Understanding Trusts: What You Need To Know

What Is a Trust?

A trust is a legal arrangement that allows assets to be transferred from the trust creator (known as the grantor or settlor) to a trustee, who then manages and administers those assets for the benefit of the trust beneficiaries.¹

Trusts are established to control how assets are distributed and administered during life and after death. The document that creates the trust is called the trust agreement or declaration of trust. It details how the trust assets will be managed and distributed to the beneficiaries.

Trusts can be used for various purposes as part of an estate plan. While a will passes through probate court upon death, assets placed in a trust avoid this process. This saves time, expenses, and public disclosure associated with probate.

Trusts allow grantors to retain control over their assets while alive but distribute them privately and efficiently upon death. Trusts can be customized to meet a grantor's wishes for asset protection, tax minimization, and management of distributions.

What Is the Main Purpose of a Trust?

The primary purpose of a trust is to manage and protect assets for the benefit of one or more beneficiaries. While the specific purposes can vary based on the type of trust and the intentions of the grantor (the person or entity creating the trust), some of the most common purposes include:

• Estate Planning: Trusts can ensure that assets are distributed to beneficiaries as specified by the trustor upon their death, often bypassing the often time-consuming and costly probate process.
• Asset Protection: Trusts can protect assets from creditors, lawsuits, or other financial threats, especially if irrevocable.
• Tax Efficiency: Certain trusts can help minimize estate and gift taxes, allowing more of the grantor's assets to be passed on to beneficiaries.
• Control Over Asset Distribution: Trusts allow the grantor to specify conditions for asset distribution, such as disbursing funds when a beneficiary reaches a certain age or achieves a specific milestone.
• Providing for Minors or Special Needs Individuals: Trusts can be set up to provide financial support for minors until they reach adulthood or for individuals with special needs without jeopardizing their eligibility for certain government benefits.
• Charitable Giving: Charitable trusts are designed to support charitable organizations while providing tax benefits for the grantor.

While these are some of the primary purposes of trusts, the flexibility of trust structures means they can be tailored to serve a wide range of specific objectives and needs.

Depending on your needs and financial situation, you can use different types of trusts. It is important to take the time to research setting up a trust within your estate plan thoroughly. Consider all available options, considering your financial objectives, family, and personal preferences.

How Do Trusts Work?

A Trust is an estate planning tool based on a fairly straightforward principle, but their specific mechanisms vary widely depending on their type and purpose. Here's a basic overview of how trusts work:

1. Establishment: A trust is created when a person, referred to as the grantor or settlor, transfers ownership of specific assets to the trust. This is accomplished through a trust agreement outlining the terms of the trust created with an estate planning attorney.
2. Management: Once the trust is established, a trustee (or multiple trustees) is designated to manage it. This person or entity is responsible for ensuring that the assets within the trust are handled and distributed according to the trust's terms.
3. Beneficiaries: The grantor specifies who will benefit from the trust; these individuals or entities are called beneficiaries. They are the parties that will ultimately receive the assets or income from the trust based on the conditions outlined in the trust documents.
4. Terms & Conditions: Trust documents will outline specific terms and conditions under which the beneficiaries will receive assets or income.
5. Types of Trusts: Trusts can be either revocable or irrevocable. A revocable trust allows the trustor to alter or terminate the trust during their lifetime. In contrast, an irrevocable trust cannot be easily changed or terminated without the beneficiary's permission.
6. Taxation: Depending on the type of trust and jurisdiction, the trust itself may be subject to taxes. In some cases, the income generated by the trust's assets might be taxed in the hands of the trust, while in other cases, it might be taxed in the hands of the beneficiaries.
7. Duration: Trusts can be established to exist for a specific period or indefinitely. Some trusts might be set up to terminate upon a specific event, such as the grantor's death or when a beneficiary reaches a particular age.

How to Choose a Trustee?

Choosing a trustee is a crucial decision when setting up a trust. The trustee is responsible for managing and distributing the assets in the trust according to its terms, so it's vital to select someone reliable, competent, and trustworthy. Here are some key considerations to help you in this decision:

• Understand the Role: Before selecting a trustee, make sure you understand the duties involved. These duties can include managing investments, distributing assets to beneficiaries, preparing tax returns, and more. The role can be time-consuming and complex, requiring a blend of financial acumen, discretion, and integrity.
• Consider Professional Qualifications: Depending on the complexity of the trust, you might want a trustee with financial, legal, or investment expertise. Professionals like attorneys, accountants, or financial planners can be suitable candidates.
• Assess Reliability & Integrity: The trustee must be someone you can trust implicitly. They should have a history of being responsible, ethical, and unbiased.
• Think About Longevity: Since some trusts may last for decades, consider the age and health of a potential trustee, especially if you're thinking about an individual rather than an institution.
• Corporate Trustee Option: Banks and trust companies offer trustee services. While they charge fees, they bring professionalism, neutrality, and continuity. They're especially valuable for complex trusts or if you're concerned about potential conflicts of interest among family members.
• Evaluate Potential Conflicts of Interest: If the trustee stands to benefit from the trust or has relationships with beneficiaries, it might create conflicts of interest.
• Consider Co-Trustees: Having two or more trustees can provide a system of checks and balances. It can also divide the workload. However, ensure co-trustees can work well together to avoid disputes.
• Review Fees: If you're considering a professional or corporate trustee, understand their fee structure. Ensure it's reasonable, given the size and complexity of the trust.
• Discuss With Potential Trustees: Before deciding, have an open conversation with potential trustees. Discuss your expectations and ensure they feel comfortable with the responsibilities.
• Plan for Succession: In the event that your chosen trustee can no longer serve, have a backup plan. Designate successor trustees in the trust document.
• Re-Evaluate Periodically: Over time, circumstances can change. It's a good idea to periodically review your choice of trustee and make changes if necessary.

Remember, the right trustee for your situation will depend on the specifics of your trust, your personal relationships, and your financial circumstances. It's a decision that warrants careful consideration and, ideally, consultation with legal or financial professionals.

Can a Trust be Amended or Revoked?

Yes, you can amend or revoke a trust, depending on the type of trust and the terms of the trust agreement.

Revocable trusts can be amended or revoked by the grantor at any time during their lifetime. To amend a revocable trust, the grantor must sign and notarize an amendment to the trust agreement.

Irrevocable trusts cannot be amended or revoked by the grantor once they are established. However, there are some exceptions to this rule. For example, if the trust agreement allows the grantor to retain the power to amend or revoke the trust, the grantor may be able to do so.

Additionally, suppose there is a change in circumstances that makes it impossible or impractical for the trust to carry out its purpose. In that case, the court may order the trust to be modified or terminated.

If you are considering amending or revoking a trust, consult an experienced estate planning attorney to help you understand the legal implications of your decision.

What Happens to Trust Assets After the Beneficiary Dies?

The fate of trust assets after the death of a beneficiary depends on the terms set out in the trust agreement and the type of trust in place. Here are some scenarios that can unfold:

• Specific Provisions in the Trust Agreement: The trust document may have clear instructions on what happens upon the death of a beneficiary. This is the most common scenario, where the grantor provides explicit directions.
• Contingent Beneficiaries: The trust may list contingent or successor beneficiaries. In this case, if the primary beneficiary dies, the assets will be distributed or held for the benefit of these successor beneficiaries.
• Survivorship Clauses: Some trusts have survivorship clauses, requiring a beneficiary to outlive the grantor or another event by a certain period (e.g., 30 days) to inherit. If the beneficiary dies within this period, the assets would go to other beneficiaries or as otherwise directed by the trust.
• Return to the Estate: If there are no contingent beneficiaries and no provisions about what happens upon a beneficiary's death, the assets might revert to the grantor's estate and be distributed according to their will or, in the absence of a will, the intestacy laws of the jurisdiction. In this case, the assets lose their estate tax exemption.
• Per Stirpes or By Representation: If the trust specifies that distributions should be made "per stirpes" or "by representation," and a beneficiary dies before receiving their share, that share will typically be divided among their descendants (e.g., their children).
• Termination of the Trust: The trust document may state that upon the beneficiary's death, the trust is to be terminated, and the remaining assets are to be distributed in a certain manner.

What is the Difference Between Trusts vs Trust Funds?

Trusts and Trust Funds are often used interchangeably, but there is a subtle difference between the two.

• Trusts are legal agreements establishing a fiduciary relationship between a grantor (the person who creates the trust) and a trustee (the person or entity who manages the trust assets). The trust document outlines the terms of the trust, including the assets transferred to the trust, the beneficiaries who will receive the trust assets, and the trustee's duties and responsibilities.
• Trust Funds are specific types of trusts used to hold assets for the benefit of a beneficiary or beneficiaries. Individuals or families typically create trust funds to provide financial support for minors, special needs individuals, or other beneficiaries.

Pros: What Are the Benefits of a Trust?

Trusts offer a variety of benefits, serving different needs and objectives. Here are some of the advantages of establishing a trust:

• Avoid Probate: Probate can be time-consuming, public, and costly. Assets held in a trust bypass the probate process, allowing for a quicker and often more private distribution.
• Control Over Assets: With a trust, the grantor (the person creating the trust) can dictate specific terms for asset distribution, ensuring that assets are used or distributed according to their wishes.
• Protection from Creditors: Certain trusts can offer protection from creditors. If structured appropriately, assets within these trusts can be shielded from the beneficiaries' creditors, lawsuits, or even divorcing spouses.
• Tax Benefits: Trusts can provide tax advantages, including minimizing estate taxes and facilitating charitable giving strategies.
• Privacy: Unlike wills, which become public records during probate, trusts can maintain the confidentiality of the grantor's wishes and the details of the assets.
• Protection in Incapacity: If the grantor becomes incapacitated, a trust can provide a clear mechanism for managing and distributing assets without needing court-appointed guardianship or conservatorship.
• Multigenerational Planning: Trusts can be structured to benefit several generations, ensuring that assets remain within and benefit the family for an extended period.
• Charitable Giving: Charitable trusts allow individuals to support charitable causes while enjoying tax benefits.
• Special Needs Planning: Special needs trusts are designed to benefit individuals with disabilities. They can provide supplemental resources without jeopardizing eligibility for government assistance programs.

Cons: What Are the Drawbacks of a Trust?

While trusts offer numerous benefits, they also come with potential drawbacks to consider when contemplating their use. Here are some of the disadvantages:

• Setup and Administrative Costs: Setting up a trust requires legal expertise, which means incurring attorney fees. These costs can be substantial, particularly for complex trusts. Additionally, Trusts may have annual administrative costs, such as trustee fees, tax preparation fees, and accounting costs.
• Complexity: Managing a trust, particularly a complex one, can be daunting. There's a need to understand trust laws, the responsibilities and duties of a trustee, tax implications, and more.
• Irrevocability of Certain Trusts: Some trusts, once established, cannot be altered or revoked. While this can serve specific estate planning goals, it can also be restrictive if circumstances change or if there are unintended consequences.
• Potential Tax Consequences: Depending on the type and structure of the trust, there can be tax implications. For instance, trust income may be taxed at higher rates than individual income.
• Loss of Personal Control: For irrevocable trusts, the grantor relinquishes control of the assets transferred into the trust. This means they can't easily access or use those assets, even if they later wish to.
• Rigidity: While trusts can be tailored to specific situations, they can also be rigid in their operation, particularly if not correctly structured.
• Loss of Beneficial Tax Breaks: Assets in certain trusts may not qualify for specific tax breaks, such as the step-up in basis upon death, potentially resulting in higher capital gains taxes for beneficiaries.

When considering the establishment of a trust, it's crucial to weigh these potential drawbacks against the benefits, tailored to individual circumstances and goals. Consulting with an experienced estate planning attorney can help in understanding these intricacies and making informed decisions.

How Much Does a Trust Cost?

Establishing a Trust involves several costs, which can vary widely depending on the type of trust, the complexity of the estate, the attorney's fees, and the jurisdiction. While it's challenging to provide a precise cost without specific details, let's explore the general financial components:

• Attorney's Fees: Legal fees for a Trust may range from a few thousand to several thousand dollars. Fees can be higher for complex trusts.
• Trustee Fees: When a bank or professional trustee manages a trust, their fees are typically calculated as a percentage of the trust's assets. These fees may vary based on the complexity of the trust's assets and the services provided by the trustee. If an individual serves as the trustee, the costs may be lower but could still include compensation and expenses related to trust management.
• Administrative Costs: Filing trust documents with relevant authorities and preparing and filing tax returns for the trust may incur costs. Managing trust finances might also involve accounting fees, particularly if the estate is extensive or complex.
• Asset Management Fees: Investment advisory fees will apply if the trust's assets are actively managed. Property management fees may be incurred if real estate is held within the trust.
• Ongoing Operational Costs: Additional expenses may be incurred in managing and executing income distributions, particularly if professional services are required for detailed record-keeping.

Given the range and variability of costs involved in setting up and maintaining a Trust, obtaining detailed estimates from attorneys, trustees, and other professionals is crucial before proceeding.

How Are Trusts Taxed?

Trusts can have various tax implications based on the jurisdiction, the type of trust, and how they are administered. Here are some of the general tax considerations:

Trust Income Taxation

• Trusts, like individuals, can earn income. Depending on the trust type and distribution structure, this income may be taxable to the trust itself or the beneficiaries.
• If the trust retains its income (doesn't distribute it), then the trust pays taxes on it. Trust tax rates can be higher than individual rates, and they reach their highest bracket at a lower income level.
• If the trust distributes its income to beneficiaries, the income is typically taxed to the beneficiaries at their individual tax rates.

Tax Filing

• Revocable Trusts: Generally treated as a "grantor trust" for tax purposes. This means all income, deductions, and credits are reported on the grantor's personal tax return, and the trust doesn't pay income taxes.
• Irrevocable Trusts: Typically considered a separate tax entity. They usually require their own Tax Identification Number (TIN) and need to file their tax returns.

Gift Tax Considerations

• When assets are transferred into an irrevocable trust, it might be considered a gift. Depending on the value of the assets and the applicable exemption amounts, gift taxes may be due.

Estate Tax Considerations

• Revocable Trusts: Assets in these trusts are generally included in the grantor's taxable estate upon death, possibly subjecting them to estate taxes.
• Irrevocable Trusts: Assets transferred into these trusts are usually removed from the grantor's taxable estate, potentially reducing estate tax liability.

Generation-Skipping Transfer Tax (GSTT)

• The GST tax applies to transfers that "skip" generations and is levied on amounts passed on to beneficiaries two or more generations below the donor, whether directly or in trust. There's an annual exclusion and a lifetime generation-skipping tax exemption, similar to the gift tax.

State Considerations

• State tax laws can vary significantly. Some states have their own estate or inheritance taxes, while others might tax trust income differently than the federal government.

Capital Gains

• Trusts can buy and sell assets, resulting in capital gains or losses. How these are treated and taxed can depend on factors like trust type, duration of asset ownership, and distribution decisions.

Foreign Trusts

• Trusts created outside one's home country can have unique reporting requirements and tax implications. It's crucial to understand these if considering or being involved with an international trust.

Due to the complexities and potential for significant tax liability, it's crucial for individuals considering a Trust to work closely with estate planning attorneys, tax professionals, and financial advisors. These professionals can help design the trust to maximize tax efficiency and minimize estate taxes while meeting the grantor's family and philanthropic legacy objectives.

Is a Trust Right for You?

Whether or not a trust is worth it depends on your individual circumstances and financial goals. Trusts can offer many benefits, including asset protection, tax benefits, control over how your assets are distributed, privacy, and flexibility. However, they can also be complex and expensive to create and maintain.

Here are some things to consider when deciding whether or not a trust is worth it for you:

• The size and complexity of your estate: If you have a relatively small and simple estate, a trust may not be necessary. However, if you have a large or complex estate, a trust can help you to manage and protect your assets more effectively.
• Your family situation: If you have minor children or disabled family members, a trust can help ensure their needs are met after you are gone. A trust can also protect your assets from creditors or lawsuits if you have financially irresponsible family members.
• Your tax situation: Trusts can be used to reduce estate and gift taxes. However, it is essential to consult with a tax advisor for tax planning to determine how a trust would affect your tax liability.
• Your financial goals: Trusts can be used to achieve various financial goals, such as providing for your grandchildren's education, funding a charitable legacy, or ensuring that your assets are distributed to your beneficiaries according to your wishes.

If you are considering creating a trust, it is crucial to weigh the pros and cons carefully and consult an experienced estate planning attorney to discuss your specific needs and goals. An attorney can help you to determine whether or not a trust is right for you and to create a trust that meets your specific needs.

Trusts can be a valuable tool for managing and protecting assets, but they are not right for everyone. It is important to weigh the pros and cons carefully and to consult with an attorney and financial advisor before making a decision.

Sources

1. Cornell Law School - Trust. https://www.law.cornell.edu/wex/trust.