Trust Basics: What You Need to Know About Creating a Trust
Friday, June 5th, 2020

Whether you’re seeking to manage your assets, control how your assets are distributed after your death, or plan for incapacity, trusts can help you accomplish your estate planning goals. The power of a trust is in its 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. It’s like a container that holds money or property for somebody else. There are three parties in a trust arrangement:

· The grantor (also called a settlor or trustor). The person(s) who creates and funds the trust

· The beneficiary. The person(s) who receives benefits from the trust, such as income or the right to use a home, and has what’s called equitable title to trust property

· The trustee. The person(s) who holds legal title to trust property, administers the trust, and must act in the best interest of the beneficiary

You create a trust by executing a legal document called a trust agreement. The trust agreement names the beneficiary and trustee and contains instructions about what benefits the beneficiary will receive, what the trustee’s duties are, and when the trust will end, among other things.

Funding a trust

You can put almost any kind of asset in a trust, including cash, stocks, bonds, insurance policies, real estate, artwork, and more. The assets you choose to put in a trust will depend largely on your goals. For example, if you want the trust to generate income, you should put income-producing assets, such as bonds, in your trust. Or, if you want your trust to create a fund that can be used to pay estate taxes or provide for your family after your death, you might fund the trust with a life insurance policy.

Potential trust advantages:

There are several advantages to having a trust. Each type of trust has unique features and benefits, so be sure to speak with a professional such as a lawyer or financial advisor to decide which type of trust is best for you.

Some of the most common advantages to having a trust include:

· Minimize estate taxes. In most cases, estates with a value of under $5 million are exempt from federal taxes. Additionally, spouses are exempt from estate taxes. Therefore, if a couple has a total net estate of $10 million or more, they will be subject to estate tax on the amount over $5 million. However, if a couple breaks their trust up into two equal parts, they can each use a $5 million exemption to minimize their estate taxes. This will help them to leave their beneficiaries the maximum possible amount.

· Some trusts shield assets from potential creditors. A trust removes assets from your possession and grants them to a legal entity. Therefore, if a creditor tries to seize your assets, they are protected by the trust.

· Avoid the expense and delay of probate. By having your trust clearly laid out and legally secured, you can avoid the risk of your estate going to the probate court when you die. The probate court will distribute your assets based on state law rather than what is declared in your trust or will.

· Preserve assets for your children until they are grown. If you die when your children are still minors, there is a risk that they will not receive your estate. A trust can protect your assets until your children are of age to receive your assets.

· Create a pool of investments. A team of professional money managers can manage the assets in your trust when the assets are pooled. This is often easier and safer than liquidating or combining assets and can be done with fewer fees than other money management techniques.

· Set up a fund for your support in the event of incapacity. If you are ever unable to manage your affairs, a trust can help to protect you financially.

· Sometimes shifts part of your income tax burden to beneficiaries in lower tax brackets. Estates and trusts that generate interest income are subject to taxes. If income is distributed to beneficiaries, the beneficiaries will have to pay taxes on the distributed amount. Therefore, you can avoid being taxed on the growth of your assets by distributing the growth to your beneficiaries.

· Provide benefits for charities. If you want part of your estate to go to charity, a trust can help guarantee where your money goes after you die. Additionally, you can donate to charity from your trust while alive to decrease your taxable income.

Potential trust disadvantages

Of course, a trust isn’t for everyone. Here are a few other things to consider when deciding to start a trust:

· Cost. There are costs associated with setting up and maintaining a trust. These costs differ between individual needs, type of trust, and more. Fees can include trustee fees, professional fees, and filing fees.

· Lack of control. Depending on the type of trust you choose, you may end up giving up some control of the assets in the trust. Be sure to discuss this with your estate lawyer or financial advisor before choosing what assets to include in your trust.

· Maintenance and compliance. Maintaining a trust can be time-consuming. There are compliance requirements that every trustee must adhere to including recording and notices.

· Taxes. Income generated by your trust and the assets in it that are not distributed to beneficiaries may be taxed at a higher income tax rate than your individual tax rate. Therefore, it takes considerable planning and management to effectively distribute a trust.

Most common types of trusts

There are many types of trusts, the most basic being revocable and irrevocable. The type of trust you should use will depend on what you’re trying to accomplish.

Living (revocable) trust

A living trust is a trust that you create while you’re alive. The main characteristics of a living trust are that it:

· Avoids probate. Unlike property that passes to heirs by your will, property that passes by a living trust is not subject to probate, avoiding the delay of property transfers to your heirs and keeping matters private. This is especially helpful to your beneficiaries as it will help to mitigate the risk of them not receiving part of your estate as well as save time in dividing your estate after your death.

· Maintains control. With a living will, you can change the beneficiary, the trustee, any of the trust terms, move property in or out of the trust, or even end the trust and get your property back at any time. This flexibility allows you to keep control of your trust while living and to create rules for your trust after you die.

· Protects against incapacity. If because of an illness or injury you can no longer handle your financial affairs, a successor trustee can step in and manage the trust property for you while you get better. In the absence of a living trust or another arrangement, your family may have to ask the court to appoint a guardian to manage your property. This can be costly and runs the risk of you not having your estate executed how you normally would. Therefore, this protection is important to have for a living trust.

It is important to note that a living trust can also continue after your death. You can direct the trustee to hold trust property until your beneficiary or beneficiaries reach a milestone such as reaching a certain age or getting married.

While a living trust might seem like the right option for you, a living trust might have its drawbacks. For example, the property in a living trust is generally not protected from creditors, and you cannot avoid estate taxes using a living trust.

Irrevocable trusts

Unlike a revocable trust, you can’t easily make changes or revoke an irrevocable trust. You usually cannot change beneficiaries or change the terms of the trust after it has been created. This is especially important if you want to avoid making emotional decisions later in life, or if you want to avoid hefty tax burdens in the future.

Irrevocable trusts are frequently used to minimize potential estate taxes. The transfer may be subject to gift tax at the time property is transferred into the trust, but the property, plus any future appreciation, is usually removed from your gross estate.

The benefits of irrevocable trusts are that property transferred through an irrevocable trust will avoid probate and may be protected from future creditors. This means that, while the property will no longer belong to you as an individual, it will transfer easily to your beneficiaries.

The bottom line

There are several types of trusts. So, it’s important to understand the benefits and drawbacks of each before choosing to set up a trust. Regardless of what kind of trust you choose to set up, the goals are typically the same: protect your assets and beneficiaries.

If you would like to explore the idea of opening a trust further, schedule a consult with one of our financial planners today. We are happy to help you find the right financial solution for you.