How to Minimize Estate Taxes Using Trusts

With potential changes to the current estate tax threshold on the horizon, many high-net-worth individuals have questions about how to minimize estate taxes. Strategic use of trusts may be one way to help your heirs keep more of the assets you've worked to grow and protect over your lifetime.

Trusts come in many different varieties and structures, so it's helpful to familiarize yourself with options that are specifically designed for individuals with large estates. There are a number of different trusts that are commonly used to pass wealth in a tax-efficient manner by shifting assets out of an individual's taxable estate.

What is the current estate tax exemption?

An estate tax is a levy charged by the federal government and some state governments on property that is part of your taxable estate upon your death. As of 2024, there's an estate tax exemption of $13.61 million for individuals and $27.22 million for married couples. Only assets in excess of those amounts are subject to a federal estate tax, which ranges from 18% to 40%, depending on the size of the estate.

For example, if an individual's estate is valued at $14 million, only the amount over $13.61 million—or $390,000—would be subject to this tax under current federal tax policy. Note that this assumes none of the individual's estate tax exemption was used during their lifetime.

In addition to the federal estate tax, 12 states and the District of Columbia have estate taxes and six states have inheritance taxes. The exemption thresholds and rates for state-level estate and inheritance taxes vary widely.

Will estate tax laws change?

The current estate tax exemption threshold could fall by roughly half in 2026, unless Congress acts to extend the current higher levels that were passed as part of the Tax Cuts and Jobs Act of 2017.

"That's less than two years away," says Michael R. Deming, JD, CFP, CEPA, Senior Vice President, Director, High Net Worth Wealth Planning at First Citizens. "That's why it really makes sense even for people who may not meet the current threshold to consider strategies to protect their estate from taxes."

Who pays the estate tax?

In general, estate tax payments are paid by the estate before assets are transferred to beneficiaries. However, the law allows for a tax-free distribution of assets to spouses through an unlimited marital deduction. So if you or your spouse were to pass away, all estate taxes would typically be deferred until the death of the surviving partner.

Note that the rules for tax-free transfers may be more complicated for a blended family. In this situation, you may wish to speak to a financial professional regarding estate planning strategies for blended families.

Using trusts to reduce estate taxes

Trusts may be used for many purposes, from charitable giving to providing for a loved one with special needs. Some may help reduce estate taxes because the assets placed in the trust are excluded from your estate.

For this to occur, however, the trust must be irrevocable. This means that once you put assets into that trust, you can't remove them. Revocable trusts are a different type of legal structure in which you may move assets in and out more easily.

While all irrevocable trusts have the ability to lower the taxable value of your estate, there are several that are often used to minimize estate taxes and maximize the value of your gift tax exemptions. These include irrevocable life insurance trusts, grantor retained annuity trusts, qualified personal residence trusts and spousal lifetime access trusts.

Irrevocable life insurance trusts

An irrevocable life insurance trust, or ILIT, is established to own and control a new or existing life insurance policy or policies. When the insured individual—typically the grantor of the trust—passes away, the trust collects the death benefit and distributes it according to the terms set in the trust document.

When it comes to irrevocable life insurance trusts, there are a few caveats to consider:

• With an ILIT, the grantor typically must provide funds for the trust to pay all premiums. Those transfers may be subject to gift taxes if the value exceeds the annual gift tax exclusion, which is $18,000 in 2024.
• Some people fund the premium payments upfront by transferring an income-producing asset to the trust. However, it's recommended that you consult with a tax specialist to ensure this approach doesn't trigger other tax liabilities.
• If you choose to transfer ownership of an existing insurance policy, be aware that it may still be considered part of your estate for 3 years from the date of transfer.

Note that different types of ILITs exist. An estate planning attorney can help you evaluate the options and offer guidance.

Grantor retained annuity trusts

When you establish a grantor retained annuity trust, or GRAT, you retain the right to receive annuity payments from the trust for a set period, or for the rest of your life. These payments are calculated based on the IRS-specified Section 7520 interest rate.

When the trust expires, any designated beneficiaries of the trust receive the remaining assets, typically without incurring substantial gift taxes. If you pass away before the trust expires, however, those assets will revert to the estate with the same tax impact as if the GRAT had never existed. This risk may limit the efficiency of the trust for older individuals or those in poor health.

Alternatively, a GRAT with a shorter term may be useful for transferring assets that are expected to appreciate quickly—like IPO shares. That's because any appreciation beyond the IRS-prescribed rate may pass to beneficiaries without counting against the grantor's lifetime exemptions for estate and gift taxes. However, the shortest allowable term for a GRAT is 2 years.

There are some additional opportunities to optimize tax savings with GRATs—such as passing on the annuity payments to a surviving spouse—so it's helpful to discuss implementation with a tax specialist or estate attorney.

Qualified personal residence trusts

By transferring ownership of your home to a qualified personal residence trust, or QPRT, you may remove the current value of the home—as well as any future appreciation in the property—from your estate. Although you'll no longer own the home, you may continue living there for the term of the trust. This creates a retained interest in the property, also reducing the amount you'll pay in gift tax.

At the end of the trust's term, the home will pass to your beneficiaries with no further gift or estate tax obligation—no matter how much the property appreciates in the meantime. However, like a GRAT, if you pass away before the trust expires, the property reverts to your estate, with the same tax impact as if the QPRT had never existed.

Another potential drawback is for your heirs. With a QPRT, they won't receive a step-up in basis to market value at the time of the inheritance, so they may owe more capital gains tax if they decide to sell the property.

These pros and cons of a QPRT are worth discussing with a financial professional or estate planning attorney.

Spousal lifetime access trusts

Married individuals may also want to learn about a spousal lifetime access trust, or SLAT. A SLAT is another type of irrevocable trust that may be used to reduce estate tax liability while providing income for a surviving spouse. There may also be a state income tax benefit to a SLAT.

Beyond minimizing estate taxes, you may have many other reasons to establish a trust. Learning more about common types of trusts and their uses may help you achieve those specific financial goals.

The bottom line

While it's impossible to know whether Congress will take action to keep the estate tax threshold at elevated levels for 2026 and beyond, those wondering how to minimize estate taxes may wish to speak with a professional.

"As you might imagine, a discussion of how to make plans amidst this uncertainty comes up all the time," Deming says. "We can't predict the future, but we can say that potentially many more people are facing a large, looming estate tax issue if they don't take action."

Your plan may or may not include establishing and funding one or more irrevocable trusts, and it's a decision that must be considered within the broader context of your long-term goals.