A trust is a legal entity that enables the transfer of assets from one person to the next. While all trusts have the same end goal, a different type exists for every circumstance. It works as an instrument for temporarily holding wealth under the trust’s name, separate from the original owner and beneficiary, before passing on under specific requirements.
This allows individuals to, with the use of a skilled attorney, bypass some of the costs and difficulties associated with transferring and bequeathing wealth.
Navigating the world of trusts can be confusing. For one, there are many of them. And secondly, many different types of trusts have several different names, all meaning the same thing. Here is what you need to know.
What Is a Trust?
As plainly as possible, a trust is an estate planning tool used to minimize certain costs, including taxes, and maintain privacy. It is a document that temporarily changes ownership of certain property, while sometimes still giving you control of it.
It can also be used to maintain control over how you bequeath your assets onto the next generation, or give you additional control over who receives what, and when, while avoiding probate. It can also be useful for asset protection, from creditors and taxes.
While a will can also be used to bequeath assets unto your family, there is less control in a will. A will must also pass through probate, becoming a public record, while a trust is private.
All trusts need a few basic elements to get started, namely:
- A trustor, who sets up the trust.
- One or more beneficiaries, who inherit a portion of the trust under specific conditions.
- A trustee, who manages the trust, and sees to its distribution when certain conditions are met.
- The contents of the trust, typically property and other assets. Certain assets or accounts, such as IRAs, cannot be funded into a living trust.
- A trust agreement, which basically contains the contents, objective and parties involved in the trust, while agreeing to state and federal rules regarding the creation and usage of said trust.
Living Trusts vs. Testamentary Trusts
Trusts are typically split into one of two types – living trusts, or testamentary trusts. The first is any trust that goes into effect while you, the trustor, are still alive. This includes most trusts, especially revocable living trusts, which are a common form of estate planning.
Irrevocable living trusts are, as the name implies, unchangeable. While a revocable living trust allows you to buy, sell, and move assets within your trust, file amendments and issue changes if the need arises (especially due to certain life-changing events, such as death, birth, marriage, or divorce), an irrevocable living trust cannot be amended, and must be cancelled by a court.
The benefit to an irrevocable living trust is that, while you relinquish any control over the contents of the trust, it also becomes a non-issue from a tax perspective, as the contents of the trust are no longer in your ownership. This allows you to pass on certain assets to your children or family without cutting into your estate tax limit, or for safekeeping from creditors.
Assets in living trusts do not pass through probate but will be subject to state and federal estate taxes, as well as inheritance taxes. They must also be considered when calculating government benefits. Note that California has no state estate or inheritance tax, so inhabitants must only worry about the federal estate tax.
Testamentary trusts only go into effect when you have passed away, and they are usually reserved for special circumstances. They are written into a person’s last will and testament, ordering the executor/administrator of the will to create the trust. A testamentary trust can also be created as part of a living trust – the only difference is that the testamentary trust goes into effect once you pass away, while the living trust is active from the moment you file the trust document.
Usually, the only time you may want to set up a testamentary trust is, if for any reason, you need an asset to be in your name and cannot have it in a living trust, but also want the special restrictions and provisions afforded by a trust.
Special Needs Trusts
A trust can be used to do more than simply hold funds until the trustor passes away – a trust can be used to help a parent pay for their disabled child’s lifestyle and necessities even once they are gone, through a special needs trust.
This is a type of trust that typically continues until the beneficiary passes away and is specifically designed to pay for the living expenses of a beneficiary who lacks the mental capacity to manage their own finances. This trust can also be built in a way that the beneficiary is still eligible for disability benefits. The most important thing in creating a special needs trust is finding the right trustee.
A charitable trust is an irrevocable trust that declares the contents of the trust as meant for one or more charities/certified charitable organizations. These trusts are not tax-exempt but are subject to certain tax deductions based on how much is given to how many charities. They are treated as private foundations and have the same tax provisions.
Although called a trust, this is typically a provision within certain accounts declaring a beneficiary. A Totten trust is also referred to as a payable-on-death (POD) bank account. This allows account holders to designate a beneficiary for the contents of their account, thus effectively holding the money “in trust” to be transferred to said beneficiary. Money/property in a Totten trust does not pass through probate.
Effective Use of Trusts
Trusts can be a powerful asset in your estate plans if used correctly – but if misused and implemented erroneously, they can waste precious time and resources where other, more expedient options might have been available. It is wise to consult with an estate planning professional before drafting any estate plan documents, including wills and trusts.
Descriptions online may help provide you with a better understanding of what a trust is, but they cannot be taken as legal advice. Instead, contact a local professional and go over your finances together, to draft an optimal estate plan given your circumstances and budget.