When you think about a trust, what is the first thing that comes to mind?
Many people associate trusts with those who are very wealthy, but they are actually useful for people of all financial levels.
A financial planner can help you create a trust for the purpose of reducing taxes, saving for a child’s education, preserving wealth from one generation to the next, and ensuring that your assets are properly distributed after your death.
In this guide, we’ll answer the question, “What is a trust?” We’ll also walk through who is involved in the process, the specific benefits they provide, and how you go about setting one up.
What Is A Trust?
A trust is a legal arrangement that establishes a fiduciary relationship between a trustor (or grantor), a trustee, and a beneficiary. The trustor establishes the trust by putting assets into it. The trustee manages the trust’s assets on behalf of the beneficiary according to the terms of the trust document.
A Simple Explanation Of How Trusts Work
Three parties are involved in a trust:
- The trustor is the person who establishes the trust
- The trustee is the person who manages the trust on behalf of the beneficiary according to the terms of the trust document
- The beneficiary is the person who benefits from what’s in the trust
Trusts are most often used for transfer of assets from one person to at least one other person (often more). You can accomplish the same things through other legal arrangements as well, but a trust provides greater protection and tax savings because it involves an individual or institution that is legally responsible for managing and protecting what’s within it.
How Are Trusts Different Than Wills?
You might be wondering what makes a trust different from a will.
First, wills are part of the public record and subject to probate. The probate process involves determining if there is a valid last will and testament. The court executes the will and oversees distribution of the assets. There is always a chance that someone could challenge part or all of the provisions.
A trust, on the other hand, is private and not filed with any court. It doesn’t go through probate because the trustee is responsible for distributing all assets and ensuring the trustor’s wishes are honored.
Why Would I Want A Trust?
You might be thinking, I’m not one of the elite, super wealthy. Do I really need a trust?
Even if you’re not Bill Gates or Warren Buffet, you and your loved ones can still benefit from a trust. Let’s look at some of the primary advantages, then we’ll look at a few disadvantages.
Advantages Of A Trust
One of the primary advantages of establishing a trust is that they allow you to maintain control over your assets in a variety of situations. For example, if you are going through a divorce, you can transfer certain assets into a trust in order to protect them. Or you might want to create a trust for your children but they only get access to it when they reach a certain age.
Trusts are also useful for determining how your assets are used after your death. The trust agreement will specify who will inherit specific assets and when they will gain access to them. If you’re worried about family members fighting over your assets after you die, you can use a trust to ensure they’re distributed according to your wishes.
They can also be used to reduce the impact of estate taxes and court fees on beneficiaries. By avoiding a lengthy probate process, you’re able to keep more of your assets in the family and ensure that your final wishes are carried out quickly and effectively.
Trusts also can provide privacy for you and your family. Unlike the probate process, which can draw public scrutiny, an established trust keeps your financial affairs private.
Disadvantages Of A Trust
There are a few disadvantages to establishing a trust. The first is cost. You will need to work with an estate attorney to establish a trust and move assets into it. Another disadvantage of a trust is that it takes time to work through all the paperwork involved. This is not a huge deal in the grand scheme of things but it needs to be accounted for.
Finally, trusts can become complicated in this day and age when many people have blended families and multiple marriages. Sometimes difficult decisions have to be made regarding who gets access to the assets in a trust. This can lead to hard conversations and the possibility of strained relationships.
Types of Trusts
Testamentary Trust
A testamentary trust is one that is created through a will. It takes effect upon the death of the trustor and does not take effect while he or she is still alive. The Last Will and Testament dictates how the trust should be created.
Living Trust
A living trust is created by someone while they are still alive and the trust takes effect right away. A trustee is designated who is responsible for managing the trust assets according to the desires of the trustor. They ensure that the beneficiaries receive the specified assets.
Revocable Living Trust
A revocable living trust is one in which the trustor can revoke or modify it while they are alive. Unlike some other forms of trust, assets in this type of trust are still available to creditors while the trustor is still alive, although gaining access to them can be challenging.
Irrevocable Trust
An irrevocable trust is one in which the trustor can no longer modify it after he or she has created it. They essentially revoke ownership of any assets in the trust, often for the purpose of protecting the assets from creditors or avoiding estate taxes. Individuals who are vulnerable to lawsuits, such as those who practice medicine, can benefit from the protections of an irrevocable trust.
Joint Trust
A joint trust is created for two individuals, with all the assets in both names. While both are alive, both are able to manage the trust according to their respective interests. Upon the death of one partner, the other becomes the managing Trustee.
Special Types Of Trusts
Marital or “A” Trusts
A marital trust is designed to provide financial support to a surviving spouse after the other spouse passes away. When a spouse dies, assets are placed into the trust and any income those assets generate goes to the surviving spouse.
Credit Shelter Trusts
As the name suggests, credit shelter trusts are meant for married couples who want to take advantage of their estate tax exemptions through the IRS. Any assets held in the trust up to a specified threshold can be passed on to beneficiaries free of estate taxes once both spouses die. While the second spouse is still alive, they can receive income generated by assets in the trust.
Charitable Remainder Trusts
Charitable remainder trusts allow a trustor to provide income to beneficiaries for a set time period. After that time period, whatever remains in the trust is given to specified charities.
How Do You Create A Trust?
The process of creating a trust can vary somewhat depending on what assets are being placed in the trust, the stipulations, etc. That said, the overall process involves the following steps.
Determine The Purpose Of The Trust
The first step is determining why it’s needed. The purpose of the trust will determine how it should be created and what assets can be put into it. Are you wanting to receive certain tax benefits? Protect your assets from specific individuals? The purpose of the trust will shape the steps involved.
Determine What Assets Will Be In The Trust
The next step is to decide which assets you want to place in the trust. Stocks? Cash? Depending on the trust, you can also include assets such as vehicles and property.
Specify The Beneficiaries
The trust should include the name and contact information for each beneficiary. It should also describe what each person can do with specific assets provided under the terms of the trust.
Meet With Potential Trustee
The next step is to find the potential trustee. While you can choose a friend or family member, they may not act in your best interest. After all, it’s hard to expect a family member to act objectively when they may have a potential stake in things.
An unbiased third party (like a bank) is a good choice in terms of trustee because they are not in any way related to or interested in the person who set up the trust. This allows them to objectively execute the stipulations of the trust. Make sure to bring up any questions you might have regarding things like tax implications, the trust administration process, or anything else.
Meet With Your Attorney To Draft The Trust Documents
Once you have decided on the purpose of the trust, its beneficiaries, and a trustee, it’s time to meet with your attorney. You’ll need to talk through your goals, all assets involved, specific stipulations, beneficiaries, the trustee, and any other relevant items. Your attorney will draft the trust documents based on these things.
You also may want to consider creating a power of attorney for both your healthcare and any assets not in the trust. You can use this guide to help fill out IRS form 2848 which established Power of Attorney. This will ensure that if you are unable to make decisions for yourself, decisions can still be made regarding these items.
Is A Trust Right For You?
Should you consider creating a trust? Ultimately, that depends on what you want to accomplish. If you’re not sure about the best path forward, consider meeting with your financial advisor or estate planner. They can give you advice regarding the best way to both achieve your goals and leave a legacy.
