A trust is a legal agreement between you, as the creator of the trust (often called a grantor or settlor), and a trustee regarding management of assets for the benefit of one or more beneficiaries. Generally, a trust is created when you and the trustee execute a written trust agreement that identifies the beneficiaries of the trust and provides directions about how the trust assets will be managed for the benefit of the beneficiaries. The trustee of a trust is a fiduciary who has a duty to manage and administer the trust in accordance with the terms of the trust agreement and in a manner that is in the best interest of the beneficiaries of the trust.
Most trusts are considered either revocable living trusts or irrevocable trusts.
A revocable living trust is also sometimes referred to as a revocable grantor trust, and is a trust you create for yourself, you serve as trustee to manage the assets for your benefit during your lifetime, and a successor trustee you’ve nominated within the trust agreement manages or distributes the assets for the benefit of your heirs or other designated beneficiaries upon your death as you’ve specified in the trust agreement. You can create a revocable living trust individually, or jointly with another person (ex: your spouse). You can change any part of a revocable trust, or terminate it, any time during your lifetime, provided you are not incapacitated. Your revocable living trust typically becomes irrevocable at your death.
Revocable living trusts are commonly used to avoid probate at your death. Assets titled in the name of the trust are governed by the terms of the trust agreement and are not subject to probate at your death. You can transfer your assets to your trust by retitling your real property and/or bank accounts in the name of the trust during your lifetime, or by naming the trust as a payable-on-death or transfer-on-death beneficiary to receive the assets at your death. The trust agreement specifies that at your death the successor trustee can use the trust assets to pay your last expenses and directs the successor trustee to either hold and manage the assets in trust for the benefit of named beneficiaries or immediately distribute the assets out of trust to named beneficiaries.
You determine whether your assets remain in trust for a period of time after your death to be used for a beneficiary’s benefit, or whether the assets are immediately distributed outright to the designated beneficiaries. For example, when the beneficiaries of the trust are minor children, the trust agreement may direct that the successor trustee continues to hold and manage the trust assets for the children’s benefit until each child reaches a certain age, with specific provisions detailing the use of trust assets for a child’s health, education, maintenance, and support. In such case, the successor trustee will invest the trust assets, and use the income, and sometimes principal, to pay for the child’s needs as directed in the trust agreement. When all of the trust assets are distributed outright to the beneficiaries, the trust terminates, and the beneficiaries are left to manage those inherited assets on their own.
Irrevocable trusts are less common and generally used when you want to transfer assets out of your name and estate during your lifetime. An irrevocable trust can sometimes be used to reduce estate taxes that might be incurred at your death, and/or to benefit a charitable organization, while still allowing you some limited benefit from the trust assets during your lifetime. Or, you may want to use an irrevocable trust when you want to gift significant funds or other assets to a minor or disabled child who wouldn’t be able to manage such assets on their own individually.
Trusts provide privacy for your heirs at your death, and it is often easier to administer a trust than an estate in probate. Like personal representatives in a probate, trustees are entitled to reasonable compensation for serving as trustee. And, while the use of an irrevocable trust may save on estate taxes at your death, trusts, generally, do not save on income taxes. Revocable living trusts do not file a separate income tax return and you simply report income and expenses on your personal return, as the grantor. However, at your death when the revocable trust becomes irrevocable, or if you’ve established an irrevocable trust, such irrevocable trust will likely have to file its own separate income tax return and trusts generally have higher tax rates than individuals. Compensation, taxes, and other costs of administration are paid out of the trust assets prior to trust funds being used for a beneficiary’s benefit or being distributed to a beneficiary.
Contact an estate planning attorney to determine if a trust would be a beneficial addition to your estate plan.