A Guide to Trusts: Everything You Need to Know

What Is a Trust?

A trust is a legal arrangement in which a person (the grantor) gives another party (the trustee) the right to hold and manage assets. The assets are eventually distributed to one or more chosen beneficiaries. If you want to ensure that your assets are distributed according to your wishes, 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 assets will be distributed according to the trust’s terms either during the grantor’s lifetime or after death.

A potential benefit of setting up a trust is avoiding estate taxes. As long as the trust is irrevocable and you relinquish control of it, it may reduce estate tax liability. But revocable trusts are still part of the taxable estate.

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 create a trust to allow you to have access to the funds as needed, but you will likely then have a greater tax liability.

Who Should Have Trusts?

Trusts can be an extremely useful part 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
• Owner of property in multiple states
• A desire for financial privacy and avoiding probate
• A desire to control asset distribution beyond a simple inheritance
• Multiple heirs or beneficiaries (especially with complex distribution needs)
• Parent of minor children or dependents with special needs
• Spouse who is retired or may need financial support after your death
• Heirs with large debt or creditor issues
• Heirs who may not be financially responsible

Every situation, of course, is different. But if you have high-worth assets in various locations and complex distribution needs for various children, for example, then a trust is probably the way to go. 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.

How does a trust enhance your financial privacy if that’s one of your major concerns? One benefit of having a trust is that, in most cases, it does not have to go through the court system to be verified. 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.

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. Below are some of the most common types of trusts and what they actually do.

Asset-Protection Trust

As the name implies, this kind of trust protects your assets — specifically from current or future creditors. Essentially, you allow a third party to hold the funds without naming yourself as a current beneficiary. After the risk of creditor attack has subsided, you may regain access, depending on the terms and jurisdiction.

Charitable Lead Trust

When you create a charitable lead trust, a portion of your assets goes to charity and the rest goes to your beneficiaries. It reduces gift and estate taxes while supporting causes you care about.

Charitable Remainder Trust

A charitable remainder trust lets you receive a set income for the duration of your life (or for a certain number of years), and then gives the remaining assets to a charity of your choice. It can reduce your taxes and support a cause you care about. Once created, it generally cannot be changed.

Constructive Trust

Constructive trusts are court-imposed remedies to prevent enrichment. They’re typically used when someone has wrongfully obtained or holds property they shouldn’t keep (through fraud or undue influence, for example). The court may order the person to hold that property in a constructive trust and transfer it to the rightful party, even if no written trust document exists.

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 beneficiaries. The grantor typically cannot serve as trustee and must give up all control over the policy.

Marital Trust

This common type of trust is designed to leave your estate to a surviving spouse tax-free. The surviving spouse receives income for life, with remaining assets going to other beneficiaries when the spouse dies.

Special Needs Trust

Special needs trusts allow beneficiaries who receive government benefits to access additional resources without losing eligibility for programs such as Medicaid or Supplemental Security Income (SSI). The beneficiary, however, must ensure that they do not take distributions that would disqualify them from government help. The recipient must have a disability recognized by the Social Security Administration.

Spendthrift Trust

This type of trust protects your money from your beneficiaries’ creditors until the funds are distributed. This is useful when beneficiaries have made poor financial decisions and have outstanding debts.

Qualified Terminable Interest Property (QTIP) Trust

A QTIP trust works like a marital trust, but it allows you to choose who receives funds after your spouse’s death. It’s useful in second marriages when you want to provide for your spouse while ensuring remaining assets go to your children.

Testamentary Trust

Testamentary trusts are outlined in wills and go through the court process before distribution. That means a testamentary trust will also be subject to court costs, fees and transfer taxes. Testamentary trusts are always subject to probate and may require ongoing court supervision.

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.

Also, it’s important to distinguish between two general types of trusts we’ve mentioned before: revocable and irrevocable.

Revocable vs. Irrevocable Trusts

Revocable trust

A revocable trust is exactly what 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. A revocable trust becomes irrevocable when the grantor dies, which means no further changes can be made.

Irrevocable trust

An irrevocable trust is pretty much set in stone once it’s created. The grantor gives up ownership and control. Any changes generally require court or beneficiary consent. Limited changes under certain conditions are possible, but it provides far less flexibility.

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 who want to reduce their tax liabilities or avoid predatory creditors choose irrevocable trusts.

Trust vs. Will

It’s important to note the differences between a trust and a will. A trust holds and manages your assets for the benefit of named individuals: beneficiaries. Unlike a will, a trust takes effect upon creation and funding. It potentially avoids probate for assets, which creates a quicker and more private distribution.

Trusts are essential for managing your affairs if you become incapacitated. Unlike a will, a trust can provide seamless management and protection for your assets while you are still living.

A will explains how you want your affairs — both financial and otherwise — to be handled after you’ve died. It also names an executor to be in charge of everything and usually goes through probate. A will is the only legal document that can name a guardian for minor children.

Although a will is simpler and less expensive initially, a trust can provide savings in the long term by helping you avoid probate. According to NerdWallet, many estate plans incorporate both a will and a trust.

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:

• Trusts generally avoid probate and are administered privately unless improperly funded or contested.
• A will must be authenticated and verified through probate court, which can take months or years.
• Your trust takes effect immediately; a will takes effect after death.
• With a trust, you can set stipulations for distributions that occur during your lifetime. A will goes into effect after you pass away.

Both wills and trusts can be contested, but challenging a trust is generally more difficult. That is partly due to trusts usually not having a public probate process. Contesting a will is a primary reason for lengthy probate proceedings.

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

1. Establish your primary reasons for creating a trust.

Determine your goals: ensuring that your spouse has quick access to funds, specifying who receives parts of your estate, or avoiding estate taxes and probate fees. This helps you decide between revocable or irrevocable trusts and which specific type fits your needs.

2. Speak with a lawyer and financial adviser.

We recommend creating a trust with legal assistance. You’d ideally get advice from a financial expert, as well, since they can help you manage various aspects of your trust and financial outlook, from property allocation to tax mitigation.

A lawyer can help you avoid potential pitfalls and knows about both state and federal laws that could affect your estate planning. Moreover, a lawyer ensures that your trust is legally valid, enforceable and tailored to your specific needs. Laws are complex and lawyers can help you navigate them, avoiding potential challenges to best protect your assets and beneficiaries.

3. Write your trust document.

We recommend you do this 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. Finalize and sign the trust.

Sign your trust document. Notarization isn’t always required for the trust itself, but it’s typically needed when transferring property into the trust. Some states may also require witnesses for certain trust-related documents, so check local laws or consult an attorney.

5. Create and fund your trust.

You must fund the trust by transferring ownership of your assets — such as bank accounts and real estate — into the trust’s name. That often means retitling accounts and property deeds. You can also name the trust as beneficiary on life insurance or retirement accounts, but it’s important to consult a professional to avoid tax or legal issues.

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 you learn more about trusts, check out some of the following resources:

• Fidelity is a long-standing financial institution that can help you with the administration and management of a trust.
• The Federal Deposit Insurance Corporation (FDIC) is a great government resource that provides general information on how trust accounts are insured, but each trust is unique.
• AARP is specifically designed to help older adults with a wide variety of goals, including retirement and estate planning. They offer members 20 percent off if you use Trust & Will.
• National Academy of Elder Law Attorneys (NAELA) offers information on trusts as well.