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What is a Trust & How Does a Trust Work?

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What is a Trust & How Does a Trust Work?We all hear about trusts from time to time, but what is a trust and how does a trust work?  Are they only for the wealthy, or can they also be appropriate for people of more moderate means?

What is a Trust?

A trust is basically an agreement whereby a person transfers property to another person or company that holds and manages the property for the benefit of another person or entity.

There are generally 3 parties involved with a trust:

  • Grantor, Trustor or Settlor: The person transferring property to the trust
  • Trustee:  The person or company who manages and controls the trust assets
  • Beneficiary:  The person or entity who benefits from the trust property

How Does a Trust Work?

The grantor, trustee, and beneficiary do not always have to be different people or entities.  In fact, all three could be the same person.  Additionally, there can be multiple grantors, trustees, and beneficiaries.

The grantor specifies in the trust agreement who the trustees are, who the beneficiaries are, and how the trust property is to be managed and distributed.  The trustee then manages and administers the trust property for the benefit of the beneficiaries according to law and the terms of the trust agreement.

Trust property can include just about anything, including real estate, businesses, life insurance, and securities.

Uses of Trusts

A trust is a legal entity that comes in all shapes and sizes.  Trusts are used to accomplish a number of important objectives, including the following:

  • Avoid the publicity, cost, and delay of probate.
  • Reduce gift, estate , GST, and income taxes
  • Protect assets from lawsuits and creditors
  • Manage property for a minor or someone who has special needs or is incapacitated
  • Dictate when, how, and to whom you want your assets distributed to after you die
  • Provide for loved ones
  • Accomplish charitable and philanthropic goals

There are even trusts to care for pets.

Revocable or Irrevocable Trust

A trust may be revocable or irrevocable.  The terms of a revocable trust can be amended or revoked after it is established.  The terms of an irrevocable trust generally cannot be revoked or modified once it has been created except in limited situations outlined in the law or trust agreement.  Some trusts start off as revocable trusts but become irrevocable at a later date.

Inter-vivos or Testamentary Trust

A trust can be created during the life of the grantor or at death.  An inter-vivos trust is a trust created during the life of the grantor and a testamentary trust is a trust created at death through the will of the deceased.

Not just for the Wealthy

Some people mistakenly assume that trusts are only for the wealthy.  It is definitely true that the financial affairs of the wealthy do tend to be quite complicated and oftentimes involve the use of one or more trusts in order to accomplish their charitable, legal, tax, and personal goals.

However, in many cases, trusts are appropriate for people of much more modest means.  I for one am not a wealthy person or a trust fund baby.  I don’t have a yacht, private jet, or 57 Cayman Island bank accounts.

However, I do have a revocable living trust, and many of my assets are titled to this trust.  Its main purpose is simply to help my wife and I avoid probate when we die.

Not everyone needs a trust.  However, you shouldn’t assume that you don’t need a trust simply because you are not rich.

Here are a few examples of when a trust can be useful:

  • There is a disabled person in your family
  • Planning is required to avoid paying estate taxes
  • You are worried about heirs squandering or losing their inheritance and want to put in place certain restrictions and protections.
  • Protecting your assets is important to you
  • You want to avoid probate
  • You want to provide for a surviving spouse for his or her life after which you want your remaining assets to pass to your children.
  • Your preference is that heirs do not receive all assets directly and immediately after your death.  Perhaps you want your children to receive a portion of their inheritance when they graduate from college, a portion when they get married, and the rest when they have children or are ready to purchase a home

Retitling Assets to a Trust

It’s important to remember that failing to transfer assets to the trust once it has been created will most likely defeat the purpose of creating the trust in the first place.  It’s an easy mistake to commit and I see people make this blunder all the time.

My wife and I set up a revocable living trust and transferred many of our assets to it in order to avoid probate.  However, if none of our assets were titled to the trust, upon our deaths, these assets would pass outside of the trust and potentially be subject to probate.

How to Set up a Trust

It is generally advisable to seek out appropriate legal and tax advice when dealing with a trust.  An  estate planning attorney can review your personal circumstances and let you know if a trust is appropriate for you as part of your estate planIf you do need a trust set up, an attorney can draft the appropriate trust agreement for you.

Alternatively, there are a number of online services that can also help you create a trust at a fraction of the price an attorney would likely charge you.

Some of the online services out there include:

One downside to using an online service is that you generally don’t have the benefit of an actual attorney reviewing your documents to make sure they are legally valid and accurately reflect your wishes.

However, some options, such as Rocket Lawyer, also give you the option of having an actual attorney review your documents, which is great.

What are your thoughts about trusts?  Have you ever considered creating a trust?  Leave a comment below!

Image: Jim Martin/Bigstock


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