Setting Up a Trust
Most people have heard of trust funds, though few understand how they work. A trust is a versatile legal tool that can serve as a key part of your estate plan. Whether you want to manage your personal finances better or ensure that your loved ones are well cared for in years to come, a trust can help.
Most people have heard of trust funds, though few understand how they work. A trust is a versatile legal tool that can serve as a key part of your estate plan and also serve as a credit shelter. Whether you want to better manage your personal finances or ensure that your loved ones are well cared for in years to come, a trust can help.
This article answers some basic questions you may have about setting up a trust.
What Law Governs Trusts?
Trusts have a very long history. There are many different types of trusts, each designed to solve a unique problem. Most laws that govern trusts are state laws. A local estate planning or trust attorney can ensure that the terms of the trust documents are compliant with state laws. Depending on your financial situation and goals, you may also encounter some important federal regulations, such as the federal estate tax exemption.
Although trust laws vary from state to state, some consistency has been achieved through the Uniform Trust Code. This is a model code designed to standardize trust laws throughout the country. Over half of the states have adopted some version of this code.
Basic Principles: What Is a Trust?
All trusts share some basic features.
The Cast of Characters
All trusts feature a basic relationship between three recurring characters: the grantor (sometimes known as the trustor or settlor), the trustee, or co-trustees, and the beneficiaries of the trust. All trusts transfer assets from the grantor to a trustee for the benefit of—you guessed it—a beneficiary. The grantor creates the trust, the trustee manages the assets in the name of the trust, and the beneficiary reaps the rewards. These roles can overlap depending on the kind of trust involved.
The Trust Agreement
Trusts are created by the grantor in a document known as a trust agreement. This legal document states the trust's purpose, names trustees and beneficiaries, identifies and transfers assets into the trust, and prescribes any special rules. It may also name successor trustees if the primary trustee cannot or chooses not to fulfill their duties.
The Trustee's Fiduciary Duty
A trustee can be an individual, a board, or an institution (e.g., a trust company or brokerage that specializes in managing trusts). Technically, the trustee actually owns the trust assets, but they do so as a fiduciary of the trust beneficiaries. This means that the trustee is legally obligated to manage the assets responsibly and productively for the benefit of the beneficiaries. A breach of fiduciary duty can lead to serious legal consequences.
Trustees may be entitled to compensation for their services. Depending on the trust terms, payment may or may not come from the trust income.
Changing the Trust Agreement: Revocable vs. Irrevocable Trusts
There are two broad categories of trusts: revocable and irrevocable. In a revocable trust, the grantor reserves the power to revoke or change the trust agreement. In an irrevocable trust, changes are not allowed without the beneficiary's consent. Each category has advantages and disadvantages depending on the grantor's underlying goals.
Living vs. Testamentary Trusts
Trusts that take effect during the grantor's life are known as living trusts (inter vivos trusts). These are best understood in contrast to testamentary trusts, so named because they are created in the grantor's last will and testament. Whereas living trusts take immediate effect once formed, a testamentary trust takes effect upon the grantor's death.
What Is the Purpose of a Trust?
Trusts can achieve many goals that often overlap. Some common goals include:
- Asset Management: Trusts are useful if you do not feel confident managing your assets yourself. For example, some estates are simply too large for one person to realistically look after on their own. Trusts are an excellent way to protect and increase the value of your property by letting someone with more experience manage it for you (e.g., a team of financial advisors).
- Asset Protection: A trust allows you to transfer assets while preserving some control through the instructions in your trust agreement. By transferring ownership to a trustee, a trust can act as a shield against those who might have a negative interest in your property. For example, a trust can protect assets from creditors or a surviving spouse in the event of a divorce. You can learn more about this by looking at FindLaw's page on Irrevocable Living Trusts.
- Avoiding Probate Court: Probate is the court-supervised process of (1) validating a will if one exists, and (2) distributing property when someone dies. Depending on the estate's size and value, the probate process can be long and expensive. However, since a deceased grantor's estate does not own the property they placed in a trust, that property can bypass probate. You can learn more about this by looking at FindLaw's page on Revocable Living Trusts.
- Protecting Beneficiaries: Trusts allow you to set aside funds for beneficiaries who cannot manage the funds themselves. Minor children, aging parents, and other vulnerable family members might fall into this category. Occasionally, well-heeled spendthrifts also need protection against themselves (think of the proverbial “trust fund baby").
- Protecting Privacy: Trusts allow grantors and beneficiaries to preserve some anonymity. For example, real estate is listed in public records under the name of the owner. Since the trustee technically owns property held in trust, only the trustee will be listed. This allows grantors and beneficiaries to keep a low profile.
- Reducing Estate Taxes and Tax Liability: Trusts allow you to reduce the size of your estate by transferring ownership of assets to a trustee. Trusts also allow grantors to reduce income tax and gift tax liability and leave less property within the reach of state and federal estate taxes. Life insurance trusts are a specialized way of doing this by transferring proceeds from a life insurance policy directly into a trust rather than to the policy beneficiary's estate.
An Attorney Can Help Set Up Your Trust
Trusts are diverse and versatile. Although they are useful in many contexts, they are frequently used to create efficient estate planning solutions. Depending on your goals and the nature of your estate, a trust can be legally complex. If you are thinking of setting up a trust, a local trust or estate planning attorney can provide valuable legal advice.
Can I Solve This on My Own or Do I Need an Attorney?
- DIY is possible in some simple cases
- An attorney is on your side during complicated legal decisions
- Cases with trusts and beneficiaries are rarely cut and dry
- Get tailored advice and ask your legal questions
- Many attorneys offer free consultations