Trusts: What Is a Trust and How Does It Work?

A trust is a fiduciary legal arrangement that allows a person (known as the trustor, settlor, or grantor) to give a third party, or trustee, permission to hold trust property or assets (in the form of a trust fund or trust account) for the trust’s beneficiaries.

You may want to establish a trust in place of or in addition to a last will and testament for one of several reasons:

• Estate planning: Trusts allow you to dictate how you want to disperse your assets to your loved ones in advance and help them avoid costly probate processes and taxation. You can also establish a trust for your children in which the trust company holds your assets until they reach adulthood.
• Long-term care: The terms of the trust may provide long-term healthcare over some time for surviving spouses, family members, or loved ones with mental health issues, physical disabilities, or other incapacities.
• Privacy: In some cases, you may want to establish a trust document to keep your affairs private since traditional wills executed through probate court often contain public information.
• Probate court avoidance: Establishing a trust helps your loved ones avoid the expensive and lengthy probate process required by state law when someone dies and leaves a will. Avoiding probate means beneficiaries can access assets such as bank accounts and life insurance benefits quicker than they would through the probate process.
• Tax purposes: Including a trust as part of your tax planning helps your loved ones benefit from lower tax rates with the IRS on trust assets (such as real estate) compared to traditional wills. Trusts establish a federal estate tax exemption, which means your beneficiaries will pay lower income tax on their tax returns.

Depending on your needs and how you decide to disperse your assets, you may choose from several trust funds, each with varying structures. Some of the most common types of trusts include:

1. 1. Charitable lead trust: This type of trust provides financial donations to the charity or charities of your choice for a limited period, after which any remaining assets transfer to other beneficiaries.
2. 2. Charitable remainder trust: A charitable remainder trust provides you with income for some time, with any funds left over going to the charity or charities of your choice. This type of trust helps lower or avoid gift taxes.
3. 3. Credit shelter trust: Also called a family trust or a bypass trust, this type of trust allows you to leave your surviving spouse an amount up to the estate tax exemption while the remainder of your estate goes to your spouse tax-free.
4. 4. Generation-skipping trust: Often used in second marriages, this means that after your surviving spouse’s death, your assets will go to the beneficiaries you name as opposed to your surviving spouse’s family members.
5. 5. Irrevocable life insurance trust: This trust means any payout from your life insurance policy avoids estate taxes. Often you cannot change life insurance trusts after you make them.
6. 6. Living trust: Also called an inter-vivos trust, a living trust allows you to use your assets during your life and have them transferred to your beneficiaries through a trustee after your death.
7. 7. Marital or “A” trust: This trust benefits your surviving spouse, who will include it on their taxable estate.
8. 8. Qualified terminable interest property trust (QTIP): QTIP trusts apply to married couples and maximize the exclusion amounts when you use for the marital tax deduction. Under the marital deduction, property interest transfers after death mean lower or no estate or gift taxes.
9. 9. Special needs trust: This type of trust allows a loved one with disabilities to receive income from the trust without giving up any government benefit payments they may already receive.
10. 10. Spendthrift trust: This trust protects the assets you leave to your loved ones from creditors and keeps your beneficiaries from selling their interest in the trust.
11. 11. Testamentary trust: Also called a will trust, with a testamentary trust, your loved ones must process any financial assets through probate court.
12. 12. Totten trust: Used only for financial assets like bank accounts, you create this type of trust during your life and act as the trustee, and the remaining assets transfer to your beneficiaries upon death. Totten trusts cost nothing to set up, and you can establish them by adding legal titles to your financial accounts, such as “As Trustee For,” “In Trust For,” or “Payable on Death to.”

You create trusts with an estate planning attorney at a law firm or a trust company by signing a legal document outlining how and when they will disperse your assets to the trust’s beneficiaries. The trust company or trustee holds the assets of the named beneficiaries until the time of dispersal.

Some trusts allow the grantor to be both a successor trustee and a beneficiary concurrently. Others disperse the assets slowly over time after the grantor’s death or all at once. Many trusts help beneficiaries lower or avoid estate taxes, protect assets from creditors, and avoid the probate process.

All trusts fall under one of two types: revocable or irrevocable.

• Irrevocable trust: An irrevocable trust helps your beneficiaries avoid estate taxes and probate. Once you’ve created it, you can’t make any changes or terminate the trust. Choosing an irrevocable trust will remove your trust assets from your estate, meaning they’ll no longer be taxable. However, when your beneficiaries receive the assets, they may have to pay income tax.

• Revocable trust: Revocable living trusts allow you to control your assets during your lifetime as a living trust and pass them on to your beneficiaries without a probate process. The revocable status allows you to make changes or terminate the trust at any time, though it becomes irrevocable upon your death. You may assign a successor trustee in the event of incapacity or death.

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