A trust can be an excellent way to protect an inheritance, control how assets are distributed, or provide professional management for the next generation.
But once assets remain in certain trusts after death, another consideration enters the picture: the trust may become its own taxpayer, and an unusually expensive one.
For 2026, an estate or trust reaches the highest 37% federal income-tax bracket once taxable income exceeds just $16,000. A single individual does not reach that same 37% bracket until taxable income exceeds $640,600.
That difference can create some surprisingly large tax consequences.
Consider a parent who leaves a $1.5 million investment portfolio in trust for an adult daughter. The parent does not want the entire inheritance distributed immediately, so the trustee is given discretion over when and how much to distribute.
Suppose the trust generates $100,000 of ordinary taxable income during the year and retains all of it.
Using the 2026 federal trust tax brackets, the regular income tax would be approximately $34,900.
Now suppose the daughter has $100,000 of taxable income of her own. If, in a simplified example, that same $100,000 of ordinary income were instead taxable to her, her incremental federal income tax would be approximately $23,900.
That is roughly an $11,000 difference in one year.
And potentially even more is at stake. Trusts can also become subject to the 3.8% Net Investment Income Tax at very low income levels. For individuals, that tax generally does not begin until modified adjusted gross income exceeds $200,000 for single taxpayers or $250,000 for married couples filing jointly. For estates and trusts, the threshold is tied to the point at which the highest trust tax bracket begins: $16,000 in 2026.
Does that mean the trustee should simply distribute all income every year?
Not necessarily.
Trust taxation involves a concept called distributable net income, or DNI. Generally, when qualifying trust income is distributed to a beneficiary, the trust may receive a corresponding distribution deduction and the beneficiary reports that income on a Schedule K-1. When income is retained, the trust may bear the tax instead.
That makes a trustee's distribution policy more than an estate-planning decision. It can also be a tax-planning decision.
Perhaps the beneficiary is in a relatively low tax bracket this year, making a distribution attractive. Next year, she may sell a business, receive a large bonus, or otherwise have substantially higher income. Retaining more income inside the trust could then become comparatively more attractive.
At the same time, taxes cannot be viewed in isolation. The trust may have been created specifically to protect assets from creditors, provide disciplined management, or prevent a beneficiary from receiving too much money too quickly. Distributing assets merely to reduce this year's tax bill could undermine the reason the trust exists in the first place.
That is why good trust planning does not end when the documents are signed.
A trust may be carefully drafted to protect assets, provide flexibility, and support the next generation. But those benefits can be undermined if the assets inside the trust are managed without considering how the trust itself is taxed.
Investment decisions matter. Distribution decisions matter. The character of the income matters. And the beneficiary's own tax situation matters.
A portfolio that generates substantial interest, realizes unnecessary capital gains, or retains income inside a highly compressed trust tax bracket can create a very different after-tax result than one managed with those issues in mind.
That is also why professional investment management can be especially valuable inside a trust. The objective is not simply to earn a competitive return. It is to manage the portfolio in the context of the trust's distribution rules, tax treatment, beneficiaries, and broader estate-planning purpose.
At Hanover Advisors, we help families and trustees coordinate those decisions. That can mean evaluating the tax character of a trust portfolio, considering when distributions may shift income to a beneficiary in a lower tax bracket, harvesting losses when appropriate, and making sure the investment strategy supports the reason the trust was created in the first place.
A trust can be an excellent vehicle for preserving and protecting family wealth. But the structure alone does not determine the outcome.
The important question is not simply whether assets should remain in trust. It is whether the trust, the beneficiary, and the investment strategy are working together efficiently.
For families using trusts across generations, that coordination can be worth thousands of dollars a year, while still preserving the control and protection the trust was designed to provide.