Trusts: A Quick Introduction

Trusts aren’t just for the ultra-wealthy, and not just for inheritance.  Trusts can also work to protect your assets.  But there a few important things to know first, so let’s review the basics along with the main types of trusts.

The Basics

A trust is a legal entity, transferring title (ownership) of an asset to one party (person) while assigning control of it to another.  So they involve 3 key roles as defined here.

Key Definitions

  • The person creating the trust is the grantor.
  • The person who manages it is the trustee.
  • The person who receives it is the beneficiary.

The Trustee

Normally the trustee is the only one who plays an active role.  They handle investments, manage assets, and decide on distributions.  They hold fiduciary (financial) responsibility and are typically an attorney, accountant, or someone with expertise in taxation, estate tax, and money management.

Keep in mind that trusts usually include fees, paid to the trustee.

Types of Trusts

The primary distinction in the various types of trust is revocable versus irrevocable.  This makes a big difference in what they are and aren’t useful for.

  • In a revocable trust the grantor can work with the trustee on major decisions.  This gives you a measure of control, but the IRS considers the assets still in the grantor’s taxable estate.  And that in turn means the grantor pays taxes at their personal rates.
  • An irrevocable trust can not be changed in any way by the grantor.  Taxes on income and capital gains are paid by the trust if not passed on to the beneficiary upon death of the grantor or their estate.  Assets are not considered part of the estate.

It should be noted that a revocable trust becomes irrevocable at the death or disability of the grantor.

Beyond this key distinction there is a host of different types, each with its own pros and cons.  A living trust takes effect during the grantor’s lifetime and is passed on to a successor upon your death, avoiding the probate process.  An irrevocable life insurance trust (ILIT) can be an estate funding mechanism.  It starts with a gift to an irrevocable trust which uses the money to purchase life insurance on the grantor.  It then provides tax-free cash to beneficiaries for meeting estate tax obligations.

The alphabet-soup of types goes on, including CLT (charitable lead), CRT (charitable remainder), CST (credit-shelter trust), GST (generation-skipping), PRT (personal residence trust), and QPRT (qualified personal residence) to name only a few.

So it should be pretty clear that it’s advisable to hire a financial planner or tax accountant to help you choose the right type and to set up the trust.

The Benefits

In brief, the various trusts can help you maintain control of your assets while you’re alive and competent and have your intent honored if you’re medically unable or deceased.  Depending on the exact type of trust and its setup they can offer the following benefits.

  • Control assets and investments to provide security for beneficiaries.
  • Minimize estate and/or income taxes.
  • Provide for expert estate management .
  • Minimize or eliminate probate expenses and court delays.
  • Maintain privacy.
  • Protect real estate holdings and businesses.

We’ll discuss that last surprising possibility in the future.

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