What Is A Trust And Why Should I Create One?
Sarah Li Cain4-Minute Read
When you hear the words “trust” or “trust fund,” what comes to mind? Most folks imagine tens of millions of dollars passed down through generations.
The truth is, anyone can set up a trust to benefit the future of their loved ones. Let’s take a look at what a trust is and why it might be a good idea for you to create one.
What Is A Trust?
Trusts are legal entities that create a third party to own property for the benefit of a beneficiary. Trusts can be made for a variety of purposes and with provisions about when and how assets should be distributed to beneficiaries.
The point of creating a trust is to ensure legal protection of the assets of the trustor – the person or group creating the trust – and that the assets are distributed according to their wishes. It can save time by reducing paperwork and in some cases, trusts can shield assets from estate or inheritance taxes.
How Does A Trust Work?
Anyone can create a trust by drafting a document and signing it – an estate planning attorney can advise and help you create one. Typically, there is no need for the courts to get involved unless someone challenges the trust.
When creating a trust, you need to designate a trustee who will oversee it once it’s in effect. This person has a fiduciary responsibility to act in the best interest of the trust and needs to file tax returns on any earned income.
Once the assets housed within a trust has been fully distributed, the trustor will need to fill out a formal revocation form in order to dissolve the trust.
Types Of Trusts
There are many types of trusts which are most commonly used for estate planning purposes. Many of the following types of trusts will have some significant overlap.
Living Vs. Testamentary
Sometimes referred to as an inter-vivos trust, a living trust is a written document where the distribution of assets is outlined, which can either distribute assets to a beneficiary while you're alive, or after you pass. A testamentary trust only goes into effect after you pass. In other words, you can designate how assets are distributed to beneficiaries upon your death.
Revocable Vs. Irrevocable
Trustors can create trusts over which they retain control until their death. A revocable trust is one that can be changed and has parts that can be canceled. Any assets that continue to be accumulated are the trustor’s up until death.
An irrevocable trust on the other hand, can’t be changed once it’s established and assets housed inside it can’t be moved for any reason. Due to the flexibility and ability to access income for the trustor, many feel that a revocable trust is better.
Funded Vs. Unfunded
A trust can exist without anything in it, and assets can be immediately transferred when the trustor has passed. That is, an unfunded trust can become a funded trust once assets are added to it. It can also be used to transfer assets immediately to create a trust fund, depending on its purpose.
Why Should I Consider Creating A Trust?
The following are the most common reasons for creating trusts:
Attorneys and accountants use trusts to shield their clients from estate and income tax liabilities. In addition, a trust is considered an excellent way to reduce capital gain income taxes that the trust’s beneficiaries might need to pay.
Planning For Special Needs
If a dependent receives Social Security disability benefits, the trustor may want to create a trust that offers the beneficiary income without jeopardizing their benefits eligibility. Furthermore, parents may establish a trust for minor children in the event they die before they reach the age of majority.
While many associate trust funds with the ultra-wealthy, many middle-class families establish trusts to ensure their assets can help provide their children with ample resources, such as college expenses.
Depending on where you live, your will may be read publicly. Proceedings of the court system are public in all states. This includes probate court, where estates are overseen. If you want your financial matters to remain private, consider setting up a living trust. Since the trustor’s death automatically transfers ownership of the assets, it never comes under the probate court’s jurisdiction.
Trusts are often used to preserve part of a trustor’s assets while allowing them to qualify for nursing home benefits through Medicaid. Considering Medicaid’s rules need to be followed closely, it’s a good idea to speak with an attorney who specializes in Medicaid planning if you’re looking to seek this type of protection.
What Is A Trust Fund?
A trust fund is an estate-planning option formed to hold assets or property with help from a neutral third party. For example, parents or trustors may house their assets into a trust to protect their dependents’ Social Security disability benefits or for minor children. Assets can include stocks, investment properties, life insurance policies and savings accounts.
What Is A Living Trust?
A living trust is also referred to as a revocable trust. These types of trusts allow a trustor to retain control over their assets throughout their lifetime. For instance, a surviving spouse wants to leave her child the family home while retaining all ownership rights during her lifetime but doesn’t want it to go through the probate process after she dies.
What Is A Life Insurance Trust?
Some trusts hold life insurance policies purchased by and written on the trustor for the benefit of their beneficiaries. It would be considered a revocable or living life insurance trust if the trustor makes any changes to the policy. A trustor who can’t do anything else other than paying the insurance premium would have created an irrevocable trust.
Summary: Trusts Are An Important Planning Vehicle
Creating a trust can benefit you and your beneficiaries, whether it’s to keep control of assets, provide for minor children or shield assets for tax purposes. Since estate planning matters are complicated, it’s a good idea to seek the advice of an experienced estate planning attorney.
Managing assets is one of the most important parts of your personal finances. You can learn more about how to improve your financial life at the Rocket HQSM learning center.
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