Trusts are a common financial institution that holds a half-understood place in most people’s minds. On the one hand, the stock character of the “trust fund child” evokes imagery of a privileged individual with potentially unearned wealth. However, what role a trust plays in that narrative is often misunderstood.
Trusts can be a valuable financial planning or estate planning tool for people of many social and financial backgrounds. This seven-point guide seeks to demystify what a trust is and provide some understandable points about the advantages and drawbacks of different kinds of trusts.
A trust is defined as an agreement that establishes a relationship between two people: a trustor and a trustee. That definition is broad, intentionally so, but also a bit confusing for a lay person. A definition that you might find more helpful is a trust establishes an account that contains property, assets, or cash, is overseen by a trustee, and eventually passes on to a final recipient, called a beneficiary.
You can use trusts for a variety of reasons. Most commonly, trusts are used to protect your possessions legally and make sure that your items pass on to the appropriate people after you pass on. From a more bureaucratic perspective, trusts can reduce the amount of paperwork needed to pass on assets and potentially avoid taxation on the assets within your trust.
Trustors also go by a more common name: grantors. When you create a trust, you become the grantor. You are the one transferring the property to your trustee. A trustee can be chosen explicitly by you, or it could be a professional trustee, or it could even be you under certain circumstances.
Once you transfer your ownership, the trust account becomes the responsibility of the trustee. The trustee has to manage the account on behalf of the future beneficiaries. Trustees are also bound to act as fiduciaries. A fiduciary is legally bound to act in the best interest of their clients. This means that your trustee is not allowed to make overly risky decisions with the assets of your trust, nor are they allowed to profit from the trust beyond whatever allowances you place into the contract of the trust.
Not all trusts offer an equal amount of control over your assets and the trust itself. All trusts fall into broad categories: revocable and irrevocable.
If you create a revocable trust, then the terms of the trust and the assets within the trust can be changed or even terminated up until the time of your death or incapacitation. This allows you a great degree of freedom in how they would like the assets in your trust to be managed by the trustee and may even let you adjust who the beneficiary of the trust is.
By contrast, if you create an irrevocable trust you are setting the trust terms in stone once it has been created. The advantage to irrevocable trusts is that although they cannot be altered by you after they are created, they are also not included in your taxable estate.
While a trust can be established during your lifetime, you can also establish a trust after you die. A trust created in a last will and testament is known as a testamentary trust. Since you have to die in order to establish this trust, it is irrevocable by nature. Technically you don’t create this trust. Instead, your executor creates the trust on your behalf as part of the execution of the will.
One of the downsides you will find if you make a testamentary trust is that it forgoes the chief benefit of a trust: bypassing the probate process. Probate is the process of certifying a will and managing the end of life affairs of a deceased person. Most trusts cannot be touched by the probate process since probate only delegates parts of your estate that are not already spoken for. Since a testamentary trust is established as part of your last will and testament, it must be cleared by the potentially months-long probate process along with the rest of the will. This process may also have limited benefit in exempting the assets to the trust from taxation.
One of the most unique types of trusts is a living trust. Living trusts are created during your lifetime, and it is fully revocable. This allows you to designate yourself the trustee of the living trust and allows you to use the assets contained within it. This makes living trusts extremely flexible but at a cost.
Since you have such broad control and benefit from your living trust, it will be counted among your taxable estate and income for tax purposes. However, the trust structure will still allow you to transfer control of it past the probate process upon your death. Additionally, a living trust also works with a pour-over will to funnel all unassigned items of your estate to the living trust.
If you decide that you don’t need your trust anymore, you can even 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 into another trust at a later date.
In addition to providing financial security, establishing a trust can also provide unparalleled levels of control. Unlike with assets that are distributed by last will and testament with no strings attached, trusts can dictate not only who gets the assets of a trust but when those assets are distributed.
Trustees can be instructed to divest the contents of a trust under certain circumstances. Common circumstances under which the funds of a trust may be made available to beneficiaries include the beneficiary getting married, achieving a certain age, or beginning college.
While trusts are incredibly versatile as an estate planning tool, they are not free. They take time and money to create and maintain. Additionally, once you establish a trust, it can be difficult to adjust or terminate depending on the terms of the original trust document.
To ensure that your trust is built correct and to ensure that your wishes are met, you will need a trusts & estates attorney. An experienced trusts & estate 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. AAL has a number of experienced trusts & estates attorneys who can advise you on the best way to preserve your legacy and your wishes by establishing a trust for your 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.