A trust is a legal entity that holds and manages real or personal property, both tangible and intangible: real estate, money, stocks and bonds, personal possessions, etc. Property put in a trust transfers it from an individual's personal ownership to that of the trust. The person who creates the trust is called its grantor (or creator, donor, settler, or trustor). Anyone who eventually benefits from a trust's proceeds is called a beneficiary.
Trusts come in different forms, and there is no such thing as a standard trust. Living trusts and testamentary trust are two of the most popular, as are revocable trusts and irrevocable trusts. Each has advantages and disadvantages. As long as the trust conforms to state law, any provision can be included.
Trusts serve different purposes. Among them:
Helping to reduce estate taxes
Funding the education of children and grandchildren
Providing for people with disabilities
Helping those who might have trouble managing their own affairs or handling money
The person or institution overseeing the trust – a friend, lawyer, relative, bank, corporation, or in many cases, the grantor – is called the trustee. While retaining legal title to the trust, the trustee has less than full ownership of it and can only use its property for the purposes explicitly defined by the grantor in the trust document.
All decisions related to the trust should be made only for the benefit of the trust and its beneficiaries, who maintain equitable title to its assets.
Living and Testamentary Trusts
Two of the most common types of trusts are the simple living trust and the testamentary trust. The living trust – or inter vivos trust – is created, funded and managed during a grantor's lifetime. A testamentary trust, created in a will or living trust, is only activated after the grantor dies and the related will is probated.
Living Trusts to Avoid Probate
Property placed in a living trust must go through a change of ownership from the grantor to the trustee (who is often one and the same person). In terms of estate planning, if the grantor is also the trustee, a successor trustee is usually named in the trust document. The successor is designated to take over the trust in the event of the original grantor/trustee's death or incapacity.
If the trust is created specifically to avoid probate, it must be a living trust. But while a living trust can bypass probate, it does not necessarily provide any special tax advantages. All income created by the trust is taxed to the grantor while alive, and all assets are subject to federal estate taxes upon the grantor's death.
Testamentary Trusts for Minor Children
A testamentary trust is often set up to manage assets inherited by minor children and is used in estate planning in conjunction with a will, which must go through the probate process. A testamentary trust can be funded from the assets of a decedent's estate, or from the proceeds of a life insurance policy, an IRA, a profit-sharing plan, etc.
Generally, the trustee of a testamentary trust is named in the decedent's will. If not, or if the named trustee is unavailable to serve, the probate court will appoint one to administer the trust's provisions. In this respect, the trustee performs actions similar to those carried out by the executor of a will.
Revocable and Irrevocable Trusts
Trusts may be revocable, meaning their terms can be changed or terminated at any time by the grantor, or irrevocable, meaning that once set up, they cannot be modified in any way.
Revocable Trusts Allow for Some Freedom
A revocable trust gives the grantor, especially if he or she is also serving as the trust's original trustee, the freedom to sell, spend or give away assets while alive, or, alternatively, pass those assets on to the trust's beneficiaries, after his or her death.
Irrevocable Trusts Exempt from Estate Taxes
Irrevocable trusts allow for gifts of property while the grantor is still alive – subject to federal gift taxes – but are exempted from federal estate taxes after the grantor dies. So irrevocable trusts sacrifice flexibility in exchange for its tax advantages. Irrevocable trusts are best used by wealthy individuals who want to minimize estate taxes and can afford to give away assets to children and grandchildren.
Funding a Trust
Trusts must be funded by changing ownership of property from the grantor to the trustee, who then holds the property (sometimes called the principal or corpus) for the benefit of the beneficiaries, who must be clearly identified in the trust document. Funding the trust can involve changing car titles, executing deeds or bills of sale, re-registering stocks, etc.
In a living trust, the exact property that begins it must be listed on a schedule. Property can then be added to it and/or subtracted from it at any time. A standby is one that is created when a trust owner doesn't have enough money to fund the overall trust adequately. The trust is still established as a living trust, but it's considered to be in standby mode. If the owner dies while it is still a standby trust, assets can be added to it – as directed by a will – so that its contents avoid probate.
Advantages of Trusts over Wills
Trusts became popular recently as alternatives to wills, over which they have several advantages. Among them:
Trusts can help reduce taxes (depending upon how they are structured)
Trusts can bypassing probate
A living trust is a way to protect the privacy of the grantor. It details do not become public record
Trusts can help in the management of financial affairs while someone is still living
Trusts can be easier to execute or change than wills
Trusts can offer more options and flexibility both in the choosing of a trustee and in the management of property distributed to beneficiaries
Trust in some cases help to provide protection from beneficiaries' creditors
Having a living trust doesn't mean that someone doesn't need a will or that probate will not be necessary. This is especially true if there are estate assets that have not been transferred to the trust.
Disadvantages of Trusts vs. Wills
Trusts do have some disadvantages related to wills. Such as:
Upfront costs to prepare a trust are generally greater than those of preparing a will
Trusts don't limit the time that creditors of an estate can make claims against it
Trusts don't necessarily protect assets from disgruntled heirs
Trusts don't necessarily save time over probate, which over the years has been made easier to administer in many jurisdictions.
The Successor Trustee's Role
The role of a successor trustee parallels that of the executor of a will, but because there is no probate, property can be distributed promptly and without a court's sanction. To fulfill his or her fiduciary responsibilities to the trust document, a successor trustee must prepare an Affidavit of Assumption of Duties, sometimes known as an Acknowledgment of Trusteeship. In some states it is necessary to register such a document, along with a certified copy of the grantor's death certificate, with a county’s record office.
The successor trustee must determine what assets are held in the trust as well as their value at the time of the grantor's death. This process may require the assistance of professional appraisers, accountants and/or tax experts, who can be recompensed from the trust's resources.
The trustee also must handle any assets from a pour-over will – for example, property that isn't documented in a living trust and isn't left to a named beneficiary, but pours over into the trust during probate.
Beneficiaries must be notified and property must be transferred to them as stipulated in the trust document. Any debts, estate expenses, and taxes must be paid by the trustee and any long-term management of the trust is also his or her continuing responsibility.
Trusts persist until their purpose is fulfilled. If there are no long-term commitments – such as managing the trust's assets for minor children or making recurrent distributions to charities – the successor trustee can end the trust after all required tasks have been accomplished.