Should you create a trust?

People often create trusts to help them manage their assets, but not all trusts are designed to accomplish the same goal. There are a variety of different types of trusts, each designed to address specific needs within your estate plan. The type that’s best for you depends on a number of factors, including your net worth, if you have children or grandchildren, how you want your assets distributed and more.

Here’s a primer on the basics of setting up a trust, along with a description of some common trust types and why you might consider them as part of your overall estate plan.

What is a trust?

A trust is a legal arrangement – and fiduciary relationship – established through a trust agreement or trust document, in which a grantor (also known as a trustor or settlor) gives another party known as the trustee the legal right to hold and manage assets for the benefit of a beneficiary who will ultimately benefit from the trust assets. This arrangement is governed by trust law and plays a pivotal role in asset protection and estate planning.

Creating a trust

A trust is created by the grantor. The grantor writes the rules governing how the trust is to operate and gives instructions to and appoints a trustee. The grantor also names the trust beneficiary. If the trust is revocable, the grantor can change the rules of the trust at any time by amending the trust agreement. If the trust is irrevocable, the grantor can’t make changes to the rules. Revocable trusts and irrevocable trusts each have advantages and disadvantages, including income tax and federal estate tax implications.

When creating the trust, you (as the trust grantor) appoint a trustee. The trustee’s role is to follow the rules laid out by the grantor on how to manage trust assets, when to distribute assets, how much to distribute and to whom to distribute trust assets. The trustee is also responsible for keeping records of the trust and filing annual trust income tax returns. This process is known as trust administration.

The grantor can name any number of individuals or entities as trust beneficiaries. They can be family members, friends, or charities – anyone you want, in any combination. Typically, the trust beneficiaries are lineal descendants in succession (children first, then grandchildren) or charities that the grantor cares about. The trustee is instructed not to distribute assets to individuals that are not named beneficiaries (children’s spouses) or entities that are not named beneficiaries (children’s creditors). This language protects trust assets from a divorce or a creditor of a beneficiary (e.g., a beneficiary other than the grantor).

In addition to naming the beneficiaries, the grantor can state what each beneficiary is to receive out of the trust. This is usually described as the income (interest and dividends that the trust earns) and the principal (initial trust funding amount plus capital appreciation). The grantor can state a beneficiary is only entitled to income or principal or both. This specificity in the legal document ensures that the asset distribution aligns with the grantor’s wishes.

Benefits of a trust

Now you know the foundations, but you may still be wondering why you should create a trust. There are several potential advantages to setting up a trust. First, it allows you to have ongoing professional management of your assets, while still providing flexibility for how you use and distribute these assets. Depending on the type of trusts you create, you can detail specific parameters for how and when assets are distributed to beneficiaries. Trusts may also provide certain tax benefits, such as minimizing federal estate tax exposure, and can help avoid probate court costs.

Moreover, trusts can offer significant asset protection benefits. By placing assets into a trust, you may shield them from creditors and legal claims against beneficiaries. This is particularly important for individuals concerned about preserving wealth for future generations.

Is a trust right for you? And if so, what type of trust?

Below are common types of trusts and how they are used in estate plans:

Revocable living trusts

A living trust, specifically a revocable living trust, is designed to help ensure that assets are used for the benefit and welfare of the grantor during life, and to keep assets out of probate upon the grantor’s death. Revocable trusts commonly contain language to help reduce the impact that federal or state estate tax will have on a married couple’s combined estate.

As the name suggests, a grantor can make any changes to the trust at any time, and because of this, all assets titled to the trust are considered to be owned by the grantor. The grantor will usually serve as the trustee, and the grantor is also the beneficiary of this trust during their lifetime. This type of trust provides flexibility in managing assets and can include both real property and personal property.

A successor trustee is named to manage the trust if the grantor becomes incapacitated or dies. This successor trustee must follow the instructions left by the grantor when making distributions for the grantor’s benefit or to the next level of trust beneficiaries. This ensures that the grantor’s personal information and wishes are respected and that the trust property is managed according to their intentions.

Special needs trusts

If you are concerned about a family member who has a disability that limits his or her ability in any way, you might want to consider a special needs trust. This trust provides financial support to a person who is unable to manage his or her own financial affairs. Special needs trusts are also structured in a way that will allow the beneficiary to qualify for governmental benefits (such as medical and housing benefits) that he or she might be eligible to receive. By setting up this type of trust, you ensure that the trust fund assists without disqualifying the beneficiary from essential services.

Spendthrift trusts

Instead of leaving an heir a large sum of money that he or she may quickly squander, you might consider placing that inheritance into an irrevocable spendthrift trust. The trustee would then distribute the inheritance to the heir later, perhaps when the heir reaches a certain age, or in the form of an income stream over time, or for specific expenses, such as for college or medical expenses, or to buy a home or start a business. Assets that are in this type of trust are not subject to the creditor claims or divorce proceedings of the beneficiary. This form of asset protection ensures that the trust assets are used responsibly and according to your wishes.

Irrevocable life insurance trusts

For high-net-worth individuals, owning life insurance as part of your estate plan is often a wise move, but owning life insurance in your own name can be a big mistake – because the death benefit is subject to estate taxation for the owner. To solve this problem, have an Irrevocable Life Insurance Trust own the policy. Instead of paying for the insurance premium directly, you’d give that money to the trust beneficiaries by placing that money in the ILIT on their behalf. The trustee would use this money to pay the insurance premium. The ILIT could be the beneficiary of the insurance policy, and your heirs could be the beneficiaries of the ILIT.

An additional benefit of an ILIT: Instead of beneficiaries automatically getting the insurance proceeds immediately upon your death, you can instruct the trustee to distribute the money to the heirs more slowly (see spendthrift trust above). This provides controlled asset distribution and can offer additional asset protection.

Charitable trusts

If you want to donate assets to a charity after your death, you might consider establishing a charitable remainder trust or another form of charitable trust. These trusts allow you to contribute to a worthy cause while also receiving tax benefits. They can be an effective way to manage your assets, support charitable giving and potentially reduce your taxable estate.

Testamentary trusts

A testamentary trust is created through your will and comes into effect upon your death. This type of trust is useful if you have minor children or want to set conditions on an inheritance. The trustee manages the trust assets according to your instructions outlined in the trust document, ensuring that your specific assets are handled as you intended.

Other types of trusts

If you are in a second marriage, plan to leave money to grandchildren, or have any other specific estate planning needs, there are a number of other specialized trusts that can help you accomplish your objectives. For instance, a qualified personal residence trust allows you to remove your home from your estate, potentially reducing estate tax liability, while still allowing you to live in it for a specified period.

As you can see, for many people, the question isn’t, “Should I create a trust?” but rather, “Which trust should I create?” Trusts don’t just have to be one-size-fits-all. Depending on your individual needs and financial situation, you can choose a trust structure, or multiple types of trusts, that can help you achieve your estate planning goals. Working with a knowledgeable estate planning attorney can help you navigate the complexities of trust law and ensure that your trust assets are managed effectively.