In California, there are two types of a living trust: revocable trust and irrevocable trust. Many homeowners do not fully understand the difference between the two. Furthermore, a myth rooted in decades-old taxation and estate planning realities has homeowners convinced that irrevocable trust is something that could save them money by reducing their tax burden.

In this blog post, we will discuss the best use of irrevocable trust and why this is not the most beneficial estate planning tool for most California homeowners.

What is a living trust?

A living trust is nothing more than a contract. It’s a contract between the settlor (the maker of trust–who is usually mom and dad) and the trustee to hold the assets (the home) for the beneficiaries (the children). The trustees manage the trust property for the beneficiaries.

If the trust is revocable, the settlor can change it or dissolve it at any time. An irrevocable trust is just what it sounds like: it’s a contract that cannot be revoked by the settlor because the assets inside the trust no longer belong to them.

Let’s say that husband and wife decide to give their house to their son Johnny in an irrevocable trust. Ten years later, the husband gets very ill, and the wife needs money to take care of him. She decides to sell the large house, move into a small condo and use the proceeds from the house sale to cover her husband’s medical bills.

Since the house was put in an irrevocable trust, neither husband nor wife are the owners of the property—their son Johnny, who is the beneficiary, is. The couple needs full Johnny’s cooperation and a signature on the escrow paperwork to sell the house. In this theoretical example, Johnny says ‘no.’ He has the power to do it! So, the elderly couple is at his mercy, and he may have none…

What is the current estate tax exemption?

An irrevocable trust is primarily an estate planning tool for the super-rich. Unfortunately, many homeowners, especially older ones, still think that irrevocable trust is a great way to avoid paying estate tax, also known as a death tax. However, most California residents will not have to pay any estate tax.

First of all, contrary to popular belief, California has no estate tax. Secondly, the personal federal estate tax exemption amount for 2021 is $11.7 million. It was $11.58 million in 2020. This means that when you pass away, the value of your estate is calculated and any amount more than $11.7 million is subject to the federal estate tax unless otherwise excluded. Keep in mind that the exception amount of $11.7 million is per person. So, a married couple has a combined exemption for 2021 of a whopping $23.4 million!

When does irrevocable trust make sense?

Years ago, the estate tax exemption was only $600,000. If you died worth $1 million back then, you would have to pay the estate tax on $400,000 (1,000,000 – 600,000 = 400,000). To avoid paying the “death tax”, estate planning specialists have devised a popular mechanism: use an irrevocable trust to put enough assets in it so that your total doesn’t exceed $600,000. If you owned multiple houses, you could slowly put some of them into irrevocable trust; by the time you pass away, your assets do not exceed the taxable amount.

Fast forward to 2021, when the exception amount is $11.7 per person… Clearly, the irrevocable trust method to beat estate tax is no longer needed for most Californians.

Sure, if you are a multimillionaire or billionaire, it is still a great tool for estate planning. Say, you own a piece of a company that goes public. Initially, the stock may be cheap.  You put a large chunk of it into an irrevocable trust. When the same stock is worth millions (or billions), you won’t have to pay estate tax on it because it’s no longer yours (due to irrevocable trust).

This, of course, is somewhat of an oversimplification since the super-rich use irrevocable trust in conjunction with other high-level estate planning tools.

Once again, for most of us, we will never have to resort to these advanced estate planning techniques because we are never going to be worth tens of millions of dollars.

To sum up, an irrevocable trust may be a great estate planning tool for the wealthiest Californians. For the rest of us, creating an irrevocable trust may result in more problems and heartache than benefits.

Certified Probate & Trust Specialist 

As a Certified Probate & Trust Specialist you can rest assured that as a Real estate professional, I have the understanding of the Probate transaction and can represent sellers or buyers in probate transactions, as well as investors looking to purchase probate properties. 

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All Information is deemed reliable but not guaranteed. Information is for educational purposes only.