What Is the Best Trust to Avoid Estate Taxes?

The most effective trust to avoid estate taxes depends on an individual’s financial circumstances, assets, and wealth transfer objectives. This planning is necessary due to the federal estate tax, a tax on the transfer of a person’s assets to their heirs after death. While a substantial federal exemption of $13.99 million per person shelters many estates, those with assets exceeding this threshold must consider ways to minimize their liability.

This high exemption is not permanent and is scheduled to be reduced by about half at the beginning of 2026, making proactive planning important for more families.

The Role of Irrevocable Trusts in Estate Tax Planning

At the heart of estate tax planning is the distinction between revocable and irrevocable trusts. A revocable trust allows the person who creates it, the grantor, to retain full control over the assets. While useful for avoiding the probate court process, a revocable trust does not remove assets from the grantor’s taxable estate because the grantor never gives up control.

To reduce estate taxes, one must use an irrevocable trust. When assets are moved into an irrevocable trust, the grantor legally gives up their ownership rights. Consequently, upon the grantor’s death, those assets are not included in their gross estate calculation for tax purposes.

This benefit comes with the loss of control and direct access to the transferred assets. The decision to place assets into an irrevocable trust cannot be easily undone, and the grantor must be financially secure enough to part with the assets permanently.

The transfer of assets into an irrevocable trust is considered a gift to the beneficiaries for tax purposes. Depending on the value of the assets transferred, this may require the grantor to file a federal gift tax return and use a portion of their lifetime gift and estate tax exemption.

Trusts Focused on Specific Assets

Certain trusts are designed to manage specific, high-value assets. An Irrevocable Life Insurance Trust (ILIT) is created for the sole purpose of owning a life insurance policy. When an individual owns a policy on their own life, the death benefit is included in their gross estate. By having an ILIT own the policy, the proceeds are paid to the trust and pass to beneficiaries free from estate taxes.

To ensure the policy is excluded from the estate, the grantor cannot retain any “incidents of ownership,” such as the right to change beneficiaries. If an existing policy is transferred into an ILIT, the grantor must survive for three years after the transfer for the proceeds to be excluded from their estate. Funding for the policy’s annual premiums is accomplished through yearly gifts to the trust, which can be structured to qualify for the annual gift tax exclusion of $19,000 per recipient.

A Qualified Personal Residence Trust (QPRT) is an irrevocable trust used to transfer a primary or secondary home to beneficiaries at a reduced gift tax cost. The grantor transfers the title of their home into the QPRT but retains the right to live in it, rent-free, for a set number of years. The gift’s taxable value is the home’s current market value minus the value of the grantor’s retained right to live there.

If the grantor outlives the specified term, the house passes to the beneficiaries and is removed from the grantor’s taxable estate. Any appreciation in the home’s value after the transfer also occurs outside of the estate. Should the grantor wish to continue living in the home after the term ends, they must pay fair market rent to the new owners. If the grantor dies before the trust term expires, the home’s full value is brought back into their estate for tax purposes.

Trusts for Income and Charitable Goals

Some trusts are structured to reduce estate taxes while also meeting other financial objectives, such as generating income or fulfilling philanthropic goals. A Grantor Retained Annuity Trust (GRAT) is used to transfer the future appreciation of an asset to beneficiaries with minimal or no gift tax. The grantor places assets expected to grow in value into an irrevocable trust for a fixed term and receives a fixed annual payment, or annuity, from the trust.

This annuity is calculated to return the original value of the assets plus an interest rate set by the IRS, known as the Section 7520 rate. If the assets in the GRAT grow at a rate higher than this rate, the excess appreciation remaining at the end of the trust term passes to the beneficiaries free of estate and gift taxes. The main risk is if the grantor does not survive the GRAT term, as the trust assets will then be included in their taxable estate.

A Charitable Remainder Trust (CRT) is for individuals who wish to support a charity while retaining an income stream from donated assets. The grantor transfers assets into an irrevocable trust, which removes the asset from their taxable estate and provides an immediate income tax deduction. The trust can then sell the asset without paying capital gains tax and reinvest the proceeds.

The trust pays an income stream to the grantor or other beneficiaries for life or a specified term. There are two main types: a Charitable Remainder Annuity Trust (CRAT), which pays a fixed dollar amount, and a Charitable Remainder Unitrust (CRUT), which pays a fixed percentage of the trust’s value. At the end of the term, the remaining assets are distributed to the designated charity.

Advanced Trusts for Family Wealth Transfer

For high-net-worth families, more complex trusts facilitate multi-generational planning and asset protection. A Spousal Lifetime Access Trust (SLAT) is a technique for married couples. In a SLAT, one spouse makes a gift of their separate property into an irrevocable trust for the benefit of the other spouse. This transfer uses the donor spouse’s lifetime gift tax exemption and removes the assets from their combined taxable estates.

While the donor spouse cannot directly access the funds, the beneficiary spouse can receive distributions from the trust. This provides the couple with indirect access to the transferred wealth. Upon the death of the beneficiary spouse, the remaining trust assets pass to the couple’s children or other descendants, free of estate tax. A risk is a divorce or the premature death of the beneficiary spouse, as either event would cut off the donor’s indirect access.

A Dynasty Trust, also known as a Generation-Skipping Trust, is a long-term trust designed to pass wealth through multiple generations while minimizing transfer taxes. A Dynasty Trust avoids estate tax at each generation by making distributions directly to grandchildren or more remote descendants. The trust is structured to last for as long as state law permits.

The grantor must allocate their Generation-Skipping Transfer (GST) tax exemption to the assets contributed to the trust. This exemption is the same as the estate tax exemption, $13.99 million per person. Once the exemption is applied, the assets within the trust can grow and be distributed to successive generations without being subject to the 40% GST tax or further estate taxes.

Establishing and Funding Your Trust

The first stage of creating a trust involves gathering information and making decisions. You must compile a detailed inventory of all assets, identify beneficiaries, and select a trustee to manage the trust. This information forms the basis for the trust agreement, a legal document drafted by a qualified estate planning attorney that outlines the rules for managing and distributing the assets.

Once the trust agreement is drafted, it must be signed and notarized. However, the trust is not active until it is funded. Funding is the legal process of transferring ownership of your assets from your name into the name of the trust.

This process varies depending on the asset.

• For real estate, a new deed must be prepared and recorded with the appropriate county office.
• For financial assets like bank or brokerage accounts, you must work with the institution to retitle the accounts into the trust’s name.
• For business interests, ownership documents must be amended to reflect the trust as the owner.
• Transferring a life insurance policy requires completing a change of ownership form with the insurance company.

Each asset must be formally moved into the trust for its terms and tax benefits to apply.