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What Is A Trust? | Definition & Comprehensive Guide Inside

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When most people think of trust accounts, they often think that those are accounts that can only be established by super wealthy families. That could not be farther from the truth. In fact, trusts are powerful estate planning tools that can be used by almost anyone who has assets. Trusts can simplify the transfer of property to beneficiaries, avoid the probate process, save on estate taxes, and provide many more benefits. Setting up a trust is not difficult, and it 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 trust definition might sound complicated, but it is really not that complex. At its most basic form, a trust owns property that is managed by the trustee and the beneficiaries receive the benefit from the property. This could be in the form of trust income or eventually receiving distribution of the trust assets.

A grantor may choose to name himself as both trustee and beneficiary of the trust during his lifetime. This is especially true in the case of grantor trusts and living revocable trusts. This allows him to enjoy the benefit of the trust assets during his life, and then a successor trustee can be named to manage the trust or distribute assets upon his death.

Now that we have answered the question, “What is a trust,” we will tackle the basics of its operation. So, how does a trust work? A trust has many purposes and benefits, and trusts also come in many different varieties. One of the main advantages of a trust is the avoidance of probate. A trust can be used to distribute assets upon the death of the grantor. Unlike with 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 death of the grantor, and the trustee simply distributes the assets according to the terms of the trust agreement. In addition, the details of the trust will never become public record unlike the terms of a will that has been entered to probate.

Trusts can also be used to 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 reduces the amount of taxes that will be due. Trusts are extremely valuable tools for use in an estate plan, and they can save your loved ones lots of headache and money after your death.


How To Setup A Trust Fund

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Setting up a trust account might seem complicated, but it is quite simple. You will likely need an estate planning attorney to help you draft the trust document, but things are fairly straightforward after that. You should discuss with your attorney who you would like to act as trustee and who your named beneficiaries are. 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. Once the legal document has been drafted and signed, then the trust must be funded.

Funding the trust simply 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, then 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 number with the IRS while others simply use the Social Security number of the settlor.


Different Categories Of Trusts

There are many different categories of trusts depending on how and when they are established. Each category of trust is unique and may provide benefits that other types of financial trusts do not provide. Here are some of the most common categories of trusts.


Revocable Vs Irrevocable 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 the creation of the trust. 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. A revocable trust is treated as a disregarded entity by the IRS, 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.


Living Trust Vs Testamentary Trust

A living trust is created during the lifetime of the trustor, while a testamentary trust is created 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. If you think about the revocable trust definition, it would be impossible for the grantor to revoke a trust after his death.

Funded Vs Unfunded Trusts

Once a trust is created, it needs to be funded with assets. A trust without assets is of no use to the grantor or the beneficiaries. To fund a trust, the settlor simply needs to transfer ownership of assets or property over to the trust. Specifically what assets are transferred to the trust depends on the personal finances of the settlor and his or her tax planning strategy.


Common Types Of Trusts

Now that you have learned about the basic categories of trusts, there are many different types of trusts that fall into one or more of these categories. Here are some of the most common types of trusts that you may encounter.


Insurance Trust

This kind of 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 really 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 big benefit of a special needs trust is the fact 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 receives 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 home will no longer be included as part of the grantor’s estate, so the estate taxes that may be due can be greatly reduced.

Credit Shelter Trust

This kind of trust is often utilized by wealthy couples. The trust is established upon the death of either spouse, and specific assets are placed into the trust. The surviving spouse has certain rights in the trust and even has the ability to access the assets in the trust and 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, and the purpose is 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, the 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.

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 and testament, but few understand the power of trusts and how they might be able to benefit from them. Trusts allow property and assets to be transferred after the death of the grantor quickly and easily. There is no need to go through the legal process known as probate, and the terms of the trust remain completely private. In addition, there are rarely challenges to distribution of the trust property. While heirs may challenge a will, there is little legal standing for the challenge of a trust document.

Lastly, trusts can provide huge tax benefits. With the exception of revocable living trusts which provide few benefits, many trusts can save you thousands of dollars on your tax bill. The assets that you place into a trust can also be protected from creditors or potential lawsuits. This is extremely beneficial when it comes to professionals like doctors who might be subject to large lawsuits.


The Bottom Line

Trusts are wonderful tools that can be established at nearly any financial institution. Simply seek some 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 create a trust after your death. Assets placed into the trust can be easily transferred to your beneficiaries, and your trustee has a fiduciary duty to properly manage and maintain the assets. If you think that trust investing might be right for you, then you should contact your attorney today to discuss the trust laws in your state.

Frequently Asked Questions

What are the benefits of a trust?

The main 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 biggest benefits is the avoidance of probate. Trusts allow you to pass assets to your heirs after your death without going through the probate court. The details of the transfer also remain completely private. In addition, trusts can save you tons of cash in estate taxes. Similarly, they can shield your assets from creditors in the event 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 qualify for due to the value of your assets.


What is the difference between a trust and a will?

A trust becomes valid immediately upon execution while a will does not become valid until the testator is deceased. 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.


How much does a trust cost?

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. In addition, trusts will incur ongoing management fees. For large trusts using a third-party trustee, those management costs might be in the thousands of dollars each year. For smaller trusts where the grantor also serves as trustee, those costs will be nominal.


Why would a person want to set up a trust?

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 that have already been discussed in this article. A trust allows for the avoidance of probate, complete privacy of asset distribution, protection from creditors, large tax benefits, and reduces the odds of a challenge to the will. These are the main reasons that someone would want to use a trust as part of their estate planning.


​Is a trust better than a will?

It depends on your personal situation and your goals. In some cases, you may benefit more from a trust than a will. However, in other cases, you might need both documents. If you have minor children, you definitely need to have a will so that you can name a guardian for those children. If you have assets and property that need to be transferred to beneficiaries, that can be accomplished with a trust. One document is not better than the other, but there are pros and cons to each. An estate planning attorney can help you decide which is right for you, and the answer might be that you need both!