Trusts and Wills
Trusts and wills are the primary tools for directing how assets are managed and distributed. The exam tests basic trust concepts, key trust types, and the difference between dying with and without a will.
Revocable vs Irrevocable Trusts
| Feature | Revocable Trust | Irrevocable Trust |
|---|---|---|
| Grantor control | Full (can modify or terminate) | None (cannot be changed) |
| Probate | Avoided | Avoided |
| Income tax benefit | None (grantor pays tax) | Possible (trust is separate entity) |
| Estate tax benefit | None (assets included in estate) | Assets excluded from estate |
| Asset protection | None (creditors can reach assets) | Yes (creditors generally cannot) |
Exam Tip: Gotchas
- Revocable trust = probate avoidance, no tax benefit. The grantor still pays income tax and the assets remain in the taxable estate.
- Irrevocable trust = estate tax benefit, but grantor gives up all control. Once transferred, changes require beneficiary consent or a court order.
Trust Terminology
| Term | Definition |
|---|---|
| Grantor (settlor/trustor) | Person who creates and funds the trust |
| Trustee | Fiduciary who manages trust assets according to the trust document |
| Beneficiary | Person(s) who receive benefits from the trust |
| Corpus (principal) | The assets held in the trust |
| Trust document (indenture) | Legal agreement governing the trust's terms |
Revocable Living Trust
- Grantor can modify, amend, or revoke at any time during their lifetime
- Assets remain part of the grantor's taxable estate (no estate tax benefit)
- Income is taxed to the grantor (grantor trust)
- Primary benefit: avoids probate - assets pass directly to beneficiaries
- Grantor typically serves as trustee during their lifetime
- Becomes irrevocable upon the grantor's death
Think of it this way: A revocable living trust is like a container you fully control while alive. You can add to it, take from it, or dissolve it. At death, the container locks and assets pass directly to beneficiaries, skipping the probate process entirely.
Irrevocable Trust
- Cannot be changed or revoked once established (with limited exceptions)
- Assets are removed from the grantor's taxable estate (potential estate tax savings)
- Trust is a separate tax entity - the trust pays taxes on income, or beneficiaries pay tax on distributions received
- Grantor gives up control of the assets
- Used for estate tax reduction, asset protection, and charitable planning
Inter Vivos vs Testamentary Trusts
| Type | When created | Probate |
|---|---|---|
| Inter vivos (living trust) | During the grantor's lifetime | Avoids probate |
| Testamentary trust | Created by the terms of a will, effective at death | Subject to probate (established through the will) |
Exam Tip: Gotchas
- Testamentary trusts go through probate. They are created through a will and therefore DO go through probate, even though they are trusts. Do not confuse them with living trusts, which avoid probate.
Specialized Trusts (Basic Awareness)
Bypass Trust (Credit Shelter Trust)
- Uses the deceased spouse's estate tax exemption to shelter assets from estate tax for the benefit of heirs (not the surviving spouse's estate)
Think of it this way: Without a bypass trust, the first spouse to die might leave everything to the survivor, effectively forfeiting the deceased spouse's estate tax exemption. The bypass trust preserves that exemption by funding a separate trust at the first death.
Generation-Skipping Trust
- Transfers assets to grandchildren or later generations, potentially avoiding estate tax at the children's generation
Grantor Retained Annuity Trust (GRAT)
- Grantor transfers assets to an irrevocable trust but retains annuity payments for a set term
- Remainder passes to beneficiaries at reduced gift tax cost
Charitable Remainder Trust (CRT)
- Provides income to the donor (or other beneficiary) for a period, then the remainder goes to a charity
- Donor receives a partial income tax deduction
Wills
- A will (testament) is a legal document directing how a person's assets are distributed at death
- Assets passing through a will go through probate (court-supervised process)
- A person who dies with a valid will dies testate
- A person who dies without a valid will dies intestate - state law controls distribution
- Wills can be revoked or amended during the person's lifetime (via codicil or new will)
- A will does not control assets with beneficiary designations (retirement accounts, life insurance, transfer on death (TOD) / pay on death (POD)) or jointly held assets with survivorship rights
Exam Tip: Gotchas
- Testate vs intestate: Dying with a valid will = testate. Without = intestate (state law controls).
- Wills do NOT control beneficiary-designated assets. Retirement accounts, life insurance, TOD/POD designations, and jointly held assets with survivorship rights all pass outside the will.
Estate and Gift Tax Fundamentals
- Annual gift tax exclusion: $19,000 per recipient (2025-2026); married couples can give $38,000 per recipient via gift splitting
- Lifetime estate and gift tax exemption (unified credit): $13.99 million per person (2025); increasing to $15 million per person (2026) under the One Big Beautiful Bill Act
- Portability: A surviving spouse may elect to use the deceased spouse's unused exemption amount (DSUE), effectively doubling the couple's combined exemption
- Portability must be elected on a timely filed Form 706 (federal estate tax return)
- Estate tax rate: 40% on amounts exceeding the exemption
- Gifts made during lifetime reduce the available lifetime exemption at death (unified system)
Exam Tip: Gotchas
- Portability is NOT automatic. It must be elected by filing Form 706 even if no estate tax is owed. The surviving spouse cannot use the deceased spouse's unused exemption without this filing.