A trust is often included in a complete estate plan. Deciding whether a trust is an appropriate mechanism for distributing your assets starts with understanding what these legal agreements and for and how they work. Here’s an overview of the different types of trusts.
What Is a Trust?
A trust is a legal way of transferring assets to a third party (trustee) who will hold and distribute them to beneficiaries at the grantor’s death. In other words, a person (the grantor) puts large assets like a house or a business into a trust and specifies a beneficiary who will receive those assets when they die.
How Is a Trust Different from a Will?
Trusts and wills are legal arrangements that allow individuals to bequeath assets to loved ones. A last will and testament is essentially a notarized list of possessions and instructions for their distribution. Setting up a trust is more involved and requires a transfer of property. In other words, to add a property to a trust, the grantor must transfer ownership to the trust.
For instance, say a person put their home in their will. The only process they would need to go through would be to draw up the will and have it witnessed and notarized. If, however, they were to put the house in a trust, the process would require more documentation, including the transfer of the home to the trust (more on that below).
Unlike making a will, setting up a trust can take some time, especially in collecting the appropriate documentation and properly distributing your assets. Also, setting up a trust can be pricey, especially if you have a complicated estate and need to hire an estate attorney to do it for you.
Why Establish a Trust?
Depending on the individual’s motivation for establishing a trust, there are multiple advantages to establishing a trust.
- Flexibility. As part of an estate plan, a trust offers unique flexibility over distribution timelines and structures. For instance, a trust can distribute assets at different specified times. Also, if you have a large estate and minor children, the trust can dictate when those children may inherit the assets.
- Avoid probate. While most estates go through some form of probate, a trust significantly minimizes the time it takes to distribute property.
- Privacy. Unlike a will, the contents of which are public, the assets in a trust remain private.
- Protection. There are several financial reasons why people choose to set up a trust. Assets removed from the grantor’s estate (i.e., in a trust) are not usually taxed. Also, transferring assets out of your estate may block a creditor’s access to your assets if there are judgments against you.
What Are the Types of Trusts?
Something that makes trusts confusing is multiple types and names, some of which overlap and all of which function slightly differently. Familiarizing yourself with the types may help you decide if a trust is right for your estate.
Living or Revocable Trusts
A living trust, also called a revocable trust, allows you to place assets in a trust while you’re alive for the benefit of your beneficiaries after you pass. A living trust is beneficial if you want to avoid will contests or if you have a business and want it to run smoothly should something happen, and you become incapacitated. Living trusts are also helpful if you want someone to manage some of your property.
An irrevocable trust is exactly what the term applies. The trust terms may not be altered after the trust is created. One of the primary reasons to create an irrevocable trust is to protect the grantor from being taxed. The assets are moved out of the grantor’s estate to avoid taxation on the income from those assets.
A testamentary trust is set up after death according to a person’s will. The will dictates the terms of the trust; these terms may be altered at any time until the testator’s death. This trust has more flexibility and simplicity than a living trust.
Several specialty trusts apply to special individual situations or estates. They include the following:
- Marital trusts. Testamentary trusts are established for surviving spouses. Assets are placed in these trusts when one spouse dies.
- Charitable trusts. These trusts distribute assets to beneficiaries for a specified period, after which the funds are allocated to a charity.
- Education trusts. Beneficiaries can receive and use money only for educational purposes.
- Spendthrift trusts. When a beneficiary isn’t able to make sound decisions regarding funds, the trustee decides how the beneficiary should use the assets.
- Qualified personal residence trust. This trust is irrevocable and allows the transfer of property to heirs but allows the grantor to live in the property for a specified period.
- Generation-skipping trust. This trust is set up to help transfer funds to grandchildren.
While it is possible to set up a trust on your own, the process can be complicated. Most people work with an attorney or advisor who understands the process and can advise on which types of trusts would be best for the estate and circumstances.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.