What is a trust?

A trust is a legal entity in which you can place your assets for use by you or your heirs, with rules about which assets go to whom and how they can be used.

Zack Sigel 1600

Zack Sigel

Published November 29, 2018

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A trust is a legal entity in which you can place your assets for use by you or your heirs. Like a last will and testament, a trust has rules about which assets go to whom and how the assets can be used.

But trusts can also be used while you’re still alive. These are called living trusts or inter-vivos trusts. You may use these types of trusts to, for example, create a fund for your children to access when they reach a certain milestone.

The grantor (or trustmaker) establishes the trust and chooses which assets are placed into it. The trustee of the trust may be the same person as the grantor, but it can also be a lawyer, a financial institution, or any other person you choose. Assets in the trust no longer belong to you but to the trust itself. The location of the trust as well as its location, grantor, trustee or trustees, and named beneficiaries, are listed on the respective trust document.

In an irrevocable trust, you relinquish your ability to cancel the trust or modify the terms of the trust in return for immunity from paying taxes on its assets. Another option is the revocable trust, which can be modified by the grantor, including adding or removing assets, changing the beneficiaries of the trust, or updating the rules governing the trust.

In this article:

Benefits of a trust

A trust provides a safe way to allocate your assets and protect them for future use by your loved ones. When you establish the trust, you set the terms, and they are enforced just like a contract. Because the trust is a separate entity, it can’t be modified or revoked by any of its beneficiaries.

(Read more about the different types of assets.)

For example, if you don’t want your children to be able to access the funds in a trust before they turn 30, then nothing they can do will let them access the funds before then. You can stipulate almost any reasonable condition you want; it’s common to lock down assets in a trust for a child’s educational expenses or mortgage payments.

You can also limit the amount a beneficiary can withdraw at any time, which you might want to do if you accidentally raised a spendthrift.

Trusts are especially useful for very large estates, including those that own multiple corporations or real estate properties. That’s because they can usually avoid probate, the legal process by which assets are distributed to beneficiaries when there are claims to the assets are contested. And, unlike probate, the results of which are made public, trust disbursements are private.

Shield from liability and taxes

The assets in a trust are owned by the trust, even though beneficiaries may be named to receive those assets. That means the assets can’t be used to pay liabilities incurred by the beneficiary until the assets have been transferred to him, her, or it, if the beneficiary is an institution. (Liabilities incurred by the grantor may still be deducted from the assets in a revocable trust.)

Capital gains taxes – taxes paid on the increase when an asset grows in value – may be charged to the grantor of the trust if the trust is revocable. In an irrevocable trust, the trust may pay taxes out of the assets in the trust, or the grantor may specify that the beneficiary pays taxes on the gains when the assets are disbursed.

An irrevocable trust can also help a large estate avoid the estate tax, as the assets in the trust belong solely to the trust until they’re disbursed to your survivors. Note, however, as of December 2017, that the estate tax only applies to estates worth $11.18 million or more. Additionally, if your beneficiaries live in a state with an inheritance tax, they may have to pay taxes on the capital gains.

Downsides of a trust

Trusts are not for everyone. For one, they could be expensive to set up and maintain: depending on how and where you establish the trust, you may be charged up to several thousand dollars just to start and several thousand more to maintain the trust.

Additionally, the terms of the trust could be burdensome for your beneficiaries. Consider the nightmare scenario of setting aside money in a trust for your child to use for college only for the child to get seriously ill and rack up huge medical expenses. In that case, it may be difficult or even impossible for the child to access the money to pay his or her medical bills even though it’s just sitting there.

Another concern is that the rules of the trust may be too complicated. For example, if you allocate funds in the trust for your beneficiary to buy a house, will your beneficiary still get the funds if he or she moves into a van down by the river?

Wills are more affordable

If you don’t have a lot of assets to give away, a simple will may be a better option for you; drawing up a will is often much less expensive than establishing a trust. In this case, you can make a will online that will satisfy your estate-planning needs.

You can even create a will for free, although we don’t recommend it because of the expensive potential legal battle that a less-than-ironclad will could cause for your survivors.

Irrevocable trust vs revocable trust

There are many types of trusts, including a bare trust, an absolute trust, and a discretionary trust. But all of these types fall into one of two broad categories: irrevocable trusts and revocable trusts.

Irrevocable trust

The irrevocable trust can’t be modified or revoked except when required by law and even then under very specific circumstances. When you give up an asset to an irrevocable trust, you no longer own the asset, and almost certainly cannot get it back.

As stated above, you won’t be forced to use any assets in an irrevocable trust to pay any debt or liabilities. Think of the trust like another person; if you did the crime, why should the trust pay the fine? Any applicable taxes, like the capital gains tax, will be paid by the trust.

Revocable trust

The revocable trust can be modified by the grantor. Revocable trusts are also called a living trust, in that they can only allocate assets to people while you’re alive. When you die, your revocable trust becomes irrevocable (because you’re dead).

With a revocable trust, your beneficiaries can access the assets as long as the trust’s terms are met. Once an asset has been disbursed to the beneficiary, the beneficiary becomes the owner of the asset even if the grantor wishes to modify the rules of the trust.

Living trusts are also not shielded from taxes. You’ll have to pay income tax on any earnings you receive from assets in the trust.

How trusts work with wills

A last will and testament is a document outlining your desires for after your death. In a will, you can bequeath property to beneficiaries and nominate people to oversee your estate or become guardians of your children.

When a will is executed, one thing it can do is create a trust, which is called a testamentary trust. A will that can do this is sometimes called a pour-over will, because the assets “pour over” into a trust. This makes sure that specific rules govern how your beneficiaries receive and use your assets.

You can require that some assets are given away through the will and that others are put into the trust, or choose that all your assets go into a trust. You can also use a will to move assets into a trust that already exists.

An important reason to use your will to create a trust is avoiding probate, which can be expensive, time-consuming, and painful for your survivals. Assets distributed through a will are subject to probate, but those in a trust are usually not.

Read more about the difference between trusts and wills.

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Takeaway

A trust is a legal entity that can protect your assets for use by you or your loved ones.

Passing down your assets without a trust

A trust may be either too complex or too expensive for many people. There are other ways, some of which are free, that can ensure your beneficiaries are taken care of after you’re gone.

A last will and testament

As stated above, if you leave behind a smaller estate, a will is a much simpler and generally more affordable way to pass assets on to your heirs. A will is a document containing instructions not just about your assets but also what happens to minor children if your spouse is no longer alive. However, your will must be “proved” when it’s executed, which means your assets go through probate.

Life insurance

If you have in-force life insurance coverage when you die, its death benefit will be paid to the beneficiaries named in the policy. Life insurance benefits are tax-free if you paid your premiums with after-tax earnings, and they do not have to go through probate. A licensed representative at Policygenius can help you find a life insurance policy that fits your needs and budget.

Uniform Gifts to Minors Act/Uniform Transfers to Minors Act

The UGMA and UTMA laws (the difference depends on your state) allow you to give an asset to a minor for use when he or she comes of age, or for qualified expenses that benefit him or her. Such transfers function like a trust, with a custodian to oversee the asset and make expenditures on behalf of the child as permitted by the law. Assets given under UGMA or UTMA belong to the minor, but he or she directly spend funds from the asset until reaching the age of majority.

Other ways to pass down assets without a trust

  • Name someone the beneficiary of your checking account, savings account, or retirement account
  • Contribute money to a 529 plan for your child’s future education expenses.
  • Give a gift, the first $15,000 of which is tax-free in 2018 and 2019.
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