Death, taxes, and trust funds: your full guide
Listen and Follow Heir Necessities: Apple Podcasts | Spotify | YouTube
Ever wondered what will happen to your parents' trust after they die?
You're not alone.
Most inheritors have the same question.
Unfortunately, there isn't a single straightforward answer.
In this episode, I’m unpacking what happens to a trust at death and what that could mean for you.
Listen, watch, or read to learn:
The difference between a revocable and irrevocable trust
When a trust does or doesn't get a step-up in basis (+ what the step-up in basis actually is)
What it means to inherit from a trust versus inheriting assets held in trust
If you spend 10 minutes with this episode, you'll know exactly what you’re dealing with.
It's a must-listen if you're a grantor, beneficiary, or future trust fund kid.
And if you’re looking for additional resources, grab my free Guide for Trust Fund Kids here: https://sunnybranch.myflodesk.com/trustfundkids
🗓️ Schedule a FREE call to talk more about how I can help you navigate a current or future inheritance.
Transcript:
Hey, I'm Katherine and thanks for joining me at Heir Necessities, the podcast that turns complex financial topics into real talk for Gen X, Millennial, and Gen Z inheritors. Each episode of this podcast, I'm breaking down a different topic related to generational wealth and inheritance.
My goal is that you can stop trying to manage your money by asking Google or ChatGPT what to do and come here instead for real advice, real solutions, and real guidance that you can start implementing in your life today.
In this week's episode of Heir Necessities, I am diving into a question that I get asked maybe more than any other question. Specifically, how does a trust work after someone dies?
It might seem like there's a straightforward answer to this question, but actually it can go one of many different ways and I'm going to be diving into all of them.
Before I do, a quick plug: if you are a long-time or a new listener to Heir Necessities and have been enjoying the show, I would be so appreciative if you could take five seconds to leave us a review wherever you listen to podcasts.
Spotify, Apple Podcasts, five stars are hugely helpful for the show and they help me connect with and support more inheritors just like you. Now, let's dive into all things trusts and death.
How Does a Trust Work When Someone Dies: Revocable vs. Irrevocable?
The first thing that you need to know is that how a trust works when someone dies largely depends on whether the trust was revocable or irrevocable at the time that the person died.
Quick primer on revocable versus irrevocable trusts. Revocable trusts are almost exactly what the name implies. It means that the person who created the trust, the grantor, can revoke, amend, or change that trust without any consequences during their lifetime.
An irrevocable trust, by contrast, does not have that same flexibility. Generally, an irrevocable trust is created and then it cannot be revoked, modified, or changed except within certain very specific parameters.
You can think of a revocable trust as a trust that someone still has control over. They can change the terms, they can change what's in there, they can do all kinds of crazy things, basically whatever they want.
What Does It Mean to Have No Incidence of Ownership Over an Irrevocable Trust?
An irrevocable trust is a trust that they no longer have any control over — what's called any incidence of ownership over that trust. There may be certain limited things that they can control, such as the ability to change the trustee, but broad strokes, if I create an irrevocable trust, I can't then go and change everything in the trust or take all the money out of the trust or give myself a whole bunch of money from the trust if it would violate the terms of the trust document.
Now that we know the difference between an irrevocable and a revocable trust, the question is, what happens when someone dies?
Let's talk about the revocable trust first because that is going to be by far and away the much more common situation.
What Happens to a Revocable Trust When the Grantor Dies?
So generally what happens is that when someone has a revocable trust and then they die, that trust becomes irrevocable at their death. And the trust document will provide for what happens after their death.
Who the trust flows to, whether it distributes out, whether it stays in trust — all of that is spelled out in the trust document.
But what's really important to know about revocable trusts is that assets held inside a revocable trust will get a step-up in basis because they are included in the decedent's — the person who died's — estate. So brief pause here to explain the step-up in basis.
What Is a Step-Up in Basis and Why Does It Matter for Trust Beneficiaries?
The step-up in basis is a preferential tax treatment that happens when someone dies. So say I buy a share of Microsoft stock for a dollar 30 years ago and when I die, it's worth $100 — if I die holding that stock in a revocable trust, then my heirs are going to inherit that stock with a basis that is stepped up to the stock's value on the date of death.
The step-up in basis is a very, very important tax benefit for heirs, but it's treated differently in revocable versus irrevocable trusts.
So, the point that we have learned here is that a revocable trust becomes irrevocable at death, but because it was initially revocable, assets held within a revocable trust get a step-up in basis. By contrast, when someone dies and they have an irrevocable trust, that trust is technically its own entity.
It has its own tax ID number and it sits outside of that person who died's actual estate. Assets held inside that irrevocable trust generally do not get a step-up in basis.
Do Assets in an Irrevocable Trust Get a Step-Up in Basis When the Grantor Dies?
So when you are inheriting from a trust, one of the first questions that you need to ask is: was that trust revocable before this person died, or was it irrevocable?
After they die, revocable or irrevocable, they're irrevocable now after death, right? But the tax treatment of the stocks or the assets inside that revocable trust really matters. So that's one of the first questions you want to ask when you're trying to understand how a trust works after someone dies.
The tricky thing here is that this is where any clarity ends. And I hate to say this because I know inheriting money from a trust can be complicated and confusing and difficult, but every trust document is different. And there's no hard and fast rule about what happens with a trust fund after someone dies.
What Is the Difference Between Inheriting Money From a Trust and Inheriting Money Held in Trust?
For example, it could be that someone created a revocable trust as a probate avoidance or just an ease-of-transfer tool. So they created a revocable trust, they die, the trust becomes irrevocable, the assets get a step-up in basis, and then all of the assets in that trust just distribute out.
So you inherited money from someone who had a trust, but you did not inherit money that is held in trust. And this is one of the central pieces that you need to understand if you're trying to figure out how a trust works after someone dies — the difference between inheriting money from a trust and inheriting money that is held in trust.
And just because the person who died — the person that you are inheriting from — had a trust, it does not mean that you are necessarily going to inherit money that is also held within a trust. That is wholly dependent on the terms of the trust document.
So again, you need to understand what the provisions of that trust say. And if that trust has just outright distributions, then it really doesn't matter to you that the person who died had a trust fund, right? It's going to distribute out to you.
What Happens If You Inherit from an Irrevocable Trust That Distributes Outright?
You can put it in your taxable account, whatever you want to do with it, and go along your merry way. At that point, you really don't need to worry about the fact that it was in a trust fund anymore.
A caveat there: if it is an outright distribution but from a trust that was irrevocable before death, you do need to know that because the assets will have the same flow, right? If the trust distributes out after the person who died died, it will distribute out to you.
It might be free of trust, but you did not get a step-up in basis on those assets. And that means that you are going to have a trickier time rebalancing that portfolio and figuring out really how to bring that portfolio in line with your risk tolerance, your goals, and your values.
It's absolutely something that you can still do, and it's much less common to inherit from an irrevocable trust that distributes out, but it does need to be aware of.
What Should You Know If You Are Inheriting Money That Stays Held in Trust?
Let's recap what we know so far. We know the difference between a revocable and an irrevocable trust. We know the tax differences in terms of the money that you inherited from those trusts.
And we know that it's possible that both of those trusts could basically cease to exist upon the death of your loved one and then distribute money out straight to you, at which point all you need to know is whether you got the step-up in basis or not and you can go along your merry way as a multimillionaire inheritor.
Now here's where the tricky part comes in — if you are inheriting money that is continued to be held in trust. And I'm going to make this even more complicated because the person who died did not need to have a trust to create a trust that would govern your inheritance.
What Is a Testamentary Trust and How Does It Affect Inherited Money?
They could create what is called a testamentary trust, which is a trust that is created by their will. And so in this specific case, the person who died didn't have their own trust, but in their will, they created the provisions of a trust that will then hold and guide your future inheritance.
Important to know that in this scenario, you still did get the step-up in basis — just because I know you're wondering about that question.
Whether the person who died had a revocable trust, an irrevocable trust, or no trust at all but created a trust through a testamentary process in their will — now you're a new trust fund beneficiary because you have inherited money that is continued to be held in trust for your benefit. And now you have a whole new set of questions that you need to be asking yourself.
Side note: if you didn't inherit money that's held in trust, I would stop listening now and just be glad that none of the following is going to apply to you because it can be a bit of a headache to be a trust fund beneficiary.
What Are Trust Distribution Terms and Why Do Beneficiaries Need to Understand Them?
As a new trust fund beneficiary, the first thing you're going to want to understand is the terms of your trust. Specifically, what are the terms tied to distributions?
How do you get money? What money are you allowed to have access to? What control are you allowed to have over trust assets?
The second equally important piece you need to understand is who is your trustee. It could be that the person who died wanted to give you full flexibility, so they made you the trustee of your own trust, in which case you have that trust for asset protection purposes, but functionally you still have a lot of latitude and flexibility in how those assets are managed and how you take distributions.
Or it could be that the person who died wanted to exert a lot of control, and so they put a corporate trustee in place with a pretty strict trust document, and now you're going to be reaching out to that corporate trustee for questions or whenever you need money — potentially for the rest of your life.
What Legal Rights Do Trust Fund Beneficiaries Have After Someone Dies?
I mean, when I said at the beginning it's a hard question to answer — how does a trust work after someone dies? Because the short answer is that it can pretty much work any which way.
Especially if you're inheriting money that has continued to be held in trust, it's going to be hugely variable depending on the provisions of the trust fund created.
So you as a new trust beneficiary need to understand distribution provisions, you need to understand who your trustee is, you need to understand what you are legally entitled to, and what legal rights you have as a trust beneficiary. All of those things are outside the scope of this episode of Heir Necessities, but I have a ton of other episodes and content for trust fund beneficiaries specifically. I'm going to drop links to that in the show notes.
So if you're struggling as a new trust fund beneficiary, you can figure out what you need to know and how to get that information.
Does Having a Trust Fund Mean You Will Automatically Become a Trust Fund Beneficiary?
But the big point overall of this episode is that just because you hear the word trust after a loved one dies, it doesn't mean that you are going to become a trust fund beneficiary or a trust fund kid.
The person you inherited from had a trust that's going to distribute out to you and you never have to think about it again. Or it could mean, again, that you have a trust fund that's going to govern your life for the next 60-plus years.
If you're trying to figure out how all of this applies to the trust that you're actually inheriting from, I'd love to chat. You can reach out to me at katherine@sunnybranchwealth.com, send me a DM on Instagram @sunnybranchwealth, and if you're not ready to move forward yet, I will catch you on next week's episode of Heir Necessities.
Let’s take the next step together
Understanding how to protect, invest, grow, and/or give away a multi-million dollar inheritance isn’t easy. Inheritors can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, reach out to Katherine Fox, CFP® and CAP®, financial planner for inheritors, to learn how Sunnybranch can help you evaluate your financial situation and build a plan for your financial future.
