What Is a Trust Account?

A trust account is an account in which funds or assets are held in the name of a trustee and eventually distributed to a named beneficiary. A trust account can also be used to temporarily hold funds in escrow. For example, if you bought a home using a mortgage, your mortgage lender probably set up a trust account for you. The lender uses this account to pay property taxes and home insurance on your behalf. This type of trust account is known as an escrow account.

Different types of trust accounts are used as estate planning tools. This includes:

• Irrevocable trusts
• Revocable living trusts
• Life insurance trusts
• Grantor Retained Annuity Trust (GRAT)
• Special Needs Trusts
• Asset Protection Trust
• Testamentary trusts (established after the death of the grantor providing the assets)

This article will discuss the practical aspects of setting up a trust account and the necessary estate planning documents involved.

What Is a Trust Account?

When you create a trust, you transfer legal ownership of real property, cash, and other assets to a trustee, a person or institution who is responsible for managing the trust. The person who creates the trust is known as a trustor, settlor, or grantor.

A trust should not be confused with a living will, a durable power of attorney, a healthcare directive, or a last will and testament. These documents provide instructions regarding end-of-life care and asset distribution in the event of a decedent's incapacity or death. In contrast, a trust is a legal entity created to hold, protect, and distribute assets. Moreover, a trust does not go through probate and does not become public record.

The trust document states the specific powers the trustee has over the trust assets. The trustee or co-trustees have a fiduciary duty to protect the assets of the trust.

The property and assets held in the trust are no longer the property of the grantor. Most trusts are not subject to income taxes. Thus, income earned on those assets is no longer taxable income to the grantor. Nor are these assets or income part of their estate for federal estate tax exemption purposes after the grantor dies and the estate goes through the probate process. These tax benefits are one reason people choose to establish a trust.

These assets are managed for the benefit of a third party, known as the beneficiary. The beneficiary could be the same person as the grantor who created the trust. Family members and loved ones could be secondary, or primary beneficiaries. Trust beneficiaries will receive a distribution of trust funds as determined by the terms of the trust agreement.

Drafting a trust document does not have any impact until the grantor can transfer assets into the trust account. Typically, an FDIC-insured bank or other financial institution acts as the custodian or holder of the trust assets once they are placed into a trust account at the institution. The name of the trust must be on the account. All expenses of the trust and distributions from the trust will be made from this account.

Setting Up a Trust Account

Your trust is just a stack of paper until you fund the trust account. There are several steps involved to properly set up a trust account.

Select the Type of Trust

Your first decision is to select the type of trust that works best for you. You may create a trust during life (inter vivos) or after you pass away (testamentary). A trust can be revocable during your lifetime or irrevocable. The type of trust you choose will determine the form of trust account you open.

Draft and File Documents

State laws determine how your trust should be written. Be sure to sign and notarize this legal document. In some states, you are required to file your trust documents with the state probate court.

Appoint a Trustee

A trustee will execute the terms of the trust. A person can be named a trustee if they are over age 18, mentally competent, and have not committed a crime (different states specify the type of crime). If you select an individual to serve as your trustee, make sure that person understands the nature of the trust and their duties before they agree to serve.

The trust department of a financial institution or a law firm commonly serves as trustees.

You can serve as the trustee of your own trust for some types of trust funds, but for others, you will need to appoint someone else. Remember to designate a successor trustee should the initial trustee die or become incapacitated.

Name a Beneficiary

In order to create a trust, you must also name a beneficiary. You can name multiple beneficiaries. Most people name their loved ones, such as their minor children, grandchildren, or surviving spouse.

Go to the Bank

The trust document will give the bank instructions on how to set up the trust account, including a name and trustee designation. Often, this looks like “trustee for the benefit of …" which indicates the individual or organization for whom the trustee is handling the assets.

Transfer Assets

You must determine which of your assets you want to place in the trust. Assets such as cars, real estate, stock, and bank accounts have legal titles that must be changed to the name of the trustee. Keep in mind that the trustee has legal ownership of the trust property.

Some assets, such as art and jewelry, don't carry a legal title. In these instances, you must transfer your right to the property to the trustee. Retirement accounts and life insurance cannot be transferred to a trust as assets.

Get Legal Advice From an Estate Planning Attorney

Setting up a trust requires a solid understanding of your state's trust laws. It's also a lengthy legal process. When you are ready to create a trust account, it's a good idea to consult with an estate planning lawyer. They can use their expertise to make sure your trust account is going to perform the way you want it to.