Contrary to what many people think, trusts are not reserved only
for the wealthy. The truth is, people from all walks of life may
benefit from a trust.
What Is a Trust?
Generally speaking, a trust is a legal entity that allows
someone to transfer the legal title of an asset to one person while
assigning control of the asset to another. The person who creates
the trust, the original owner of the asset, is known as the
grantor. The person who manages the trust is known as the trustee.
And the person who receives the benefits is known as the
beneficiary.
The trust's grantor names a trustee to handle investments,
manage trust assets, and make decisions regarding distributions.
The grantor can work with the trustee on major decisions in a
revocable trust, or the trustee can be assigned full authority to
act on the grantor's behalf.
A trustee may be an individual such as an attorney or
accountant, or it may be an entity that offers experience in such
areas as taxation, estate tax law, and money management. Trustees
have a responsibility -- known as "fiduciary responsibility" -- to
act in the beneficiaries' best interests.
Trust Categories
Trusts are drafted as either revocable or irrevocable and may
take effect during your lifetime or after death.
- Revocable trusts can be changed or revoked at any
time. For this reason, the IRS considers any trust assets to still
be included in the grantor's taxable estate. This means that the
grantor must pay income taxes on revenue generated by the trust and
possibly estate taxes on those assets remaining after his or her
death.
- Irrevocable trusts cannot be changed once they are
executed. The assets placed into a properly drafted irrevocable
trust are permanently removed from a grantor's estate and
transferred to the trust. Income and capital gains taxes on assets
in the trust are paid by the trust to the extent they are not
passed on to beneficiaries. Upon a grantor's death, the assets in
the trust may not be considered part of the estate and therefore
may not be subject to estate taxes.
Most revocable trusts become irrevocable at the death or
disability of the grantor.
Benefits of a Trust
Although trusts can be used in many ways, they are most commonly
used to:
- Control assets and provide security for the beneficiaries (of
whom can be the grantor in a revocable trust).
- Provide for beneficiaries who are minors or require expert
assistance managing money.
- Minimize the effects of estate or income taxes.
- Provide expert management of estates.
- Minimize probate expenses.
- Maintain privacy.
- Protect real estate holdings or a business.
Generally speaking, most people use trusts to help maintain
control of assets while they're alive and medically competent, as
well as indirectly maintain control of the disposition of assets if
they're medically unable to do so or in the event of death.
Flexibility to Meet Your Needs
Different kinds of trusts are designed to meet different needs
and objectives. The examples that follow are some of the types that
may be available to you.
A living trust takes effect during your
lifetime and allows you, as grantor, to be both the trustee and the
beneficiary. Upon your death, a designated successor trustee
manages and/or distributes the remaining assets according to the
terms set in the trust, avoiding the probate process. In addition,
should you become incapacitated during the term of the trust, the
successor or co-trustee can take over its management.
An irrevocable life insurance trust (ILIT) is
often used as an estate tax funding mechanism. Under this trust,
you make gifts to an irrevocable trust, which in turn uses those
gifts to purchase a life insurance policy on you. Upon your death,
the policy's death benefit proceeds are payable to the trust, which
in turn provides tax-free cash to help beneficiaries meet estate
tax obligations.
A qualified personal residence trust (QPRT)
allows you to remove your residence from your estate and reduce
gift taxes while you get to use the home for a predetermined number
of years, after which time ownership is transferred to the trust or
beneficiaries. The potential drawback is that if you die before the
term of the trust ends, the home is considered part of your
estate.
A generation-skipping trust can help you leave
bequests to your grandchildren and avoid or reduce your
generation-skipping transfer tax exposure, which can be up to 40%
on the federal level in 2021.
A charitable lead trust (CLT) lets you pay a
charity income from the trust for a designated amount of time,
after which the principal goes to the beneficiaries, who receive
the property free of estate taxes. However, keep in mind that
you'll need to pay gift taxes on a portion of the value of the
assets you transfer to the trust.
Another charitable option, the charitable remainder
trust (CRT), allows you to receive income and a tax
deduction at the same time and ultimately leave assets to a
charity. The trustee will use donated cash or sell donated property
or assets, tax free and establish an annuity payable to you, your
spouse, or your heirs for a designated period of time. Upon
completion of that time period, the remaining assets go directly to
the charity. Highly appreciated assets are typically the funding
vehicles of choice for a CRT.
Consider the Costs
Different types of trusts and trustees can require a variety of
fees for administration and wealth management. As you develop your
trust strategies, remember to consider the costs that may be
involved and weigh them carefully in relation to the benefits.
Is a Trust Right for You?
Although not quite as popular as wills, trusts are becoming more
widely used among Americans, wealthy or not. Increasing numbers of
people are discovering the potential benefits of a trust -- how it
can help protect their assets, reduce their tax obligations, and
define the management of assets according to their wishes in a
private, effective way.
