Whether you’re seeking to manage your own assets, control how your assets are
distributed after your death, or plan for incapacity, trusts can help you accomplish your
estate planning goals. Their power is in their versatility — many types of trusts exist, each
designed for a specific purpose. Although trust law is complex and establishing a trust
requires the services of an experienced attorney, mastering the basics isn’t hard.
What is a trust?
A trust is a legal entity that holds assets for the benefit of another. Basically, it’s like a
container that holds money or property for somebody else. You can put practically any kind
of asset into a trust, including cash, stocks, bonds, insurance policies, real estate, and
artwork. The assets you choose to put in a trust depend largely on your goals. For example,
if you want the trust to generate income, you may want to put income-producing securities,
such as bonds, in your trust. Or, if you want your trust to create a pool of cash that may be
accessible to pay any estate taxes due at your death or to provide for your family, you
might want to fund your trust with a life insurance policy.
When you create and fund a trust, you are known as the grantor (or sometimes, the settlor
or trustor). The grantor names people, known as beneficiaries, who will benefit from the
trust. Beneficiaries are usually your family and loved ones but can be anyone, even a
charity. Beneficiaries may receive income from the trust or may have access to the
principal of the trust either during your lifetime or after you die. The trustee is responsible
for administering the trust, managing the assets, and distributing income and/or principal
according to the terms of the trust. Depending on the purpose of the trust, you can name
yourself, another person, or an institution, such as a bank, to be the trustee. You can even
name more than one trustee if you like.
Why create a trust?
Since trusts can be used for many purposes, they are popular estate planning tools. Trusts
are often used to:
- Minimize estate taxes
- Shield assets from potential creditors
- Avoid the expense and delay of probating your will
- Preserve assets for your children until they are grown (in case you should die while
they are still minors) - Create a pool of investments that can be managed by professional money managers
- Set up a fund for your own support in the event of incapacity
- Shift part of your income tax burden to beneficiaries in lower tax brackets
- Provide benefits for charity
The type of trust used, and the mechanics of its creation, will differ depending on what you
are trying to accomplish. In fact, you may need more than one type of trust to accomplish
all of your goals. And since some of the following disadvantages may affect you, discuss the pros and cons of setting up any trust with your attorney and financial professional before you proceed:
- A trust can be expensive to set up and maintain — trustee fees, professional fees,
and filing fees must be paid - Depending on the type of trust you choose, you may give up some control over the
assets in the trust - Maintaining the trust and complying with recording and notice requirements can
take up considerable time - Income generated by trust assets and not distributed to trust beneficiaries may be
taxed at a higher income tax rate than your individual rate
The duties of the trustee
The trustee of the trust is a fiduciary, someone who owes a special duty of loyalty to the
beneficiaries. The trustee must act in the best interests of the beneficiaries at all times. For
example, the trustee must preserve, protect, and invest the trust assets for the benefit of
the beneficiaries. The trustee must also keep complete and accurate records, exercise
reasonable care and skill when managing the trust, prudently invest the trust assets, and
avoid mixing trust assets with any other assets, especially his or her own. A trustee lacking
specialized knowledge can hire professionals such as attorneys, accountants, brokers, and
bankers if it is wise to do so. However, the trustee can’t merely delegate responsibilities to
someone else.
Although many of the trustee’s duties are established by state law, others are defined by
the trust document. If you are the trust grantor, you can help determine some of these
duties when you set up the trust.
Living (revocable) trust
A living trust is a special type of trust. It’s a legal entity that you create while you’re alive to
own property such as your house, a boat, or investments. Property that passes through a
living trust is not subject to probate — it doesn’t get treated like the property in your will.
This means that the transfer of property through a living trust is not held up while the
probate process is pending (sometimes up to two years or more). Instead, the trustee will
transfer the assets to the beneficiaries according to your instructions. The transfer can be
immediate, or if you want to delay the transfer, you can direct that the trustee hold the
assets until some specific time, such as the marriage of the beneficiary or the attainment of
a certain age.
Living trusts are attractive because they are revocable. You maintain control — you can
change the trust or even dissolve it for as long as you live. Living trusts are also private.
Unlike a will, a living trust is not part of the public record. No one can review details of the
trust documents unless you allow it.
Living trusts can also be used to help you protect and manage your assets if you become
incapacitated. If you can no longer handle your own affairs, your trustee (or a successor
trustee) steps in and manages your property. Your trustee has a duty to administer the
trust according to its terms, and must always act with your best interests in mind. In the
absence of a trust, a court could appoint a guardian to manage your property.
Despite these benefits, living trusts have some drawbacks. Assets in a living trust are not
protected from creditors, and you are subject to income taxes on income earned by the
trust. In addition, you cannot avoid estate taxes using a living trust.
Irrevocable trusts
Unlike a living trust, an irrevocable trust can’t be changed or dissolved once it has been
created. You generally can’t remove assets, change beneficiaries, or rewrite any of the
terms of the trust. Still, an irrevocable trust is a valuable estate planning tool. First, you
transfer assets into the trust — assets you don’t mind losing control over. You may have to
pay gift taxes on the value of the property transferred at the time of transfer.
Provided that you have given up control of the property, all of the property in the trust,
plus all future appreciation on the property, is out of your taxable estate. That means your
ultimate estate tax liability may be less, resulting in more passing to your beneficiaries.
Property transferred to your beneficiaries through an irrevocable trust will also avoid
probate. As a bonus, property in an irrevocable trust may be protected from your creditors.
There are many different kinds of irrevocable trusts. Many have special provisions and are
used for special purposes. Some irrevocable trusts hold life insurance policies or personal
residences. You can even set up an irrevocable trust to generate income for you.
Testamentary trusts
Trusts can also be established by your will. These trusts don’t come into existence until
your will is probated. At that point, selected assets passing through your will can “pour
over” into the trust. From that point on, these trusts work very much like other trusts. The
terms of the trust document control how the assets within the trust are managed and
distributed to your heirs. Since you have a say in how the trust terms are written, these
types of trusts give you a certain amount of control over how the assets are used, even after
your death.
The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and its advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Advisor. IFP and [dba Name] are not affiliated.