What Is a Trust? Learn More About Proactive Estate Planning 

What Is a Trust?

A trust is a legal arrangement in which the holder of an asset—the trustor—gives another person the right to control those assets on behalf of a beneficiary. The person or entity that controls the trust assets is called the trustee. A trust can contain any type of assets, such as cash, shares of stocks and mutual funds, or real estate. 

Many people believe you need large amounts of wealth to establish a trust. But trusts can be a valuable tool for individuals of any means to provide for their families and protect their resources after death. 

Investor and cofounder of Lyfe Accounting Sean Standberry says, “I don’t care if you have a million dollars or $10,000. When you die, you can’t take it with you. And someone’s going to want your money or your assets when you pass away. So you want to leave this world as organized and as clean as possible because if you don’t, then you are risking your family and your friends fighting over you and your assets.”

While trusts can contain vast sums of money, they can also be opened to protect modest amounts of money and ensure your assets are used the way you intended. So how does a trust work? Keep reading to find out. 

What Is the Purpose of a Trust?

Allocation of Resources After Death

Many people leave behind resources after passing away. Whether it’s a few thousand dollars or a million, you’ll want that money to go to the right people and be used appropriately. A trust allows you to name the people you want to inherit your assets and communicate how much money each person will receive. 

Not only can you designate who will inherit your money with a trust, but you can also specify when and how your beneficiaries use the money. You can set up a trust specifically for helping your beneficiaries with education, purchasing a first home, or even getting together for the holidays. A trust ensures your descendants or beneficiaries have access to the things that matter to you. 

“If you want your future generations to know who you were and what you cared about, this is your opportunity to do it,” says tax attorney and founder of Anderson Business Advisors Toby Mathis. “So let’s say, for example, I love traveling. And I say to my future beneficiaries, I want you to travel. So every year, if you want to leave the United States, the trust that I set up will cover the cost to leave the United States for two weeks a year as long as you’re traveling and learning other cultures.”

Charitable Giving

Trusts are a useful tool for supporting a charity or cause you believe in. Rather than donating a one-time sum, setting up a charitable trust allows you to support a non-profit or charity for an extended period of time. It’s possible to set up a charitable trust with specific guidelines for how the organization can use the money. 

One of the most well-known charitable trusts is the Bill and Melinda Gates Foundation Trust—founded by Bill and Melinda Gates and partially funded by Warren Buffet. Buffet and the Gates have declared their desire to donate the majority of their wealth to charity. The trust is set up in a way that requires the money to be used within 20 years from the passing of the founders. The trust will ensure that their wishes are carried out after their deaths. 

Tax Reduction

Irrevocable trusts allow individuals to leave assets to their loved ones without being subject to an estate tax. 

“Estate taxes are imposed on the value of the assets that someone owns at the time of their death,” says Suzanne Saylor, partner at law firm Samuel, Sayward, and Baylor. “Using an irrevocable trust for estate tax planning is planning to remove assets from a person’s taxable estate, so the state tax is reduced.” 

The U.S. federal estate tax is between 18% and 40%, but the tax only applies to assets worth over $12.06 million. Individuals leaving behind large amounts to their loved ones can use irrevocable trusts to reduce the worth of their assets, allowing their loved ones to avoid a heavy tax. 

17 U.S. states charge an additional estate or inheritance tax. While state taxes are typically much lower than federal taxes, the threshold is also lower. Estates worth an excess of $1 million can usually expect to pay taxes after the death of the state owner if living in an estate tax state. 

To reduce capital gains taxes, many individuals set up charitable trusts. Charitable trusts are not subject to capital gains taxes. Most charitable trusts designate a charitable beneficiary and a non-charitable beneficiary, such as the trustor’s family. This allows trusts to benefit both a charity of your choosing and your loved ones while also reducing taxes.

Avoid Probate

Probate is the legal process in which the state determines who your assets pass to after you die. It can be long and complicated. In some cases, probate can leave loved ones without resources until the process is complete. 

“In order to avoid that, what you can do is create—as part of your estate plan—what we call a revocable living trust, and you deed your real property to the revocable living trust so when you pass away, you pass away essentially without any assets or real assets in your own name. They’re in the name of the trust,” Greg Maxwell of Amicus Law Firm says. “And so when you pass away, the trust has a successor trustee listed on that document who then distributes the assets in the trust per the terms in the trust.”  

Understanding the Different Types of Trusts

There are dozens of types of trusts. Each type serves a different purpose. The first decision you must make is whether you want a revocable or irrevocable trust. The main difference between revocable and irrevocable trusts is their ability to be altered. 

A trustor who sets up a revocable trust may change the terms of the trust at any point during their lifetime. Upon the trustor’s death, the trust becomes irrevocable, meaning the terms of the trust cannot be changed. 

A trustor may also set up an irrevocable trust during their lifetime, which means they cannot change the terms. The benefit of an irrevocable trust is that it is not considered part of your taxable estate and cannot be used to settle any debts upon your death. On the other hand, revocable trusts are subject to estate taxes and are unprotected from creditors. 

“Asking what kind of trust you need is very similar to saying, I need a car,” says the president of Gannon Wealth Security Partners, Jim Evans. “Well, do you need a car for storage capacity, multi-passenger, fuel economy, or are you looking for a lot of power? You know, what type of vehicle are you looking for? So when you think about trusts, just think, what type of vehicle am I looking for?”

Here are a few of the most common types of trust funds that meet the needs of individuals in a variety of circumstances: 

Fund Structures

• Bypass (or Credit Shelter) Trust: This type of trust allows a surviving spouse to receive funds after their spouse’s death while limiting estate taxes. A bypass trust is irrevocable.
• Irrevocable Insurance Trust: An insurance trust is for the purpose of removing a life insurance policy from a taxable estate, allowing beneficiaries to use the funds from the insurance policy without being taxed. 
• Charitable Trust: Charitable trusts benefit a charity or non-profit organization. These trusts also lower estate taxes. A charitable trust can be designed as a lead trust or a remainder trust. A lead trust designates a certain amount of money to benefit a charity while the remainder goes to family or other beneficiaries. A remainder trust designates a certain amount of money to go toward your beneficiaries, while the remainder goes to a charity. Charitable trusts are always irrevocable.
• Qualified Terminable Interest Property Trust (QTIP): A QTIP directs assets to beneficiaries at different times. Normally, a spouse is the first beneficiary to receive funds, often resulting in a lifelong stream of income. Then, children receive the remaining funds after the spouse dies. QTIP trusts are irrevocable.
• Spendthrift Trust: A spendthrift trust protects its beneficiaries from bad spending habits or creditors. The funds in this trust are distributed to the beneficiaries incrementally, so an inheritance cannot be spent all at once. If the beneficiary gets into financial trouble, creditors cannot come after the money in the trust. A spendthrift trust can be revocable or irrevocable.
• Estate Trust: Estate trusts, or testamentary trusts, are created after the trustor’s death as directed by a will. Because estate trusts are formed after the trustor passes away, these trusts are irrevocable. 

How to Set Up a Trust

1. Choose a trust fund structure that matches your goals.

First, decide which type of trust you’ll create. To do this, think of your purpose for creating the trust. Is it to benefit a spouse? Children? Grandchildren? Someone else? How would you like those people to spend that money, and what type of protections will they need? These questions will guide you to the right type of trust. 

The list of possible trust fund structures is far from complete. If none of the options meet your goals, speak with an estate planner or a lawyer who specializes in trusts to find a structure that fits your circumstances. 

2. Work with a lawyer or an online service to create a trust document.

You’ll need a document that states the names of the trustor, trustee, successor, and beneficiaries. The document should also establish which properties and assets are to be held by the trust, how much money will go to each beneficiary, and what the beneficiaries can use the money for. 

Working with a lawyer to create your trust will ensure the document includes all necessary language for your desires to be carried out. For a more affordable option, look at sites like FreeWill and LegalShield—they allow you to create a DIY trust.

To make your trust official, don’t forget to sign and notarize it after everything is complete. 

3. Transfer assets to the trust.

You’ll need to transfer ownership of each asset listed in the trust agreement. The best way to do this is to create a bank account in the name of the trust. Then, transfer funds into the bank account. If the trust includes property, like a home or vehicle, you’ll need to get a new title of ownership that lists the name of the trust as the owner rather than yourself.

Don’t Leave Your Assets Unprotected

Planning for your future now helps you care for your family and continue supporting the values you believe in, even after you pass on. If you were to pass away without a plan in place, the burden of distributing your resources and continuing your legacy will fall to your loved ones, which can be difficult while they are also potentially coping with your loss. 

It’s best to prepare now, so you know your loved ones will be cared for after your death. With a trust in place, friends and family can focus on honoring your memory without being bogged down with the legal stuff. 

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