was stepped up to $40, the price at which it was selling at the time of your passing. The IRS ruling, however, states that assets in an irrevocable trust will no longer receive a step-up in cost basis. As a result, your heir’s taxable gain will now be $30 per share ($50 to $20). As a result, his or her tax liability will be more onerous.

What about life insurance? I’ve heard that it makes sense for a trust to own the policy instead of me individually. Is that true?

Yes. One way to enjoy the benefits of trusts without the adverse tax consequences is by funding the trust with permanent life insurance, instead of individual securities. A relatively small outlay of funds either annually or upon purchase of a policy can result in a substantial death benefit for your heirs. What’s more, that benefit is income tax-free.

However, life insurance is not estate-tax-free. As a result, many people place their policies inside an irrevocable trust and, in fact, designate the trust as both owner and beneficiary By doing so, they achieve the following goals:

They remove assets from their taxable estate.
They avoid estate tax on their policy’s death benefit, as that benefit is paid to their trust, not their estate.
They remain unaffected by the recent IRS ruling that eliminates a step-up in cost basis for assets owned by an irrevocable trust.
They exercise a degree of control, if they wish, on how their inheritance will be managed and/or used.

Where there’s a will …

… there ought to be an estate plan. Your will is critical, but it is only one component of a plan that should be designed to meet your specific needs, preferences, tax situation and family circumstances. Consult with an attorney who specializes in this discipline, as well as an accountant and financial adviser. A team approach can help ensure that important details are considered and addressed and that your plan truly reflects who you are and what you want for your family.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Brian Large is a Partner and Relationship Manager who has been with Lenox Advisors since 2000. He is responsible for working with both corporate and high-net-worth individual clients of the firm. With his individual clients, Brian and the rest of the Lenox team specialize in comprehensive estate, insurance and wealth management strategies. Brian also works with corporate clients structuring in-depth employee benefits strategies and executive carve-out programs.