If the first thing that comes to mind when thinking of a “trust” or a “trust fund” is a wealthy family leaving riches to undeserving and spoiled children — you’re not alone.
However, this stereotypical image doesn’t really have to be the case. You don’t necessarily need to be “obscenely rich” to own your own lifestyle. Let’s explore how you can actually make use of a trust and plan your future — even if you’re not a millionaire.
A trust is a legal relationship between three sides — The Grantor (asset owner), The Trustee (a person or firm), and The Beneficiary (the inheritor). It’s created by signing a legal document (aka “trust document” or “deed”).
This fiduciary arrangement allows a person or a firm called a trustee, to hold assets — your money, investments, real estate, or any other property — for various purposes before the beneficiaries inherit them.
- Trustor (aka settlor, donor, grantor, or trust maker)
- The Trustee (aka fiduciary)
- The Beneficiary (the inheritor)
Much like a will, a trust is also an estate planning tool that can specify exactly how and when the assets will be passed on to the beneficiaries. Because this is how trust is commonly used, it’s easy to mix these two up.
The main difference between a will and a trust is that a will becomes active only after one’s death. A trust is active from the day you create it, and you, the trustor/grantor, can distribute assets in any way that you specified in the terms of the trust.
There are Irrevocable Trusts, often created for tax purposes, which cannot be altered after their creation, and Living Trusts, which can be changed by the grantor (more on that later).
Things can get complicated very easily with different terms that represent similar things, such as testamentary trust, testamentary will, etc.
For now, what you need to know is that people commonly use trusts to skip the probate process — that long and often costly court procedure of proving the validity of the will. This means that your loved ones gain access to the assets after your passing much more quickly than they would if you used a will.
Apart from saving them the trouble and the time, it can save them expensive court fees and may reduce estate taxes.
There are different types of trust, each with its own specific purpose, advantages, planning, and disadvantages. Before devising your estate plan, let’s see the most common and useful types of trust.
(Also called a living trust, revocable living trust or inter vivos trust)
A trust that can be revoked. Typically, a revocable trust evolves into an irrevocable trust after the death of the trust maker.
It’s often used to avoid probate (but not the taxes) and make it more difficult for creditors to access the assets (the creditor must petition a court for an order to get to the assets from this trust).
If the only person who can revoke the trust (usually but not necessarily the trust maker) has died, then the trust becomes irrevocable.
An irrevocable trust cannot be altered, changed, modified, or revoked after its created. Once a property is transferred to an irrevocable trust, no one, including the trust maker, can take the property out of the trust.
It’s the tax killer. Irrevocable trust assets may not be considered part of the taxable estate, so the beneficiaries pay fewer taxes after you pass. The downside is that not even you can alter this type of trust in any way once it’s active.
A grantor trust involves the elements of control listed in the federal income tax code. It includes the power to revoke the trust, the right to receive the trust’s income and/or principal, and the role of the trustee.
Grantor trust rules are complex and often need a lawyer’s interpretation so that you fully understand how they precisely work.
While assets can pass to a spouse tax-free, when the surviving spouse dies, the remaining assets over the exempt limit would be taxable to the children of the couple, up to 55 percent! That’s a lot.
A married couple can take full advantage of the federal estate tax exemption amount with a bypass trust. Depending on the value of the estate, tax bypass trust saves the children maybe hundreds of thousands of dollars in federal taxes.
There are many other types of trust such as Charitable Trust or a Special Needs Trust (for a beneficiary who suffers from a disability — often including instructions about public benefits like Medicaid).
Trust is just one part of your estate plan, and one of the final steps at that.
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And now let’s head straight into the practical side of planing your trust.
Think of everything that you own: real estate, bank accounts, retirement accounts, brokerage accounts, personal property — virtually anything. It will probably add up to more than you think. Underestimating personal net worth is a fairly common tendency.
Bear in mind that IRAs, pensions, and life insurance policies often have a catch such as tax consequences (some can’t even be included in a trust). It’s best to consult a financial advisor.
Since trust is valid only if it’s funded, you will need to collect all deeds of property, stock certificates, and life insurance policies to transfer everything into the trust.
How exactly do you want your assets to be distributed after your death? What do you wish to accomplish?
Help a child with their education, or simply give everything to your beneficiaries? Maybe you want to leave most of your assets for your grandchildren or protect your trust from being used by the creditors of your beneficiaries?
Think it through.
What type of service will you entrust with your money? An estate planning attorney or an online service? These services often cost between $1,000 and $7,000 depending on the complexity.
If you find these services too costly, you can also do it yourself, in which case you should probably rely on self-help books or online guides for assistance (fair warning, it can become very complex and stressful).
Regardless of if the creator is a lawyer or yourself, the trust document will include:
Your name as The Grantor.
The name of The Trustee (this can be you, or another person/firm)
Name of Successor Trustee — who takes over as trustee and distributes property in the trust when you die (most people choose their spouse, grownup child, or friend).
The Beneficiaries — the people who will receive the assets in your trust.
There are no legal restrictions against appointing your beneficiary as your trustee at the same time. However, it’s generally not recommended to choose a family member as a trustee or successor trustee, if you strictly wish to ensure how your assets (or certain parts of your assets) should be used.
This is very important. Including yourself as a trustee means that when you transfer assets to your trust, you own everything in your trust while you’re still alive. After you die, your assets go directly to your beneficiaries.
What’s in it for you? Do you even need this?
While we all know many people assume that trust is something reserved for “the idle rich”, there are actual benefits for the middle-class citizens as well.
By now, it’s probably more than clear to you that estate planning really is something almost everybody should think about. Here are some interesting benefits of trusts:
We’ve mentioned this before but let’s analyze what this means in practice, on Michael’s example.
The settlor, Michael, establishes the trust instead of writing a will. That way, when Michael passes away, his assets won’t have to go through probate, and since the process of distributing trust assets doesn’t involve any courts, his assets won’t become a matter of public record.
If a parent or a grandparent passes away and leaves minor children as beneficiaries, a trust fund is a good way to manage the inheritance.
These Trusts can include details explaining how the money should be used — since most underage children can’t really make wise financial decisions.
In these cases, their aunts, uncles, or grandparents may use a trust fund to manage money for the children, and the trust can specify the terms so that the assets can’t be misused.
Today, a trust fund may even be considered a way to enable crowdfunding, especially when it’s for an important cause (helping orphaned children, curing difficult illnesses).
Trust funds can be set up to collect donations from the public to help with the living and medical costs of beneficiaries.
We went over the cases where trusts really make sense and explored how they can make a notable difference in situations that actually occur commonly — and not just with the rich. Now take your time to think about a trust of your own.
With this many possibilities, you could probably find one solution that works best for you personally.
Compared to a will, a trust expands your options, whether you’re trying to protect your wealth from taxes or pass it on to your children or grandchildren (family trust).
Taking the responsibility, planning ahead, and thinking about your lifestyle pays off both practically as well as emotionally. Think about it.