You’ve heard of trust fund babies — those enviable young adults who live a worry-free life since they don’t have to earn a living. Just what exactly is a trust fund that provides them an income, and for that matter, what is a trust?
A trust is a 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. Trusts can be an appealing option if your aim is to minimize taxes, protect assets and avoid the probate process. If you create a trust, you also can control how and to whom those assets will be disbursed. You can choose trustees to carry out your wishes. Many people create trusts to minimize hassle and fees for their loved ones, or to create a legacy of charitable giving.
What is the benefit of a trust?
The primary benefit of a trust is that it allows you to determine where your assets go and when your beneficiaries have access to them. A trust can save your beneficiaries from paying estate taxes and court fees, and can protect your assets from beneficiaries’ creditors or from loss through divorce settlements. It also lets you specify 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.
Trusts also allow you to pass on assets quickly and privately. By contrast, settling an estate through a traditional will may trigger the probate process, which can take a months or even years and can be a public process. 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: Places assets into a trust when one spouse dies; 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 2018 is a whopping $11.18 million per person, or $22.36 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. These have become less popular since 2011, when a change in tax law enabled the executor of an estate to elect portability of a deceased spouse’s exemption to the surviving spouse.
- Charitable remainder trust: The inverse of the charitable lead trust, in that it allots a given amount of income for beneficiaries and the remainder 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. A revocable trust, also called a living trust, can be altered and even dissolved so long as you’re alive. It will usually keep your assets out of probate but you probably won’t escape estate taxes.
An irrevocable trust, on the other hand, cannot be altered once it has been created. By creating an irrevocable trust, you give up control of your assets but can protect beneficiaries from probate and estate taxes. Most revocable trusts convert to irrevocable trusts upon the death of the grantor — the person who set up the trust.
Why create a living trust?
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 advisor can provide you with expert advice about whether a trust could be a useful component in your long-term financial plan.