FOR LAWYERS

Trusts: an Overview

By
James Parker
/
May 8, 2022
Last reviewed by
Boruch Burnham, Esq.
/
September 10, 2023

Trusts are a commonly employed legal mechanism that occupies a somewhat ambiguous position in the collective consciousness. The archetypal "trust fund child" conjures images of a fortunate individual with potentially unearned wealth. But trusts can be a great way for people from different social and economic backgrounds to reach a wide range of financial and estate planning goals. This article aims to describe the various types of trusts and their uses.

1. A trust is a legal vehicle used to set aside money, property, or other assets for the benefit of another.

It is essential to appreciate the scope of assets that can be placed in a trust because trusts can not only provide for the distribution of assets but also the distribution of income generated by those assets, as well as items that only have future value, such as a pension fund or life insurance policy. Some examples of things that may be held in trust include:

  • Real estate, such as personal residences and income-generating rental properties
  • Investments, such as stocks, bonds, mutual funds, and annuities
  • Business interests, such as shares in a family business, partnerships, or LLCs.
  • Intellectual property, such as patents, copyrights, and trademarks
  • Personal property, such as art, jewelry, collectibles, and antiques.
  • Life insurance policies and retirement accounts such as IRAs and 401(k)s

2. Every trust must have a grantor, trustee, and beneficiary.

There are three necessary parties for establishing a legally valid trust: the grantor, the trustee, and the beneficiary.

  • The Grantor: Also referred to as a "settlor," the grantor is the one that transfers property into the trust.
  • The Trustee. The trustee manages the trust and its assets and distributes the assets and any income that may have been generated by them, such as from stocks, real estate investments, etc.). Trustees are also bound to act as fiduciaries. A fiduciary is legally required to act in the best interests of the beneficiaries. This means that a trustee may not make overly risky investment decisions or be allowed to profit from administering a trust beyond the salary, fees, or other compensation they are entitled to per the trust's terms.
  • The Beneficiary: A trust's beneficiaries are entitled to receive assets or income from the trust per the conditions, limitations, and restrictions set forth in the trust documents.

It's worth noting that the grantor, trustee, and beneficiaries don't necessarily have to be individuals. Instead, legal entities such as businesses, financial institutions, and wealth management funds can also take on these roles. For instance, a large corporation could create a trust (with itself as the grantor) to provide for employee pensions. An investment company could then act as the trustee, managing the trust's assets and investing them to generate returns that fund the pension payouts to the corporation's retired employees (the beneficiaries). Some examples of beneficiaries that are not individuals may include charities, non-profit organizations, and educational institutions.

3. Some trusts can be modified or revoked, and others are set in stone.

Not all trusts offer equal control over your assets and the trust itself. All trusts fall into broad categories: revocable and irrevocable. Revocable trusts give the grantor lasting control over them, including the power to add or remove beneficiaries, transfer assets in and out of the fund, and modify its general terms and conditions regarding how the funds should be managed and disbursed. If you decide you don't need your trust anymore, you can dissolve it. If you dissolve your living trust, all of the profits and assets will return to you. This could even allow you to place the assets in another trust later.

By contrast, when you create an irrevocable trust, you are setting the trust's terms in stone once it has been created. The advantage of lifetime irrevocable trusts is that, although they cannot be altered by you after they are created, they are also not included in your taxable estate.

For example, you can use an irrevocable asset protection trust (APT) in which you name yourself as the trustee and which will let you receive periodic payments from its principal balance (or payments of profits from income-generating assets held in it) while protecting those same assets from the claims of creditors, the enforcement of legal judgments against you, and in very limited circumstances, even protection in bankruptcy.

Living trusts can be made either revocable or irrevocable. One example is the spendthrift trust. Spendthrift trusts are commonly established by parents, grandparents, or guardians to provide a steady stream of income for minor children or those with questionable money management skills. Because the beneficiaries are not able to access the funds at their discretion, they cannot withdraw any of the trust's balance, and it also prevents creditors from accessing the trust's assets to satisfy their debts. Note that spendthrift trusts are also commonly established as testamentary trusts.

4. Trusts are invaluable estate planning tools

Both living and testamentary trusts are used for estate planning purposes. Living trusts (also referred to as "inter vivos" trusts) are those created during one's lifetime and can be revocable or irrevocable. From an estate planning perspective, living trusts are used in conjunction with pour-over wills to funnel into the trust assets that had not been identified and assigned in the will but are nonetheless part of their estate upon passing (for example, real estate investments or corporate securities acquired after the will was drafted). Those assets will then be disbursed per the terms of the trust along with the rest of the testamentary assets (i.e., those that were explicitly identified and designated in the will).

A major advantage of using living trusts for estate planning is that they can pass on property and income to the beneficiaries outside of the probate process. The probate process involves a) proving the validity of the deceased person's will, if they have one; identifying assets and liabilities; paying off any debts; and c) distributing the remaining assets to the beneficiaries in accordance with the terms of the will (or the laws of intestacy, if the deceased did not leave a will). As you can imagine, this process can be extremely lengthy—years in some cases, during which the assets subject to probate are locked up and not accessible to your beneficiaries. Establishing a trust that can pass income and assets to your loved ones outside of that process so they may continue to pay their mortgages, college tuition, or whatever else you want them to have funds for in the interim.

Testamentary trusts, on the other hand, are established in accordance with the terms set forth in the grantor's will and take effect only upon their passing. The advantage here  is that the grantor keeps full ownership and control of their assets (and any income they bring in) while they are still alive. When the grantor dies, the property and income of the trust can be managed and distributed to all the different beneficiaries according to the trust's terms. However, there are disadvantages to testamentary trusts as well—including the fact that they are irrevocable by nature and are also required to go through probate.

5. A skilled and knowledgeable attorney with extensive experience in Trusts and Estates law can be a valuable resource in establishing the right trust for you

While trusts are incredibly versatile as an estate planning tool, designing and tailoring the right one for you and best suited to your circumstances is critical—especially because certain trusts can be very difficult, if not impossible, to dissolve, remove their assets from, or modify their terms. An experienced Trusts & Estates attorney can consult with you about the right trust for you, as well as the terms and conditions for when and how that trust will be passed to your chosen beneficiaries.

 

*Disclaimer: Attorney At Law does not represent all lawyers in all states. There may be differences of opinion. It's always advisable to consult with an attorney when in a legal situation.

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