Trusts allow you to control how your assets are distributed to your heirs or other beneficiaries. A trust can also help you reduce your tax burden, depending on the type of trust you use and how you manage its distributions. Establishing a trust is one of the best ways to plan your estate ahead of time.
In today’s guide, we will examine the function of a trust, discuss the types of trusts, and provide a step-by-step guide to help you set up a trust for yourself and your loved ones.
Also known as a fiduciary account, a trust is a financial arrangement designed to move certain assets into an intermediary state to eventually be distributed to one or more designated beneficiaries. If you want to ensure your assets will be distributed according to your wishes, then 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.
Pro Tip: Head to our 2023 estate-planning guide to learn more about estate planning and other important considerations.
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.
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:
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.
Pro Tip: If you are concerned about the financial stability or choices of one of your heirs, you can put your assets in a trust. That way, they can grow until your heir improves their financial standing or learns how to better manage their money.
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.
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.
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.
Pro Tip: It is best to set up an asset-protection trust in anticipation of future creditor attacks. If you wait to set it up until after creditors have begun collections processes, it could be too late to make any transfers to your 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.
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 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.
Pro Tip: You are better off creating your own trust rather than relying on the courts to create one on your behalf, since you have no guarantee that the court will make a decision that reflects your intentions or the best interests of your beneficiaries.
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.
This is one of the most common types of trust, specifically designed to leave your estate to a surviving spouse.
Special needs trusts allow for beneficiaries who receive government benefits to benefit from the 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.
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.
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.
Pro Tip: QTIP is frequently used in the event of a second or third marriage, in which case there may be ex-spouses or children of ex-spouses for whom you would like to leave the remaining funds.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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:
Costs vary widely, but you should expect to pay anywhere between $1,000 and $3,000 to set up a trust. If you go through a cheaper online service, you may be able to create a trust for just a few hundred dollars, especially if you forgo the costs of a lawyer.
The short answer is yes, you can create your own trust. You will still need to get your documents notarized, but you do not technically need a lawyer to make a trust. That said, getting legal or financial advice can help you avoid mistakes and pitfalls, especially if you are unfamiliar with trusts.
If you have property or substantial assets that you would like to pass on to future generations, then it is almost certainly worth it to set up a trust. The cost of making a trust is nothing compared to the assurance that your beneficiaries will receive their distributions quickly and without the need for probate court authorization. If you have relatively few assets or no specific wishes for how your estate should be administered after your death, however, then you probably do not need to bother with a trust.