What Is a Trust and How Are They Used in Estate Planning?

When people hear the word “trust”, they might not automatically associate it with estate planning. After all, there are different kinds of trusts! However, it’s important to understand how trusts work, since they can minimize estate taxes and also maximize your estate plan. But why else should you consider establishing one? What are the benefits? How many trusts are there, and what are the differences between them? If you’ve ever asked yourself any of these questions, you’re in the right place! Here’s what you need to know about trusts.

What Is a Trust?

According to Fidelity, a trust is a fiduciary arrangement that allows a third party, known as a trustee, to hold assets on behalf of a beneficiary or beneficiaries. An individual or entity can arrange trusts in many ways and even specify exactly how and when beneficiaries receive assets.

The Different Types of Trusts

Now that we’ve established the basic definition and function of a trust, let’s discuss the different types of trusts that you can establish.

Revocable Trusts

A revocable trust is a living trust that’s established during the grantor’s lifetime. As the name implies, the terms of this type of trust can be modified while the grantor is still alive.

Irrevocable Trusts

An irrevocable trust is the inverse of a revocable trust. Unlike the previous kind, the terms of the irrevocable trust cannot be modified or amended once they’ve been established.

Living Trusts

A living trust, also known as an inter vivos trust, is a legal arrangement where the grantor transfers ownership of their assets into a trust during their lifetime.

Testamentary Trusts

A testamentary trust is established through a person’s will and comes into effect only upon their death. Unlike a living trust, which is created during the grantor’s lifetime, a testamentary trust is created through the instructions contained within the grantor’s last will.

Special Needs Trusts

A Special Needs Trust, also known as a supplemental needs trust, is a legal arrangement designed for the ongoing care and support of individuals with disabilities or special needs. These trusts are established to supplement, rather than replace, government benefits and are subject to specific rules and regulations.

Benefits of Trusts

If you aren’t sure why you should consider establishing a trust, then perhaps you should understand the benefits! While trusts aren’t the best option for every individual and their unique circumstances, they can be a powerful estate planning tool. Some of the benefits of trusts include:

• Asset protection: Certain types of trusts, such as irrevocable trusts, can offer asset protection benefits by shielding trust assets from creditors, lawsuits, and other potential threats. Assets placed in an irrevocable trust generally no longer belong to the grantor and are therefore not subject to claims against the grantor’s liabilities.
• Estate planning benefits: Trusts can be used as effective tax planning tools. In fact, trusts can minimize estate taxes, gift taxes, and income taxes and reduce your overall tax liability. Additionally, certain types of trusts can help reduce estate tax liabilities by removing assets from the grantor’s taxable estate.
• Probate avoidance: One of the primary benefits of trusts is that they can help avoid the probate process. Assets held in a trust generally pass directly to the beneficiaries outside of probate, saving time, money, and potential complications associated with the probate process.
• Control over distribution: Trusts offer flexibility in how assets are distributed to beneficiaries. The grantor can specify conditions, such as age milestones, educational achievements, or special needs, that must be met before distributions are made.

How Trusts Work

A trust has five main components: the grantor, assets, trustee, beneficiary, and terms.

1. Grantor – Put simply, the grantor is the person who creates the trust and places their assets in it. They set the terms and determine how the Trust is managed and distributed after their passing. A grantor can be an individual, company, organization, or even a couple. To establish a trust, a person must be over the age of 18 and of sound mind.
2. Assets – This refers to any property or resources held within a trust. Trust assets can vary widely and may include real estate, stocks, bonds, cash, business interests, valuable personal property, and more. Assets are typically protected from probate and can be managed and distributed according to the grantor’s wishes.
3. Trustee – A trustee is a person or entity appointed to manage the assets held in a trust for the benefit of one or more beneficiaries. Trustees have a fiduciary duty, meaning they must act in the best interests of the beneficiaries and manage the trust assets prudently and responsibly. Trustees are responsible for overseeing and managing the assets and adhering to the terms and instructions outlined in the trust document created by the grantor.
4. Beneficiary – A beneficiary is an individual or entity who is designated to receive the assets in the trust. While a beneficiary is often a single person, it can also be multiple people, a charity, or an organization.
5. Terms – In the context of a trust, “terms” refer to the specific instructions, conditions, and provisions established by the grantor. These determine how the trust operates, how its assets are managed, and how distributions are made to the beneficiaries.

Common Misconceptions About Trusts

“Trusts are only for the wealthy.”

Many people think of trusts as a financial tool for the wealthy. Maybe your mind goes to “trust funds.” However, this couldn’t be more wrong! Trusts can be a beneficial estate planning tool for many people, regardless of their financial status or background. You don’t have to have a lot of assets or money in the bank to establish a trust!

“Trusts are complex and expensive.”

Perhaps in line with the previous misconception, many people may believe that trusts are needlessly complex and expensive. While trusts can be more difficult to set up than a will, costs vary widely depending on your situation. According to Trust and Will, they can cost anywhere from under $100 to upwards or several thousand dollars to establish. Their cost typically depends on multiple factors, including whether you make your trust yourself or use an attorney or estate planner. The complexity may also depend on how many assets you own, where you live, and how many beneficiaries you have.

“Trusts are only for older individuals.”

While trusts are certainly a helpful tool in estate planning, they’re not just for older folks or those nearing retirement! Family trusts can be established at any time and are an especially valuable tool for individuals who want to provide for their loved ones and protect their assets. If someone wants to ensure their assets are distributed according to their wishes, then a trust can be a great option regardless of their age or stage of life!

Conclusion

Remember—trusts are neither for the old nor the fabulously wealthy. They can be effective estate planning tools and can help an individual or entity avoid probate, protect their assets, and ensure they’re distributed according to their wishes. If you’re still on the fence about trusts, then seek the advise of a lawyer or professional estate planner for further guidance. They can help you determine if a trust is right for you and your circumstances.

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