Lately, we’ve been doing a lot of estate planning with clients and there have been several discussions about trusts and estates on the White Coat Investor Forum, such as:

• Anyone here have an ILIT?
• Estate Planning and State Law
• Your estate plan: trust or not?

A lot of the same questions tend to pop up in our discussions, often centered around the use of trusts, so I decided to write an article answering some very basic trust questions this month. Please note that this article is not meant as a substitute for legal advice. I’m writing to help you dip your toe in the pool of knowledge and generate some ideas about how a trust might work for you.

How does a trust work? A trust is a legal entity that allows a third party to hold and manage assets on behalf of a beneficiary(ies). The Grantor creates and “funds” the trust with his assets, the Trustee holds and manages the assets according to the trust document, and the Beneficiary is the person who will receive income or principal (also called the “corpus”) from the trust. The Trust Document is the rulebook for how the trust should be operated.

What kinds of trusts do I need to know about? There are many ways of classifying trusts. For the purpose of simplicity in this brief article, I’ve decided to divide trusts into two broad categories:

• A revocable trust, also called a “living trust” can be altered or terminated during the Grantor’s lifetime. The Grantor, the Trustee and the Beneficiary can be the same person. Because the assets in a revocable trust do not go through probate, they are sometimes used for privacy and to help smooth the transition process after you die. Assets in a revocable trust do not reduce the value of your estate and, therefore, are not protected in a lawsuit.
• An irrevocable trust cannot be amended without the beneficiary’s permission. By setting up and funding an irrevocable trust, you are transferring assets to a separate legal entity to be managed by a third party. Irrevocable trusts are commonly used for asset protection and estate planning.

Do I need a trust? It depends upon your goals and the complexity of your situation. Some reasons you might want to set up a trust are:

Privacy: When you die, your estate goes through a process called probate, or the settling of your estate in the court system. Probate records are public. You can keep your nosy neighbors from knowing what you leave behind by putting those assets in a trust.

Protection: Assets in an irrevocable trust are considered owned by the trust, not you or the beneficiaries. This provides protection from predators (your daughter marries a gold-digger) and from the actions of others (you lose a malpractice suit) and from government claims (disabled beneficiary receiving Medicaid benefits).

Property in Multiple states: Your executor will have to go through probate in every state in which you own real estate in addition to your state of residence. This is bound to be a tedious and expensive process. Transferring the real estate to an irrevocable trust will remove it from your estate and make your executor’s job much easier!

Life insurance: An Irrevocable Life Insurance Trust, or “ILIT”, is used to keep the proceeds of a large life insurance policy from being included in the taxable estate of the deceased while providing for management of the proceeds for beneficiaries who might not make wise use of money they get outright. If an ILIT is used for a term insurance policy, it will terminate when the term runs out.

Multiple marriages: If you have children from a previous marriage, you may not want everything you own to go to your current spouse outright. But if you’re the main breadwinner, you won’t want your spouse to be left destitute. A trust can accomplish both objectives, providing income for your surviving spouse and leaving the “corpus” (income-producing property) to your children at his/her death.

Control: A trust allows you to reward and punish behavior beyond the grave. Want to make sure your daughter pays attention in her university biology program? The trust can be both carrot and stick. The income spigot can also be shut off if your spouse remarries. After all, who wants to fund a nice lifestyle for their replacement?

Taxes: For those with an estate tax problem (sometimes referred to as “The 1%”), funding a trust will not only solve some of the above issues, but also reduce the taxable value of your estate. As an added benefit, your newly minted “1%” heirs will also have protection from predators for assets inside the trust(s).

Trusts are not only for the wealthy and well-connected – they serve a very useful purpose in the right circumstances and at the right time. Estate planning is one of the most valuable benefits we provide as fee-only financial planners. If you’d like to know more, contact us to set up a free initial consultation.

Trusts can be great – but they have a dark side, too. Find out some instances in which a trust may not be the best choice for you in Michelle’s vlog, 7 Reasons to AVOID Using a Trust.