Summary/TL;DR
Trusts are arrangements that may be established either during the life or upon the death of its creator (the grantor). Certain trusts will offer estate tax savings and creditor protection to their creators and their heirs, while others are used primarily for probate avoidance. To determine if you need a trust and what kind is right for you, speak with a competent estate planning attorney. Never use an online service for drafting a trust.
Introduction
Trusts are one of the most misunderstood topics in financial planning. Just about everyone, likely thanks to media portrayal of them, seem to have a misunderstanding that trusts are some sort of magical tax-haven that serve as a “magic pill” to any problem that you can imagine. Unsurprisingly, this is far from the case. Today’s post will aim to communicate the very basics of what a trust is and what they accomplish. Keep in mind the fact that I am not a lawyer, and no part of today’s post should be considered legal advice of any kind. Always seek competent legal counsel before making any decisions.
Trust Basics
All trusts contain these four characteristics:
Grantor – the individual(s) who establish and fund the trust
Corpus – the assets given to the trust by the grantor
Trustee – the individual(s) who manage the trust corpus for the benefit of the beneficiaries, as instructed by the grantor
Beneficiaries – the individual(s) whom trust property is held and managed for the benefit of
Depending on the type of trust, the same person(s) may serve as more than one of the above roles. Finally, the property transferred to the trust may be essentially anything of value and does not have to be tangible (copyrights, for example).
The legal idea underlying all trusts is the separation of “legal ownership” (the right to control an asset) from “beneficial ownership” (the right to benefit from an asset, oftentimes in the form of income). The trustee, as the one with control over the assets within the trust, possesses legal ownership over them, while the beneficiaries possess beneficial ownership.
Furthermore, all trusts fall somewhere within the following bidimensional matrix:
First, trusts are either living (inter vivos), or testamentary. Living trusts are those that the grantor establishes during their life, while testamentary trusts are established after the death of the grantor. Trusts can be further broken down into revocable and irrevocable trusts (although there is no such thing as a revocable testamentary trust). Revocable trusts are those in which the grantor may revoke their decision to fund the trust, whereas irrevocable trusts are the opposite. Once property is given to an irrevocable trust, the grantor no longer has any control over it (unless they are also the trustee, in which case the trust provisions provide parameters around that control). Because the grantor of a revocable trust has not given up any rights of control or benefit of the corpus, there are no tax advantages or creditor protection offered by revocable trusts (while the grantor is alive). The opposite is true of some (but not all) irrevocable trusts, which may offer tax and creditor protection while the grantor is alive.
Do You Need One?
Trusts are primarily used for at least one, but oftentimes many, of the following reasons:
Probate avoidance
Estate/gift tax savings
Generation skipping tax savings
Creditor protection
Administering the management of assets in a very specific and legally binding way
Put simply, if you don’t have any of the above as a goal, you don’t need a trust! Few people have a specific need for protecting their assets from the estate, gift, or generation skipping tax or from potential creditors.
It’s more common, but still not universal, for someone to have very specific desires for the how their assets should be handled after their death. An example of this might be the following: you have two adult children. The oldest has a healthy career and is capable of handling a large windfall well, and the younger one who has always struggled with holding a stable job and handling money. You might be tempted to believe that you can give all of your estate to your eldest child and trust them to “take care of” their younger sibling, but this would be naïve. Think about all that could go wrong with this arrangement – what if the two children got in a disagreement and the eldest decides to treat their sibling unfairly with respect to your desires or even disown them completely? Or what if the eldest is sued and their sibling’s share of the inheritance is put at risk of being claimed by a creditor? For these and many other reasons, a good attorney will encourage you to pass the assets to your youngest child “in trust” with your oldest child as trustee. This way, the youngest child can’t blow their inheritance all at once, the eldest child is bound by your desires, and the assets are protected from liability.
Probate avoidance is by far the most common reason a trust is utilized, although this can be accomplished through a simple revocable living trust (also just called a “living trust”) and doesn’t provide any tax or creditor protection. Furthermore, depending on the state you live in, avoiding probate might not be a very high priority. I advise speaking to a competent estate planning attorney to learn about the process and cost of probate in your state to see what’s right for you. Finally, an additional benefit of avoiding probate is the privacy that it affords your family and your estate, as the entire probate process (including your will) is accessible by the public.
Don’t Use Online Forms
Even more so than wills, trusts need to be drafted by an expert attorney to work as they need to. Using an online service to “save money” is only asking for trouble and is essentially guaranteed to actually cost your estate more in legal and court fees in the long run (and this is nothing compared to the frustration experienced by your loved ones as they try to sort things out). There’s simply too much that can go wrong, and too high of a likelihood that it will go wrong.
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