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A trust is an asset and estate manager that you can use throughout your life and after you die. As a legal entity, it has a trustee, or manager, and appointed beneficiaries, and provides detailed instructions for how you want your belongings handled when you pass away.
Trusts help your loved ones understand what you’d like done with your estate and also gives you control over how your wealth is disbursed. Here’s what you need to know about this estate planning tool to decide if you should set one up.
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A trust is a legal entity that serves to manage your assets both while you’re alive and after you die. The assets placed inside the trust are known as the corpus. Trusts can hold a variety of assets, including cash accounts, real estate, investments, heirlooms, life insurance and business interests.
There are three main parties involved in a trust:
If you’re the grantor, you will establish a trust that is a good fit for your needs (more on the types of trusts below). Depending on the type of trust you have, you’ll own and manage the trust for your lifetime (revocable trust), or you’ll no longer own or manage your assets once they’re in a trust (irrevocable trust).
After you decide on a type of trust, you’ll appoint a trustee, choose your beneficiaries and place the assets into the trust. When you die, the trustee gains instant control. This person will handle the distribution of your assets, which can happen fairly quickly if your instructions are clear.
If you have placed age limitations on when beneficiaries can receive specific assets, your trust can live on until they come of age. It can also stay intact to provide financial assistance to loved ones or to protect assets.
If you don’t have a partner, children and assets — like a home or valuables — you might not need a trust. But for many people, estate plans like a trust can be helpful. A trust can help you ensure your assets are managed according to your wishes during your lifetime, if you were to become incapacitated and after you pass away.
To figure out if you should get a trust, think about your needs, your future and what your family would do when you die. A financial advisor can also help you decide if a trust is right for your family. The size of your estate as well as your age and marital status should all factor into your decision. The following are common reasons for getting a trust:
However, it is important to keep in mind that trusts are generally more costly and complex to set up in comparison to wills. You will also have to deal with ongoing maintenance.
You can have both a trust and a will. They are both estate planning documents, but they play different roles.
Functionality: A will is a document stating how you want your assets and affairs handled when you die. It’s a legally enforceable document that can be as specific or as general as you want it to be. For instance, if you have minor children, you could detail who retains guardianship if you pass before they are legal adults.
A trust, on the other hand, is not just a document but a legal entity that houses your assets, accounts and belongings while you’re alive and then when you die. You give a third party, the trustee, the permission to manage your assets and when you do pass, your beneficiaries will inherit what you’ve left for them.
Probate: Wills go through probate, the court responsible for settling wills and estate plan to make sure they’re followed to the best of their ability. Probate is public record, which means that anything left in a will will become part of the public record. The potentially lengthy court proceedings can also be costly.
Most trusts don’t go through probate since the grantor has already given control to the trustee. This means your information isn’t made public and you’ll avoid potential costs associated with the often time-consuming process of probate.
Ability to update and change: Another key difference between wills versus trusts is that wills can be updated and changed throughout your lifetime. On the other hand, some trusts don’t allow for changes to be made after assets have been transferred into a trust.
You can choose different types of trusts depending on your needs. Most trusts fall into one of several categories:
|Commonly used types of trusts|
|Marital or "A" trust||A type of irrevocable trust where your surviving spouse is the beneficiary; designed to help them avoid paying any taxes on those assets.|
|Credit shelter trust||Also known as a Bypass or "B" trust, it allows beneficiaries to inherit assets without paying estate taxes; usually for couples with a lot of money who want to minimize tax liabilities when a surviving spouse dies.|
|Charitable trust||A trust that lets you leave your assets to charities and organizations of your choice, usually nonprofits.|
|Blind trust||With a blind trust, the grantor doesn’t know how the holdings (or assets) are doing, leaving it up to the trustees to handle it; usually a trust that elected officials use to avoid conflicts of interest.|
|Insurance trust||A type of irrevocable trust that has a life insurance policy as an asset; helps minimize estate tax liability.|
|Spendthrift trust||A type of irrevocable trust that makes qualified distributions to beneficiaries rather than a transfer of assets; meant to protect beneficiaries from themselves.|
|Special needs trust||A trust that is set up for a special needs child to manage assets and provide instructions for care.|
|Education trust||A type of living trust made specifically for a beneficiary’s education costs; can be multiple beneficiaries with a percentage that goes toward each.|
The first step to setting up a trust is figuring out which type of trust is right for you. The most popular type is a revocable living trust since it gives you control over your assets and lets you manage your account while you’re still alive.
While it’s a good idea to set up a trust as soon as you’re able to, circumstances can change throughout your life that may cause you to update your trust. A revocable trust gives the majority of people the flexibility they like.
After you’ve determined the type of trust you want, you’ll need to get your trust documents in order. Identify which assets you’d like to go into the trust, as well as your beneficiaries and how you’d like for everything to be distributed.
This is also a good time to list out any conditions necessary. For instance, if you have young beneficiaries, you might give them a minimum age to reach before getting their inheritance.
While a lawyer isn’t required for setting up a trust, hiring a professional help might be worth it. You can hire a trust or estate attorney or a financial advisor who specializes in estate planning. This person can help you set up a declaration or deed of trust, or your official trust document.
Once your document is completed, it needs to be notarized. You also may have to file trust documents with your state.
After your trust is created, you’ll need to fund it through a financial institution, which can be done online or in person.
At this point in the process, you will also need to register your trust with the IRS for tax purposes, which can be done online or by submitting a form by mail. Your trust will get its own unique taxpayer identification number (TIN).
Trusts can help minimize the tax implications of inheritance. How trusts are taxed depends on the type of trust and the assets within the trust. Cash, stocks and most real estate assets are not taxed when you inherit them. But if you sell them — like a home, for example — you may have to pay capital gains tax.
Some trusts leave the taxation up to the grantor rather than the beneficiaries. For instance, if you have a simple trust, you’re required to distribute income annually to beneficiaries and this income is taxed. The trust can’t distribute to a charitable organization and doesn’t have a grantor. A complex trust is the opposite of a simple trust: You have a grantor, you don’t make annual payouts to your beneficiaries and you have charitable organizations that are set to receive some of your funds. Grantors who have at least some of the power — like through revocable trusts — are taxed rather than the beneficiaries.
Trusts are required to file Form 1041 every year the trust has at least $600 in income. If you have a grantor trust and report income and expenses on your own tax return, however, the extra Form 1041 isn’t required.
An estate attorney or financial advisor can help you create a trust that best fits your situation. Consider consulting or hiring one before you create a trust.
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