When most people think of trust accounts, they often feel they can only be established by super-wealthy families. That could not be farther from the truth.
Trusts are powerful estate planning tools that can be used by almost anyone who has assets. Trusts can simplify property transfer to beneficiaries, avoid the probate process, save on estate taxes, and provide many more benefits. Setting up a trust is not difficult and could be very advantageous for you.
Keep reading to learn about the basics of a trust, the different types of trusts, and whether you might be able to benefit from one.
What Is A Trust And How Does It Work?
A trust is simply a legal entity that holds property and grants a fiduciary duty to the trustee to manage the assets for the benefit of the beneficiaries.
The definition of trust might sound complicated, but it is not that complex. At its most basic form, a trust owns property managed by the trustee and benefits the beneficiaries.
This could be in the form of trust income or eventually receiving distribution of the trust assets.
A grantor may name himself/herself as trustee and beneficiary of the trust during his lifetime. This is especially true in grantor trusts and living revocable trusts.
This allows the grantor to enjoy the benefits of the trust assets during their life, and then a successor trustee can be named to manage the trust or distribute assets upon their death.
Now that we have answered the question, “What is a trust,” we will tackle the basics of its operation.
How does a trust work?
A trust has many purposes and benefits and comes in many varieties. One of the main advantages of a trust is the avoidance of probate.
- A trust can be used to distribute assets upon the grantor’s death. Unlike a traditional will, the estate does not need to go through the probate court for the beneficiaries to receive their distribution.
- The trust remains valid even after the grantor’s death, and the trustee distributes the assets according to the terms of the trust agreement.
- In addition, unlike the terms of a will that has been entered to probate, the details of the trust will never become public record.
- Trusts can also save money on estate taxes or protect assets from creditors. By placing assets into an irrevocable trust, those assets are no longer considered part of the grantor’s estate. This effectively reduces the value of the taxable estate and the amount of taxes that will be due.
Trusts are extremely valuable tools for an estate plan, and they can save your loved ones a lot of headaches and money after your death.
How To Establish A Trust
Setting up a trust account might seem complicated, but it’s pretty simple. You will likely need an estate planning attorney to help you draft the trust document, but things are relatively straightforward after that.
- You should discuss with your attorney who you would like to act as trustee and your named beneficiaries.
- The trust document will detail the terms of the trust, such as how the assets are to be managed and how distributions are to be made.
- The trust must be funded once the legal document has been drafted and signed.
Funding the trust means transferring ownership of assets to the trust. You can transfer ownership of nearly anything over to your trust.
This could be cash, bank accounts, retirement accounts, proceeds from a life insurance policy, automobiles, and real estate.
Once these assets are placed into the trust, the trustee is responsible for managing those assets.
Depending on the type of trust established, you may or may not completely lose control over those assets. Similarly, you may be responsible for paying income taxes on the income of the trust assets, or the income taxes may be paid directly from the trust assets themselves.
Some trusts have their own tax identification numbers with the IRS, while others simply use the settlor’s Social Security number.
KEY TAKEAWAYS
- A trust is not something just for the ultra-wealthy. Even if you only have limited assets, you should consider establishing a trust.
- A trust can help your heirs avoid probate, save on estate taxes, shelter you from creditors or lawsuits, and provide privacy for your assets.
- Creating a trust can be relatively inexpensive, depending on the complexity it can range from several hundred dollars to thousands of dollars.
Different Categories Of Trusts
Depending on how and when they are established, there are many different categories of trusts. Each category of trust is unique and may provide benefits that other types of financial trusts do not. Here are some of the most common categories of trusts.
The main difference between these types of trusts should be evident from the names. A revocable trust may be revoked or amended by the grantor at any time after its creation. A revocable living trust is also a type of grantor trust.
An irrevocable trust, however, cannot be changed or amended. The only exception is when all the beneficiaries agree to the change.
Revocable trusts allow the grantor to retain control over the trust assets, although they do not provide asset protection or tax benefits due to that reason. The IRS treats A revocable trust as a disregarded entity, and the grantor must claim trust income on his personal tax return.
On the other hand, an irrevocable trust can provide substantial tax benefits because the assets placed into the trust are no longer considered part of the estate of the grantor. The trust is assigned its own tax identification number and must file its own tax return.
When choosing between irrevocable and revocable trusts, grantors must typically decide between flexibility and tax advantages.
A living trust is created during the trustor’s lifetime, while a testamentary trust is made after the grantor’s death through provisions in the will.
A living trust may be either revocable or irrevocable; however, all testamentary trusts are irrevocable.
Considering the definition of a revocable trust, it would be impossible for the grantor to revoke a trust after his death.
Once a trust is created, it needs to be funded with assets. A trust without assets is useless to the grantor or the beneficiaries.
To fund a trust, the settlor simply needs to transfer ownership of assets or property to the trust. Specifically, what assets are transferred to the trust depends on the settlor’s personal finances and tax planning strategy.
Must read articles related to Trusts
- What is a grantor trust?
- Deep dive into understanding revocable trusts.
- Is an irrevocable trust the best option for me?
- How does a charitable remainder trust work?
- Learn about the benefits of living trusts.
Benefits Of Trusts For Estate Planning
Trusts provide many great benefits when it comes to estate planning. Most people understand that they need a last will & testament, but few understand the power of trusts and how they might benefit from them.
Trusts allow property and assets to be transferred quickly and easily after the grantor’s death. There is no need to go through the legal process known as probate, and the terms of the trust remain entirely private.
In addition, there are rarely challenges to the distribution of the trust property. While heirs may challenge a will, there is little legal standing for challenging a trust document.
Lastly, trusts can provide substantial tax benefits. Besides revocable living trusts, which provide few benefits, many trusts can save you thousands of dollars on your tax bill.
The assets you place into a trust can also be protected from creditors or potential lawsuits. This benefits professionals like doctors who might be subject to significant lawsuits.
TIP
Wills and Trusts can be combined to create a more robust estate plan. You should consult an estate attorney to determine the best options for your situation.
Common Types Of Trusts
Now that you have learned about the basic categories of trusts, we will discuss the different types of trusts that fall into one or more of these categories. Here are some of the most common types of trust you may encounter.
Insurance Trust
This trust is established to receive the proceeds from a life insurance policy. Since the proceeds will not go into the decedent’s estate, this can lower the amount of estate tax that may become due. Once the trust has been funded with the insurance proceeds, the trustee will manage and distribute funds according to the terms of the trust agreement.
Special Needs Trust
A special needs trust is established to help care for a family member with special needs. One significant benefit of a special needs trust is that the money received from the trust does not count toward the beneficiary’s assets when determining qualification for SSI, Medicaid, or other government programs. Therefore, he or she can receive regular payments from the trust and still qualify for government assistance.
Charitable Trust
This could be either a charitable remainder trust or a charitable lead trust. With the remainder trust, the beneficiaries will receive their distributions first, with the remainder of the trust assets going to charity. A lead trust is just the opposite. The charity gets a distribution first, and then the beneficiaries will receive what is left of the trust assets.
Qualified Personal Residence Trust
A QPRT allows a grantor to transfer ownership of a primary residence or even a second home into the trust for tax-exemption purposes. The house will no longer be included as part of the grantor’s estate, so the estate taxes that may be due can be significantly reduced.
Credit Shelter Trust
Wealthy couples often utilize the credit shelter trust. The trust is established upon the death of either spouse when specific assets are placed into it. The surviving spouse has certain rights in the trust and can access the assets, not just the income, if needed.
Upon the death of the second spouse, the assets are distributed to the heirs.
This type of trust provides large tax benefits because it can lead to a large estate tax exemption.
Spendthrift Trust
Many trusts have a spendthrift clause to prevent the trust beneficiaries from squandering their inheritance. Essentially, this type of trust prevents a beneficiary from assigning his or her interest in future trust payments to a third party. Therefore, future trust payments cannot be used to obtain credit or loans.
This type of clause in a trust allows the grantor to rest easy, knowing that the heirs cannot waste their inheritance by getting into debt using the trust’s assets.
The Bottom Line
Trusts are beautiful tools that can be established at nearly any financial institution. Seek legal advice from your estate planning attorney to determine which type of trust would be most beneficial for your situation.
You can create a trust during your lifetime or use your will to make one after your death.
Assets placed in the trust can be easily transferred to your beneficiaries, and your trustee has a fiduciary duty to manage and maintain them properly.
If you think establishing a trust might be right for you, contact your attorney today to discuss the trust laws in your state.
Frequently Asked Questions
A trust becomes valid immediately upon execution, while a will is not valid until the testator dies.
Trusts and wills can both be used to transfer property and assets to heirs.
However, a will does not provide many of the benefits of a trust, like privacy, avoidance of probate, tax benefits, and asset protection.
If you have minor children, you might consider having both documents. A will is an absolute must to name a guardian for your minor children in the event of your death. A trust cannot be used for that purpose.
It depends on your situation and your goals. Sometimes, a trust may be more beneficial than a will.
However, in other cases, you might need both documents. If you have minor children, you definitely need a will to name a guardian for them.
A trust can be used to transfer assets and property to beneficiaries. No one document is better than the other, but each has pros and cons.
In most instances, you will benefit from having both a will and a trust.
An estate planning attorney can help you decide what is suitable for you.
You might be wondering, “What is a family trust and why would someone establish one?”
A person would want to establish a trust to realize the many benefits discussed in this article. A trust allows for the avoidance of probate, complete privacy of asset distribution, protection from creditors, significant tax benefits, and reduced odds of a challenge to the will.
These are the main reasons someone would want to use a trust in their estate planning.
The primary purpose of a trust is for the trustor and beneficiaries to reap the benefits of the trust. So, what are those benefits?
One of the most significant benefits is the avoidance of probate. Trusts allow you to pass assets to your heirs after death without going through the probate court.
The details of the transfer also remain entirely private.
In addition, trusts can save you tons of cash in estate taxes. Similarly, they can shield your assets from creditors in case of a lawsuit or judgment.
Finally, if properly established and funded, trusts can reduce the value of your estate for Medicaid planning purposes. This might allow you to qualify for government programs that you otherwise would not be eligible for due to the value of your assets.
It depends on the complexity of the trust agreement and the value of the assets in the trust.
- A basic trust document can be drafted by an attorney for as little as a few hundred dollars.
- However, more complex documents might cost several thousand dollars.
Trusts will also incur ongoing management fees.
- For large trusts that use a third-party trustee, those management costs might be thousands of dollars each year.
- Those costs will be nominal for smaller trusts where the grantor also serves as trustee.
You can find a Social Security Administration office near you by using our SSA office locator and searching for your closest location.
