When you hear the words “trust” or “trust fund,” the first image that may come to mind is a wealthy family in a mansion with inherited wealth passed down from generation to generation.
If asked what a trust or trust fund is, many people would probably be hard pressed to offer up an accurate definition.
However, there is nothing particularly mysterious or overly difficult to understand about a trust or a trust fund, nor do you have to be a member of the Rockefeller clan or the Gates family, to set up and benefit from a trust.
A trust is a legal vehicle that greatly expands your options when it comes to managing your assets, whether you’re trying to shield your wealth from taxes or pass it on to your children. “A trust,” according to Fidelity Investments, “is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries.”
And far from being the preserve of the monied elite, trusts are increasingly used by families from a range of economic backgrounds, not just the extremely wealthy.
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“Trusts are the 700-pound gorilla of estate planning and a very important part of many estate plans,” said Leon LaBrecque, chief growth officer at Sequoia Financial Group who is also an attorney and a certified financial planner. “They are a cornerstone of many of the plans I do.”
Creating a trust
A trust is a legal vehicle to pass assets to a trustee, who in turn holds those assets — in a trust fund — for a third party, such as a beneficiary.
Many people create trusts to minimize hassles and fees for their loved ones, or to create a legacy of charitable giving.
Working with an attorney or a financial planner, you can create a trust to minimize taxes, protect assets and spare your children from having to go through the probate court process in order to divide up your assets after you die.
A trust can also enable you to control not only to whom your assets will be disbursed, but also how the money will be paid out — a crucial point if the beneficiary is a child or a family member whose ability to properly handle money is questionable.
You can choose trustees to carry out your wishes.
“This may be an appealing feature to an individual who wants to leave assets to a beneficiary whom the grantor is worried may blow through the money or wants the assets to be directed for specific purposes or last for a specific time,” says Aaron Graham, a CFP with Abacus Planning Group in Columbia, S.C.
By creating a trust, you can:
- Determine where your assets go and when your beneficiaries have access to them.
- Save your beneficiaries (your children, for example) from paying estate taxes and court fees.
- Protect your assets from creditors that your beneficiaries may have, or from loss through divorce settlements.
- Direct where remaining assets should go in the event of a beneficiary’s death. This can be helpful in a family that includes second marriages and step-children.
- Avoid a lengthy probate court process.
This last point is a crucial one, as trusts also allow you to pass on assets quickly and privately. In contrast, settling an estate through a traditional will may trigger the probate court process, in which a judge, not your children or other beneficiaries, has final say on who gets what.
Not only that, the probate process, as it is called, can drag on for months or even years and become a public spectacle as well.
With a trust, much of that delay can be avoided, and the entire process is private.
This can save your beneficiaries from unwanted scrutiny or solicitation.
Common types of trusts
There are many types of trusts, and each is structured to accomplish different goals.
Here are a few examples of commonly used trusts:
Marital or “A” trusts
This trust is designed to provide benefits to a surviving spouse, according to Fidelity, and is generally included in the taxable estate of the surviving spouse. It places assets into a trust when one spouse dies; all income generated by those assets goes to the surviving spouse, and the principal often goes to the couple’s heirs when the surviving spouse dies.
Credit shelter trusts
These trusts allow both spouses to take full advantage of their estate tax exemptions, which in 2019 is a whopping $11.4 million per person, or $22.8 million per married couple. Assets above this amount are generally subject to a 40 percent estate tax once the second spouse dies. When the exclusion amount is held in a credit shelter trust, the surviving spouse can receive income from the trust’s assets until death, at which point the trust’s beneficiaries receive its assets free of estate taxes.
Charitable remainder trust
This type of trust allots a given amount of income for beneficiaries for a defined period of time and the remainder goes to specified charities.
Revocable vs. irrevocable trusts
People often think of a trust as an alternative to a will — a way of passing on wealth after one’s death.
However, you can also create a trust and pass on assets during your lifetime through a revocable trust.
Also called a “living trust,” a revocable trust allows you to “retain control of the assets during your lifetime,” according to Fidelity, yet can be altered and even dissolved so long as you’re alive.
The downside is that while a revocable trust will usually keep your assets out of probate if you were to die, you probably won’t escape estate taxes.
“Revocable trusts are among the most common estate planning vehicles, particularly when there is a desire to avoid the costs and delays that can accompany probate in certain states,” says Bruce Colin, a certified financial planner with his own firm in Rancho Palos Verdes, California.
By contrast, an irrevocable trust cannot be altered once it has been created and you give up control of your assets that you put into it.
But an irrevocable trust has a key advantage in that it can protect beneficiaries from probate and estate taxes.
Why create a living trust?
A living trust is pretty much what it sounds like. It allows you to place assets in a trust while you are alive, with control of the trust transferred after you die to beneficiaries that you have designated.
You might consider creating a living trust for one of several reasons:
- If you would like someone else to accept management responsibility for some or all of your property.
- If you have a business and want to ensure it operates smoothly with no interruption of income flow in the event of your death or disability.
- If you want to protect your assets from the incompetency or incapacity of yourself or your beneficiaries.
- If you wish to minimize the chance that your will may be contested.
Choosing a trust that works for you
When considering a trust, always seek professional advice to make sure you’re making the right decision for yourself and your loved ones.
An estate planning attorney or financial adviser can provide you with expert advice about whether a trust could be a useful component in your long-term financial plan.
“You just have to remember that a trust is an entity, just like a person, and sometimes it makes sense for that entity to own something for the benefit of someone else,” according to Lora Hoff, a CFP in Dallas whose practice focuses on medical professionals.
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