Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.
Updated on Monday, February 22, 2021
A family trust is a valuable financial planning tool that can be used to transfer assets to loved ones. This type of legal arrangement allows families to avoid the often lengthy probate process, as well as certain taxes.
Family trusts can come in several different forms, each of which has its own unique advantages. This article explains how family trusts work, walks you through the pros and cons and gives you the steps you’ll need to create a trust yourself.
- What is a family trust?
- Types of family trusts you can create
- Family trust pros and cons
- How to set up a family trust
What is a family trust?
A family trust is a legal financial planning entity in which you can transfer ownership of certain assets. A family trust is a type of living trust, which means someone creates and transfers assets into the trust while still alive.
Families often use this type of trust as an estate planning tool. When someone dies, their loved ones often have to go through probate court to settle their estate and take ownership of that person’s assets. A trust allows families to avoid the probate process.
There are three parties involved in a family trust. The grantor is the person who creates the trust and transfers their assets into it. The trustee is the individual or institution that manages the trust. Finally, the beneficiaries are those who will receive the assets within the trust. In the case of a family trust, the beneficiaries of a living trust are family members of the grantor.
Family trusts can be either revocable or irrevocable. The key difference between the two is whether the grantor can make changes after creating the trust and whether they can serve as their own trustee.
Types of family trusts you can create
When someone creates a family trust, they have a couple of different options. The primary differences between a revocable and irrevocable trust come down to their flexibility and how the assets are taxed.
A revocable trust is a legal arrangement that the grantor creates and transfers their assets into and can continue to make changes to throughout their lifetime. A grantor can serve as the trustee of their revocable trust, and they’re also free to adjust the assets and add or remove beneficiaries. Once the grantor dies, the revocable trust automatically becomes an irrevocable trust.
When someone creates a revocable living trust, they maintain ownership of the assets within it during their lifetime, and in many ways, this serves as an advantage. However, it also means those assets may be vulnerable to creditors and lawsuits.
In addition, those assets could be subject to estate taxes when the grantor passes away. As of 2021, federal estate taxes apply to any assets above and beyond $11.7 million in value.
An irrevocable trust is one in which, once the grantor creates the trust and transfers their assets into it, they can’t make any changes. The assets within the trust no longer belong to the grantor, and the grantor can’t serve as the trustee.
At first glance, an irrevocable trust might seem less attractive, given its lack of flexibility. But this type of trust also comes with its fair share of advantages. When assets are transferred into an irrevocable trust, they no longer belong to the grantor. As a result, they are no longer vulnerable to creditors or other lawsuits. These trusts are also an effective tool for avoiding or minimizing estate taxes: Because the assets no longer belong to the grantor, they won’t be subject to estate taxes upon the grantor’s death.
However, there are also potential tax downsides. According to the IRS, contributions to an irrevocable trust may require the grantor to file a gift tax return and be subject to taxes. Individuals must file a gift tax return if they transfer more than $15,000 in assets to another individual. Any amount above $15,000 in a single year will be subtracted from that person’s lifetime gift tax exclusion. Once someone uses up their entire lifetime exclusion, gifts above $15,000 per year will be subject to a gift tax. However, it’s likely most people won’t need to worry about paying gift taxes, as the lifetime exclusion for 2021 is $11.7 million.
Family trust pros and cons
Trusts come with several advantages and disadvantages that families should consider before establishing one.
Family trust benefits
- Avoidance of probate One of the advantages that draws many people to family trusts is the ability to avoid probate. Loved ones can inherit assets without having to go through a lengthy court process. And because the estate isn’t going through the court, families don’t have to worry about public records.
- Avoidance of certain taxes. Revocable and irrevocable trusts both come with tax benefits, but they’re different for each type of trust. Revocable trusts allow families to avoid gift taxes when they create the trust, while irrevocable trusts allow for the avoidance of estate taxes once the grantor dies.
- Potential protection against creditors. When someone creates an irrevocable trust, the assets are no longer considered theirs. As a result, they aren’t vulnerable to creditors or potential lawsuits.
- Planning for special circumstances. Living trusts allow grantors to plan for any special circumstances. First, they can use this type of trust to protect their assets and make arrangements for care if they become incapacitated. They can also use a trust to help another loved one: For example, a grantor could plan for the care of a loved one with a disability after the grantor’s death.
Family trust disadvantages
- Potential loss of control. Once someone transfers assets into an irrevocable trust, they no longer have ownership over them. As such, they cannot make changes to the trust or take back any of the assets.
- Tax consequences. While both types of trusts come with tax advantages, they can also come with disadvantages. Assets could be subject to either gift or estate taxes.
- Administrative and legal costs. Most families will have to enlist the help of an attorney to create a trust. But just how much does it cost to set up a family trust? It can generally range from $1,100 to $2,500, depending on whether the trust is for an individual or a married couple.
How to set up a family trust
Step 1. Decide if a family trust is right for you
Despite their benefits, a family trust may not be the right choice for everyone. You can speak with an estate planning attorney, or your financial advisor, to help weigh the pros and cons and decide whether a trust is the best choice for your family.
Step 2. Choose a trustee
The trustee is the individual who will manage the trust and its assets. In many cases, the trustee is either the grantor or a beneficiary, but it could also be a financial institution. Consider the complexity of the assets when deciding on a trustee.
In the case of a revocable trust, the grantor may choose to also serve as the trustee to maintain full control of the assets.
Step 3. Establish your beneficiaries
When establishing a family trust, decide on the beneficiaries. In many cases, beneficiaries may be the spouse and children of the grantor. Beneficiaries can also include other individuals and organizations, such as a favorite charity. The person creating the trust can indicate the precise benefit each person will get from the trust.
Step 4. Create your trust document
A trust is a legal arrangement, meaning it requires a legal document. Families can hire an estate planning attorney to create their trust document, though there are also online programs that may help families create a trust for a lower cost.
Step 5. Fund the family trust
Once the trust document is complete, the final step is to transfer assets into the trust. Assets could include cash, real estate, stock and bond investments and other valuables. Grantors should carefully consider what assets they transfer into an irrevocable trust, because they can’t take them back later.