A Guide to Trusts: Everything You Need to Know

What Is a Trust?

Also known as a fiduciary account, a trust is a financial arrangement designed to move certain assets into an intermediary state. The assets are eventually distributed to one or more chosen beneficiaries. If you want to ensure your assets will be distributed according to your wishes, you can set up a trust and designate exactly who receives funds. Depending on the type of trust, you can act as the primary grantor (provider of funds) and trustee (trust manager), or you can enlist a third party to manage the funds on your behalf. Either way, the funds will quickly be distributed based on your instructions at a set time or upon your death.

A potential benefit of setting up a trust is avoiding estate taxes and, as long as the trust is not in your immediate control, avoiding some taxes on the income produced by the funds. Many people choose to set up a trust during or even before retirement, reducing their tax burden and establishing the foundation of their estate planning. You can also set up a trust that allows you to have access to the funds as needed, but you will likely have a greater tax liability.

Who Should Have Trusts?

Trusts can be extremely useful parts of estate planning, but they may not be relevant or necessary for everyone. You may want to consider a trust if you fall within these categories or have any of the following circumstances:

• Large estate owner
• Multiple heirs or beneficiaries
• A retired spouse
• A desire for financial privacy
• Heirs with large debt

Some of these situations are clearer than others. If you have a large estate with multiple heirs and beneficiaries, for example, then a trust is one of the best ways to make sure the funds are distributed quickly and correctly once you are gone. The same applies if you have a retired spouse who, without your estate, may have only Social Security income or no consistent income to live on.

It may be difficult to understand how a trust can enhance your financial privacy. One benefit of a trust is that, in most cases, it does not have to go through the court system to be verified, so your estate and assets will not become a matter of public record. Instead, you can grow your wealth and have it distributed with a much greater degree of privacy and discretion.

If you designate a third party as the trustee, you can shield a large portion of your estate from creditors or even the creditors of your heirs. By having the right kind of trust, you can prevent creditors from going after your assets until they have been distributed. This allows them to grow unencumbered while you (or your heirs) pay off debt.

Popular Types of Trusts

In addition to the benefits outlined above, trusts are useful because they offer a lot of flexibility for how you (or a third party) can manage your estate. Each type of trust offers its own unique benefits, so below are some of the most common types of trusts and what they actually do.

Asset-Protection Trust

As the name implies, an asset-protection trust is designed to protect your money — specifically from current or future creditors. Essentially, you allow a third party to hold the funds without naming you — the creator of the trust — as a current beneficiary on the account. Once the risk of creditor attack has subsided, you can dissolve the trust or name yourself as a beneficiary.

Charitable Lead Trust

When you create a charitable lead trust, you decide that a certain portion of your assets will go to charity and the remaining assets will go to your beneficiaries.

Charitable Remainder Trust

A charitable remainder trust allows you to receive a set income for the duration of your life or until the termination of the trust. In either case, once you are no longer receiving income or the trust has been dissolved, the remaining funds will go to charity.

Constructive Trust

Constructive trusts are not formal trusts created by a trustee, but rather implied trusts established via courts based on certain circumstances. If you have documentation that you intend to leave certain assets or funds to a particular beneficiary, for example, then the courts can decide to grant a constructive trust to carry out your wishes.

Irrevocable Life Insurance Trust

An irrevocable life insurance trust excludes life insurance proceeds from your taxable estate. At the same time, it offers liquidity to the estate and, eventually, to the beneficiaries of the trust.

Marital Trust

This is one of the most common types of trust, specifically designed to leave your estate to a surviving spouse.

Special Needs Trust

Special needs trusts allow beneficiaries who receive government benefits to access a trust without taking away from their current state or federal subsidies. The beneficiary, however, must ensure they do not take distributions that would disqualify them from government help. The recipient will also need to meet certain standards, such as qualifying for Medicare, to be considered “special needs.” You can learn more about those requirements on the Social Security Administration website.

Spendthrift Trust

Sometimes beneficiaries have outstanding debts or financial liabilities that can put their future assets at risk. Like an asset-protection trust, a spendthrift trust protects your money from your beneficiaries’ creditors until the funds are distributed.

Qualified Terminable Interest Property Trust

A qualified terminable interest property trust, or QTIP, works much like a standard marital trust, except you can choose additional beneficiaries to receive funds upon your spouse’s death rather than providing income only to a surviving spouse.

Testamentary Trust

Testamentary trusts are outlined in wills, ensuring funds go through the standard court process before distribution. That means a testamentary trust will also be subject to court costs, fees, and transfer taxes, and the trust can be subject to court supervision even after the funds have been distributed.

How to Choose the Right Trust for You

The kind of trust you pick will depend on whom you choose as beneficiaries, when and how you want to distribute funds, and what kind of taxes or potential liabilities you want to protect your estate from. One of the most important factors when choosing a trust is whether you want to access and control the trust during your lifetime, so it is important to distinguish between two general types of trusts: revocable and irrevocable.

Revocable vs. Irrevocable Trusts

A revocable trust is exactly as its name implies: It can be revoked at any time. Frequently called a “living trust,” it allows you to access your funds, make changes to your trust, add or take away beneficiaries, or dissolve your trust at your discretion. In most cases, a revocable trust turns into an irrevocable trust upon your death, assuming you are the grantor. The principal drawbacks of revocable trusts are that they do not necessarily avoid state taxes and, since you can access the funds, they are subject to regular taxation like any of your other assets.

An irrevocable trust is set in stone once it is created. You hand over control of the funds to a third party and cannot make changes to the terms of the trust after it has been established. It provides far less flexibility, but it is one of the best ways to avoid probate costs, estate taxes, and other financial liabilities, even from the income produced by the trust. Many people who are trying to reduce their tax liabilities or avoid predatory creditors choose irrevocable trusts.

Trust vs. Will

Before we look at a step-by-step guide to establishing a trust, it is important to note the differences between a trust and a will. A trust is a fiduciary agreement dictating how your assets will be distributed and managed, particularly regarding how those funds will be distributed to your heirs or beneficiaries. A will can work very similarly, but it is often used to create far more specific requests, including how you want your affairs — both financial and otherwise — to be handled after you’re gone.

Wills and trusts are both key elements of estate planning and there is a certain degree of crossover in their powers and effects, but they also have some important differences.

• A will must be authenticated and verified through a probate court, while a trust usually does not require the involvement of the courts. It can take months or even years for your estate to be distributed through a will, but it may take far less time with a trust.
• Your trust takes effect as soon as it is created and you can even set stipulations for distributions that occur during your lifetime. A will does not go into effect until after you have passed away.
• Family members or beneficiaries cannot contest trusts, but they can contest wills. That is one of the main reasons wills can take far longer to be authenticated and executed.

How to Set Up a Trust: A Step-by-Step Guide

1. Establish your primary reasons for creating a trust

Do you want to ensure your spouse has quick access to funds when you pass on? Do you have a large family and want to specify exactly who receives a part of your estate? Do you want to avoid certain estate taxes and probate fees? Answering these questions will help you decide whether to choose a revocable or irrevocable trust, as well as one of the specific kinds of trusts outlined above. If you think you may want to change your trust in the future, then you should choose a revocable trust. You can change it to an irrevocable trust later on if necessary.

2. Speak with a lawyer or financial adviser

We generally do not recommend creating a trust without consulting a legal or financial professional. You would ideally get advice from both, since they can help you manage various aspects of your trust and financial outlook as a senior, from property allocation to tax mitigation. It is best not to put anything in writing until you have consulted professionals who can help you avoid potential pitfalls and learn about both state and federal laws that could affect your estate planning.

3. Write your trust document

This is perhaps the most important step of the process, and it should be done with the help of a lawyer. Your trust document will need to clearly establish the grantor, all of the assets to be transferred to the trust, the beneficiaries, the manager of the trust, and any successor trustees.

4. Notarize the trust agreement

Once you have combed through all the details of your trust, you will need to sign and notarize the document. This will authenticate the document and prevent any risk of confusion or even fraud upon your death. Depending on the state where you live, the signing may require additional witnesses.

5. Create and fund your trust

Your trust document establishes the existence of your trust, but it does not actually put the financial work into action. You will need to create a special trust bank account and fund it. There may be real property involved, in which case you can simply change the name on the title or deed to the name of the trust. For ongoing contributions to the trust, you can also name the trust as beneficiary for certain types or sources of income.

Resources for Setting Up a Trust

Setting up a trust is not overly complicated, especially since lawyers and financial advisers can walk you through the process. To help make trust creation even easier, check out some of the following resources:

• Fidelity is a long-standing financial institution that can help you set up a trust as quickly as possible.
• The Federal Deposit Insurance Corporation (FDIC) is a great government resource to provide you with unbiased financial advice and information related to trusts.
• The AARP is specifically designed to help seniors with a wide variety of goals, including retirement and estate planning.
• Mint is a financial application and website that can help you manage your assets and connect you with advisers to set up a trust on your behalf.