What Is a Trust and How Does It Work?
A trust is a legal entity, created to hold assets for a person referred to as a beneficiary. The person in charge of the trust is the trustee. The person who creates the trust is known as the settlor (or trustmaker, grantor, or trustor). How the trust is structured and what it does varies widely, as detailed in the aptly-named article “Trusts Explained” from U.S. News & World Report. Trusts are used in estate planning to protect assets, reduce estate taxes, help avoid having certain assets go through probate, or assist in validating and settling an estate.
Simply put, trusts are used to transfer assets from one person to another person, or institution, such as a nonprofit or a bank. The grantor establishes the trust and funds it by retitling assets to be owned by the trust. The grantor also chooses one or more beneficiaries and a trustee or a group of trustees, who are in charge of managing the trust.
You might create a trust to benefit a charity and have it managed by a bank or another type of financial institution. If the trustee is an institution, it will name a trust administrator or trust officer, who is in charge of managing the trust.
Placing assets in a trust ensures they are managed as directed in the trust documents, even when you cannot manage them yourself. Assets in a trust do not go through probate, allowing heirs to access assets more quickly than if they were transferred using a last will.
Certain kinds of trusts, and there are many, can be used to remove assets from your estate to reduce estate taxes.
Revocable living trusts provide a lot of flexibility. The grantor may change the terms of the trust or even shut the trust down at any time. The grantor may also be a trustee, so as to maintain complete control of the trust during the lifetime of the grantor. A successor trustee is named to control the trust when the primary trustee dies or becomes incapacitated. However, revocable living trusts generally do not protect assets during your life. Depending on how they are drafted, most do not protect assets even after death.
To protect assets, use an irrevocable trust. The beneficiaries of this kind of trust generally cannot be altered by the settlor once it’s established. The settlor may only change “administrative” provisions of the trust, but not its general (essential) terms. Assets are under control of the trustee only, and that person can be the settlor (YOU). In other words, you can maintain control for your lifetime. Assets in an irrevocable trust are not considered part of a probate estate. Some may be included in your estate for estate tax purposes, and some may not. So picking the right kind of irrevocable trust for your situation is important, and choosing an estate planning attorney that also understands federal taxes is also important.
Wills and trusts are both used to direct how assets are transferred after death. Trusts can be used to manage assets on your behalf, if you become incapacitated as well as after your death. Trust documents do not become part of the public record, while wills do. Wills have to be validated by the court; trusts do not. Some people place most or all of their assets within a trust to keep their business private.
Trusts provide a great deal more control over your assets and maintain privacy for the family. You control how and when assets are distributed in the trust document. For instance, children can be given money over a controlled period of time, rather than all at once. You can also use trusts to pass assets along to a family member with special needs who is receiving government benefits using a special needs trust. Passing assets directly to such an individual could put all of their government support and programs at risk.
To answer the question, “What Is a Trust and How Does It Work?” as it can apply to you, should speak with an estate planning attorney. They can provide you with even greater peace of mind than a will. Note: the above description of a trust is truly “painting with a broad brush,” since there are many legal and tax “moving parts” when it comes to irrevocable trusts.
BOOK A CALL with me, Ted Vicknair, Board Certified Estate Planning and Administration Specialist, Board Certified Tax Law Specialist, and CPA to learn more about estate planning, incapacity planning, and asset protection.
If you liked this article, “What Is a Trust and How Does It Work?” read these additional articles: Must I Sell Parent’s Home if They Move to a Nursing Facility? and When Can Estate Assets Be Distributed? and What’s the Limit for Earning with Social Security?
Reference: U.S. News & World Report (Feb. 7, 2022) “Trusts Explained”