What is a Trust
Estate planning can involve many different types of documents and planning tools. Most people know and understand what a will is. You may have heard of a trust, but don’t quite understand how they work or what their function is. This article should provide a simple explanation of the concept of a trust, how they work, and their uses, advantages, and disadvantages.
Simply put, a trust allows you to put your property into the trust and name someone maintain control over the trust as well as provide instructions on who can receive property from the trust and under what conditions.
The first step in understanding a trust is to understand the terminology used in trusts.
Grantor, Settlor, or Trustmaker – the person who creates the trust and puts property into the trust. If you are creating a trust as part of your estate plan, you are the grantor.
Trustee – a person, persons, or corporation or entity that is appointed to manage the trust assets, and to make distributions of trust property to creditors or beneficiaries.
Beneficiaries – These are the people that are permitted to receive property, now, or in the future, out of the trust, based on the terms of the trust.
Funding – The process of putting property into the trust by deeding real estate, retitling bank accounts, or naming the trust as a beneficiary of an account upon the account holder’s death.
The “Bucket Analogy”
A great analogy for a trust is a bucket. Think of your property as the water that you put into the bucket, and the trustee as the person holding the bucket. For a trust to work properly, your assets must be put into the trust through “funding.” Imagine your assets are glasses of water sitting on a table. Bank accounts, real estate, retirement accounts, money markets, stocks, bonds; each one a separate glass of water. By funding your trust you are placing the assets into the trust; it is as though we are dumping the glasses of water into the bucket.
The Living Trust
A living trust is one of the most common types of trusts used for estate planning purposes. Let’s take the bucket analogy a step further and apply it to the living trust.
A living Trust is designed to give you as the creator or “Grantor” total control over the trust while you are still alive and well. Want to add more things to the trust? Take things out? Change the beneficiaries? You can easily do all of these things because you are in control and the trust can be changed or revoked entirely. As the Grantor and Trustee, you maintain total control, as if you are holding the bucket of water and carrying it with you wherever you go. You can always access the money in the trust as long as you are “holding the bucket.”
What happens if you become incapacitated? If you can no longer take care of yourself or make decisions, you need someone to do that for you. Giving a trusted family member power of attorney is a common option, or if you’ve never set up a power of attorney, the court may appoint a guardian over you. With a trust, however, the trust simply names someone to step into your shoes and act as successor trustee during your incapacity. It is as if you can no longer carry the bucket yourself, so someone picks up the bucket and carries it for you. Because you are still alive, all of the property inside the trust is still for your benefit so the trustee can (and should) access the trust only for your benefit. Paying your bills, managing your investments, etc.
In the event of your death, the successor trustee can once again step in and “carry the bucket.” At this point the trust will have instructions on where the property is supposed to go. It can go directly to family members or children, completely outside of the trust. Image that the successor trustee is holding the bucket and they pour some of the water out into a glass for each beneficiary.
Alternatively the property can be held in trust for a period of time for your beneficiaries. Image the trustee keeps the bucket filled with water but pours just a small amount out into each beneficiary’s cup when they need it, or in small amounts over a period of time. The advantage to keeping assets in trust is to protect them. They can be protected from a beneficiary’s creditors, if they are going through a divorce, if a beneficiary has drug or alcohol dependency issues, or if they are not responsible with money.
Different Types of Trusts
Trust come in all different shapes and sizes. Here are a few of the differences among common trust types.
Testamentary Trust v. Living
A living Trust is a trust that is created now, and exists as soon as your documents are signed. We still need to fund the trust (put things into it) in order for it to work, but once the trust is funded, the trustee can manage and distribute the assets.
A testamentary trust on the other hand, is one that is inside of a will, and will not exist until after you die. Imagine that your glasses of water are still sitting on that table. After you die, your executor is instructed to place some or all of those glasses into a bucket that wasn’t there before and to give that bucket to the trustee to hold for the benefit of someone else.
Why would we use a testamentary trust? Some of the situations above, creditors, divorce, or drugs and alcohol lead some individuals to chose a testamentary trust for their children or loved ones. Testamentary trusts are also extremely common when there are minor children who can’t own property, or young adults who are still learning how to manage money and could use guidance. The advantage to a testamentary trust is that it doesn’t exist yet so we don’t have to fund it. There is no extra step required right now, all of the funding happens after you die. This makes the planning process simpler and more cost effective, and sometimes make sense if you plan on changing your estate plan later in life.
Revocable v. Irrevocable
A revocable trust is a trust that can be amended in any way and can be completely undone. The living trusts that we discussed previously are a form of revocable trust. They provide certain advantages like probate avoidance, privacy, and flexibility, but they do not provide any tax savings advantages or asset protection to the grantor.
An irrevocable trust is one that cannot be undone (or at least cannot easily be undone without the consent of all beneficiaries and often with court approval). The obvious disadvantage is that once the trust is created and assets are put into the trust, they cannot be removed and the trust cannot be changed, although certain irrevocable trusts allow for some changes such as swapping out beneficiaries or trust assets, or changing a trustee.
Irrevocable trusts are often used for some more advanced types of planning such as asset protection (making sure your creditors or potential creditors cannot take your assets from you), tax planning (trying to minimize or eliminate income, gift, or estate taxes), and Medicaid Planning (setting an individual up so they can qualify for medical assistance in a nursing home).
Common Uses for Trusts
The following is just a short sample of some of the many reasons a trust might be a good option for someone when setting up an estate plan.
- Minor children or young adult children
- Creditor issues
- Potential divorces in the family
- Federal or State Estate Tax Avoidance
- Probate Avoidance
- Medicaid Planning
- Income Tax Planning
- Charitable Giving
- Protections for Pets
- Maximizing a child’s inheritance
- Legacy Planning
- Firearm Planning
- Vacation home or cabin
If you have additional questions about how trusts work, a specific type of trust, or how a trust might benefit your estate plan, contact our office today to schedule a consultation with one of our attorneys.