How Trusts WorkChances are that you’ve heard the term “trust” before. Often, trusts are thought to be an inheritance passed from wealthy individuals to their families. While they might be commonly associated with the rich, trusts can be created by anyone.
Our content follows strict guidelines for editorial accuracy and integrity. Learn about our and how we make money.
Chances are that you’ve heard the term “trust fund” before. Often, trusts are thought to be an inheritance passed from wealthy individuals to their families. While they might be commonly associated with the rich, trusts can be created by anyone can be a financial tool to pass along your wealth and assets to future generations.
A trust provides a way for you to control how you leave your estate to your family. Simply put, it’s a legal document that lists beneficiaries and gives them ownership of your assets, including life insurance policies and investments. If you’re considering your estate planning options, keep reading to learn more about what a trust is, how it works, and what types of trusts there are.
What is a Trust?
A trust, which is a type of fiduciary relationship, is a legal document in which one party (the trustor) gives a second party (the trustee) the right to hold assets or property for a third party (the beneficiary).
While the trustee holds the title to trust property, the assets placed into the trust actually belong to the trust for the benefit of the beneficiary.
Basically, a trust helps you decide who will be part of your assets. It provides you with certain guidelines and can help to avoid the trouble and costs associated with the complex process of probating a will or having to go through probate court.
When you, the trustor, create your trust, the trustee is responsible for making sure that your wishes are carried out and that your assets are given to the beneficiaries you leave them for.
Terms you should know:
Trust – An arrangement whereby a person (a trustee) holds property as its nominal owner for the good of one or more beneficiaries
Grantor – The group or entity that creates the trust
Trustee – The organization that is governing the trust
Beneficiary – A person or group who will receive the property, assets, or included elemenets of the trust
Probate Court – The segment of the judicial system that handles the contesting of wills, and estates
Trust Vs Will
Trusts and wills are beneficial tools for estate planning. While they can work together, the two serve different purposes.
A trust is a document that can take effect as soon as it’s made. The designated trustee holds the legal title to protect assets for the beneficiaries and makes sure that the trust is carried out as instructed by you. Only assets and property that have been put in the name of the trust are included. Your assets can be distributed before death or after death.
A will only goes into effect after your death. It only covers property held in your name alone, not assets held jointly or that have been placed into a trust. A legal representative is appointed to carry out the will’s instructions, too
Where a trust does not need to be overseen by a court, a will typically needs to pass through probate. A court may need to oversee that the property and assets named in the document are distributed as directed. The process can be costly and time-consuming.
Types of Trusts
There are several types of trusts that can be created. Each type is created to accomplish different goals.
Also called a living trust, a revocable trust is one that is created during the trustor’s lifetime and can be changed, altered, or even revoked at any time. You can transfer the title of a property to the trust and have the ability to remove it if you choose. At the time of your death, assets owned by the trust aren’t subject to probate.
A benefit to a living trust is that you are able to alter it at any time, so long as you are physically and mentally able to do so. If you were diagnosed with a debilitating illness, you can get the trust in order before you are mentally unable to do so, and afterward, the successor trustee will take over managing your trust.
An irrevocable trust, on the other hand, is one that can’t be changed or modified once it’s created. Once property or assets are transferred there, they can’t be removed. An advantage of irrevocable trust is that you can reduce your estate taxes since the assets that are named in the trust are owned by the trust, and are no longer technically yours.
A marital, or “A,” trust is one that benefits the surviving spouse. Assets are placed into a trust upon the death of one spouse and the surviving spouse receives all income generated by those assets. Upon the death of the second spouse, the principal typically goes to their children or named beneficiaries.
With a credit shelter trust, both spouses can take full advantage of estate tax exemptions. Assets above a specific amount are generally subject to a federal estate tax following the death of the second spouse. By placing the exclusion amount in a trust, the surviving spouse can receive income from the assets. Following their death, the beneficiaries then receive the assets estate tax-free.
It should be noted that while the tax exclusions are certainly a benefit to some, most estates are not subject to estate taxes unless the estate is worth over $12 million.
A life insurance policy is an important tool for helping to protect your children financially following your death. You can name your children as beneficiaries of the policy. If you pass away while they are still underage, however, no benefits can be paid until the court appoints a guardian. The process can be long and expensive.
Instead of naming your children as beneficiaries of your life insurance policy, you can name the trust and trustee. The trustee can then spend the money from your policy according to the rules of the trust. For instance, you can designate that the funds be used to pay for your children’s necessities and college educations, and the rest be distributed at a specified time.
Other Types of Trusts
Charitable Remainder Trust – Trusts which benefit a particular charity or the public in general. Typically are established as part of an estate plan to lower or avoid estate and gift taxes.
Spendthrift trust – A Trust established that does not allow for the beneficiary to sell away interests in the trust.
Generation-skipping trust – This type of trust transfers assets to your grandchildren.
Special Needs Trust – A trust that can help provide financial security to someone who is special needs dependent to get medical care or day-to-day needs. It does so without compromising their ability to receive government benefits for their disability.
How to Create a Trust
While you can create a trust yourself, you may also choose to work with a trusted attorney or financial advisor. Having expert assistance can help to ensure that everything is completed properly.
One of your most important decisions when creating a trust is designating a trustee (and secondary or co-trustee). The trustee can be an individual, a bank, or a trust company. You may even decide to act as the trustee yourself.
As you create the trust agreement, decide what type of trust you want and who will be the beneficiary (or beneficiaries). Outline the rules you want in place, including how the assets contained in the trust will be distributed.
Once your trust is created, all documents will need to be signed in front of a notary public. You should retain a copy and a copy should go to the trustee. Finally, the named property and/or assets will need to be transferred to the trust.
Typically, it takes just a few days to a few weeks to create a trust. The exact rules of how to do so do vary from state to state, so you should look into the specifications before you get started.
What Are the Advantages of Creating a Trust?
There are several reasons to consider creating a trust. You can:
Allocate where your assets go and when beneficiaries can gain access to them.
Pass assets quickly, without the delays and costs associated with probate.
Maintain the privacy of your family. Help your beneficiaries avoid estate taxes.
Protect your assets from any creditors your beneficiaries may have
Trusts aren’t reserved only for the wealthy. If you are beginning to think about estate planning, a trust can help you to safely pass your property and assets to your beneficiaries. Consider consulting with a financial advisor or estate planning lawyer to discuss your options.