Used properly, trusts can benefit people from all walks of life – not just the wealthy and well-connected. Questions about trusts come up quite frequently during the financial planning process. Unless you’re a financial professional, such as a CPA, CFP®, or estate planning attorney with experience in creating trusts, you may not know about the ways trusts can reduce complexity and even reduce your tax bill.
So, what is a trust? The ‘Lectric Library says to “Think of a trust as a holding pen, a place where you put your assets before they are released to the people or organizations that you designate to eventually receive them. A trust is a legal entity and so are you. Because you and the trust are separate legal entities, anything you transfer from you to the trust becomes property of the trust. The trust then holds the property for your benefit, or for the benefit of those whom you designate.”
The three separate parties to a trust are:
- The grantor, who is the creator the trust.
- The beneficiaries, who receive income and/or principal from the trust.
- The trustee, who manages the trust according to the trust document.
Note that the grantor, beneficiary, and trustee do not all have to be the same person, at least while the trustee is alive.
The trust document is the rule book the grantor uses to stipulate how the trust is to be managed. These rules instruct the trustee on all areas of administration, such as:
- how to invest and manage trust assets,
- any limitations on trust activities,
- when and how to distribute principal (or trust “corpus”), and income earned, and
- who gets the distributions.
There are many different kinds and uses for trusts. Let’s go over six reasons for considering one:
For protection from predators: Maybe you would like to leave property to a relative but you want to ensure the beneficiary does not lose it in case of a legal action, such as a lawsuit or an unfriendly divorce. Because the trust corpus is owned by a separate entity, a properly-drafted trust will be untouchable by the legal system.
To protect someone from themselves: Young adults’ lives can be shattered by inheriting money while they are young and irresponsible. A thoughtfully-drafted trust can cede authority to a reliable trustee to determine the optimal timeline to give money to beneficiaries. The trust can even impose rewards and punishments for not living up to the requirements of the trust. One such example is a trust that requires a grandchild keep a minimum grade point average or take a minimum load of courses to be reimbursed for her college education.
If you have heard of the glorious benefits of Living Trusts (probably at a “free” seminar) and are considering whether or not you need one, Why You May Not Need a Living Trust at nolo.com addresses both sides of the issue. A Living Trust is revocable (may be changed) while you are alive but becomes irrevocable (permanent) at your death.
For disability planning: You may have a disabled relative whom you would like to provide for without disqualifying him from Medicaid or other government assistance. A “Special Needs Trust” (“SNT”) allows you to set aside funds for the care and benefit of a “special needs person”.
The key to a SNT is that distribution of funds is totally up to the discretion of the trustee. Because the beneficiary (the special needs person) cannot “demand” distributions, the trust is not considered an asset when the special needs person applies for government benefits.
For estate planning: Currently, the first $5.45 million of property per decedent is exempt from taxation, and is indexed for inflation. Multiple marriages are a common reason to use a trust in estate planning. If you and/or your spouse have children from previous marriages, a trust can be used to ensure that the remainder of the estate of the first to die goes to your children by blood while providing for the surviving spouse during his or her lifetime or until remarriage.
For privacy and simplicity: No one will know who owns trust property but you, your attorney and the trustee. Property in a trust does not pass through public probate at death. Trusts are commonly used to shield asset ownership by holding title to assets such as real estate.
For asset protection: Trusts are sometimes overlooked as a way to safeguard assets, but a trust can be a powerful tool for shielding your assets from bankruptcy, lawsuits, even divorce. Consider your children when passing along assets to them through a trust. The typical trust requires a 1/3-1/3-1/3 distribution to empty out the trust by, perhaps, age 35, to prevent a young adult from “blowing” it all at once. But is it really necessary to deplete an entity that is already structured to protect your child’s assets? If your child does not need all of the trust corpus to live on, why not include a provision to allow assets that won’t be spent to remain “locked in” and secure from the rest of the world?
A “grantor trust” (over which the grantor, or person creating the trust, retains control over assets) is a very simple, but flexible trust, with broad uses in estate and gift planning.
Trust law is complicated but that doesn’t mean that they are useful only for the polo pony set. To find out if a trust may be appropriate for you, consult an attorney and/or a financial planner who is experienced in estate and trust planning.
For more information, visit For Doctors Only at Fox & Co. Wealth Management.