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Trusts 101: Understanding the Basics

Category: Estate planning

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Having an estate plan in place is a basic responsibility of being an adult. If you don't already have your own estate plan, now is the time to get started. It’s not just something for retirees to tackle. If you have sizable assets to pass on someday or dependents that rely on you now, a trust may be good protection to explore. In addition to having a last will and testament, many people choose to have at least one type of trust included in their estate plan.

By having a better understanding of what a trust is, why you may need one, and how to go about creating one, you can make sure your assets and best interests are protected in the event of your passing.

What is a Trust?

In a nutshell, a trust is a legally binding document that outlines who should receive property and/or other assets in the event of the trustor's passing. This can include detailed instructions regarding who will receive funds from your bank accounts, who will inherit your properties, and who will take on any other assets you may own. A trust can be used to help streamline and simplify things for your loved ones.

In understanding how a trust operates, it can also be helpful to familiarize yourself with some basic definitions:

  • Beneficiary - the person (or people) who will receive benefits outlined in the trust document
  • Trustee - the person or people designated to carry out the wishes of the trust
  • Trustor (also known as donor or grantor) - the person creating the trust

The Difference between Trusts and Wills

This is a common question, as there are a lot of similarities between the two. Unlike a last will and testament, a trust is a non-public document. This makes it an ideal option for those who want to maintain more privacy when it comes to their financial affairs after they pass.

Also, a trust doesn't typically have to go through probate—which can drastically simplify and speed up the process by which your loved ones are able to receive their inheritances.

Additionally, various types of trusts can be used to protect and transfer assets while you’re alive, with tax advantages. Wills only take effect after death.

Benefits of a Trust

There are many reasons to include a trust as part of your estate plan. For starters, having a trust in place is really the only way to guarantee that you'll have the final say over what happens to your assets and properties. For those who establish a trust fund as part of the document, this can also be useful to ensuring that beneficiaries use their inheritances as wisely as possible.

Some other benefits of having a trust in place include:

  • making sure your property is protected from creditors
  • ensuring that your properties are managed how you want them
  • optimizing the tax situation for yourself and/or your beneficiaries

What is a Trust Fund?

Essentially, this is a bank account that is opened by the trustor. In the trust document itself, you can outline how much of the money in the trust fund you want distributed to your beneficiaries and in what timelines. This prevents them from inheriting a large sum of money all at once. Instead, they can receive smaller trust fund payments at increments determined by you. This is a common set-up made by parents who want to provide their children with financial support after they pass but want to avoid passing the entire inheritance on at once.

The Two Main Types of Trusts

Now that we’ve covered some of the basics, let’s look at the types of trusts you may want to explore further with an attorney. When it comes to types of trusts, there are two main categories: living and testamentary.

Living Trusts

A living trust refers to one that can be carried out while the trustor is still alive. For example, if you were to slip into a coma, a living trust could be used to carry out your wishes.

Living trusts can also be revocable or irrevocable. A revocable trust is one where the terms can be changed or updated at any time, whereas an irrevocable trust is permanent and cannot be changed without the consent of all beneficiaries involved.

Testamentary Trusts

A testamentary trust, on the other hand, is only carried out when you pass away.

Other Common Types of Trusts

While the basic types and categories of trusts are outlined above (living versus testamentary and revocable versus irrevocable), here are some other more specific types of trusts that are quite common and may apply to your situation.

Revocable Living Trusts

The single most common type of trust that many people have in place is known as a revocable living trust. The main purpose of this type of trust is being able to designate what will happen if you become incapacitated for any reason during your lifetime. If you fall into a coma, for example, a living trust can be used to ensure that your assets are managed as you want them to be. Meanwhile, the revocable aspect of the trust means that you can continue to make changes to the document as needed.

Charitable Remainder Trusts

Another common type of trust is the charitable remainder trust. The purpose of this is to allow you to make a charitable donation now rather than waiting until after your passing. The benefit of taking this route is that you'll be able to enjoy the tax deduction associated with this action while you're still alive. Meanwhile, your trust can outline how much additional money should go to the charity of your choice in the event of your passing. This type of trust is a win-win for all parties involved, making it a common choice.

Spendthrift Trusts

If you'd like to distribute income from a property directly to one of your beneficiaries rather than transferring ownership of the property directly to that person, a spendthrift trust may be right for you. 

Keep in mind that it is perfectly acceptable (and in some cases encouraged) to have more than one type of trust in place. At the end of the day, it's all about figuring out your needs and making sure those are covered in your estate plan.

Less Common Trust Situations

There are many types of specialized trusts that are available to suit special circumstances as well. While it's not extremely likely that you'll need to use any of these, it's helpful to be aware of them should a special circumstance arise.

Generation-Skipping Trusts

These are also known as dynasty trusts, and they're ideal for situations where you may want to pass assets onto grandchildren or even great-grandchildren rather than directly to your own children. This type of trust requires beneficiaries to be at least 37.5 years younger than the trustor.

Irrevocable Life Trusts

For those with life insurance policies in place, an irrevocable life trust can sometimes be a sensible option. Specifically, this type of trust allows you to remove your life insurance policy from your taxable estate by surrendering your policy ownership rights. This can be a great way to provide your inheritants with tax-free income after you pass away, but it's not right for everyone.

Family or Bypass Trusts

For married couples who have a great deal of assets, there is always concern over being subjected to a high estate tax upon passing. This is where a family or bypass trust can come in handy. This trust allows surviving spouses to utilize income from a property without actually transferring ownership into their name. As a result, they can enjoy numerous tax exemptions at both the federal and state levels.

Steps for Creating a Trust

Now that you have a better understanding of what trusts entail and why you should have one, it's about time to get drafting. Before you get started, there are a few tips worth keeping mind.

1. Consult a Professional Estate Attorney

With so many different trust options available, it can be difficult to know which type of trust is best for you. This is where turning to an estate-planning professional, such as an attorney, can be helpful. These professionals will be able to assess your unique financial situation and help you decide on the type(s) of trusts that will best suit your needs, giving you peace of mind as you move forward.

2. Consider Potential Tax Implications

The tax implications of a trust should only affect you if you set up an irrevocable living trust, but since this type of trust is so common, it's important to keep this in mind. Specifically, an irrevocable trust will mean not only giving up ownership of the properties outlined in your trust, but also passing on the tax implications that come along with maintaining them. You may want to consider how these tax responsibilities could affect your beneficiaries.

3. Understand Laws That Could Affect Your Trust

There are plenty of federal laws that come into play when it comes to legally establishing and carrying out a trust. However, some states have their own laws regarding trusts that you will need to be aware of and follow as well. Taking the time to become familiar with your state's trust laws is a must. This is where having an experienced attorney can also be helpful.

4. Choose a Reliable Trustee

One of the more important decisions you'll make when it comes to writing your trust (aside from who will inherit your assets) is choosing a trustee. Specifically, a trustee is the person or people who will be responsible for carrying out the wishes outlined in your trust.

A trustee can be a family member, a friend, or even a hired professional (such as an attorney or bank). There are many things you'll want to keep in mind when deciding on a trustee. Ideally, a trustee should have:

  • excellent communication skills
  • a basic understanding of finances and accounting
  • a commitment to carrying out your trust
  • a strong attention to detail

Do you know anyone who fits this criteria and who you would feel comfortable appointing as a trustee? If so, then you may want to speak to him or her about taking on this very serious responsibility. On the other hand, some people prefer to appoint a professional third-party as a trustee (such as a bank or lawyer) rather than somebody they know personally.

5. Thoughtfully Consider Your Assets and Beneficiaries

Deciding on who will receive what in the event of your passing is often the most difficult aspect of creating a trust. In making these decisions, it can be helpful to make a detailed list of your individual assets as well as a list of potential beneficiaries. From there, you can work on deciding who should receive what. Be sure to also consider charities as potential beneficiaries as well.

6. Save Your Trust in a Secure Location

Even once your trust is drafted and completed, it's important to have it saved in a secure location. Many people choose to print out paper copies of their trusts, and that's fine as long as they're kept in a safe place (such as a lock box or a physical safe). It is also recommended, however, that you save a digital copy of your trust along with the rest of your estate planning documents.

This is where the Cake platform can be extremely useful (you’re on the Cake blog now). Our end-of-life planning website makes it easy for adults of all ages to be proactive about their planning. Cake helps you create, upload, and save documents, including your complete trust, so you can share 24/7 access with loved ones. Beyond estate planning, we also help you create documents that express your final wishes for healthcare, financial, funeral, and legacy decisions.

With so many different types of trusts, the whole process of creating one can be a bit confusing. This is especially true if you'll need to create more than one type of trust to carry out all your wishes. By having a better understanding of your options, working with an experienced professional, and using a secure platform like Cake to share all your documents—you'll be in great shape! Create your free Cake account.


Sources

  1. "Estate Planning: Types of Trusts." CNN Money. March 24, 2017. www.money.cnn.com/pf/money-essentials-trusts/index.html
  2. "How Are Trust Fund Earnings Taxed?" Investopedia. February 6, 2018. www.investopedia.com/ask/answers/010815/how-are-trust-fund-earnings-taxed.asp
  3. Kaminsky, Michelle. "Top 5 Benefits of a Living Trust." LegalZoom. October 2016. www.legalzoom.com/articles/top-5-benefits-of-a-living-trust

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