Trusts
What is a Trust?
A trust is a financial arrangement that allows you to protect assets for beneficiaries. The person who creates the trust is the trustor. They place control of the trust in the hands of a third party, known as the trustee. The trustee holds and manages the assets for one or more beneficiaries.[1]
People set up trusts for a variety of reasons: to manage and distribute money while the trustor is living, to distribute assets after the trustor’s death, to avoid or minimize estate taxes and probate, to protect assets from creditors, or to protect and distribute money to a minor or disabled beneficiary.
Irrevocable vs. Revocable Trusts
There are many different types of trusts, but they can generally be split into two main categories:[2]
Irrevocable Trusts
These are trusts set up with certain rules and guidelines that cannot be changed. You cannot revoke or cancel the trust. It moves your assets out of your estate and into the trust.
Once you set up this trust, you have no control over it. By putting funds in this kind of trust, you reduce your taxable estate. Your inheritors pay less in estate taxes upon your death. This kind of trust, to be accessed upon your death, is also known as a testamentary trust.
Revocable Trusts
These are also known as living trusts. Once a revocable trust is set up, you still have some control if you are a co-trustee. You can even revoke the trust. It takes your assets out of probate so that beneficiaries get assets passed on to them sooner and more easily after your death.
Among the terms for the trust, you assign a trustee to take over upon your death. A revocable trust does not reduce your taxable estate.
Other Types of Trusts
Living trusts and irrevocable, or testamentary, trusts are two main categories of these financial arrangements. There are also several subtypes used for specific reasons:[2][3]
- Asset protection trust
You may set up this type of trust to protect your assets from creditors in the future. It may be set up to be irrevocable for a period of time when the assets transfer back to you. - Credit shelter, or bypass trust
The purpose of this trust is to maximize estate tax exemptions. The trust contains an amount just up to that exemption amount. The rest of the estate can go to a surviving spouse tax-free. - Irrevocable life insurance trust
This trust removes your life insurance from the estate to reduce the taxable amount. The policy is out of your control. You can not borrow against it or reassign beneficiaries. - Generation-skipping trust
Also known as a dynasty trust, this transfers money tax-free to grandchildren or great-grandchildren. - Charitable trust
A charitable trust removes money from the estate to reduce its taxable amount. The beneficiary of the trust is a charity. You can also fund a charitable remainder trust that provides you with income while living and disburses the remainder to a charity at your death. - Special needs trust
You can set up this type of trust to provide for a disabled beneficiary without interfering with their government benefits, such as Supplemental Security Income or Medicaid. - Spendthrift trust
A trust to benefit individuals who are not financially responsible is a spendthrift trust. It allows the trustee to determine how and when to distribute the funds to protect the inheritance. Some people use this to protect against an ex-spouse if a beneficiary gets divorced.
Why Set up Trusts?
There are many reasons to create trusts of all types. Specific kinds of trusts serve particular purposes, but there are general and common reasons that people set up trusts for their assets:
- Protect assets. Assets in a trust can only be moved or distributed as outlined by the trust agreement and at the discretion of the trustee, a third party. This protects assets from family members’ potentially bad decisions, whether their intentions are good or not.
- Avoid probate. Probate is the legal process that recognizes wills and distributes assets from an estate. Some assets do not have to go through probate, including those held in trusts. Many people want to avoid or minimize probate because it takes time and can be expensive.
- Maintain privacy. Trusts are private, but probate is not. You can keep your and your family’s assets out of the public eye by using trusts.
- Reducing taxes. Estate taxes can be high for inheritors. Moving assets to a trust before your death reduces your estate’s taxable amount, lowering those taxes. The savings must be balanced against the costs of creating a trust.
- Control inheritance. You can use a will to assign assets to beneficiaries after your death, but a trust gives you more control. You can dictate how and when the assets are disbursed. With a will, they are simply distributed in full on your death.
- Provide during incapacity. If you become incapacitated during your lifetime, a living trust ensures you have funds and a trustee in place to manage them.
Are Trusts Only for the Wealthy?
Many people assume trusts are for the wealthy alone. This isn’t true, and many middle-class people use and benefit from trusts. It costs money to set up a trust, but the cost can be worth the benefits. This is a calculation you need to make to determine if a trust is right for you. A trusts lawyer or financial planner can help.
Setting up a trust, for whatever reason, is not something to do on your own. You need a lawyer to take you through the process. While it is possible to do it alone, there are many pitfalls and potential mistakes that could put your assets at risk. Rely on a professional to provide advice and set up the trust for you.