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What Is a Trust and How Does It Work?


Drafting a will can help ensure your assets are passed on to your heirs according to your wishes when you pass away. But if you have a larger estate, you may consider setting up a trust to manage your assets as well. While not everyone needs a trust, there are certain benefits to creating one. Understanding what a trust is, how it works and the various types of trust can help you decide if one belongs in your estate plan. You may also want to work with a financial advisor who can help you plan out your long-term financial goals and help you prepare for the future with any trust that you may need.

What Is a Trust?

When you write a will, you’re creating a legal document that spells out what you want to happen to your assets after you die. Meanwhile, you continue to own and control those assets while you’re still alive.

A trust is a little different. When you create a trust, you’re creating a legal entity that owns and manages your assets on behalf of your beneficiaries. There are three parties in a trust arrangement:

  • The grantor, who is the person making the trust
  • The trustee, who is the person responsible for managing the trust according to the grantor’s wishes
  • The beneficiaries, who enjoy some type of benefit from the trust

A trust that takes effect while you’re still alive is called a living trust or inter-vivos trust. Trusts can be revocable, meaning the terms of the trust can be changed during the grantor’s lifetime, or irrevocable, in which the trust terms are permanent. Certain types of trusts can only be irrevocable.

How a Trust Works

The process for setting up a trust is generally more involved than writing a will. First, you need to create a trust document. This is something that an estate planning attorney can help you with.

In this document, you’ll need to name a trustee who will oversee the trust for you. If you’re setting up a revocable trust, you can act as your own trustee and name one or more successor trustees to follow you. If you’re setting up an irrevocable trust, you have to name someone else to act as the trustee. Keep in mind that the trustee assumes a fiduciary role, which means they’re required to act in the best interests of the trust beneficiaries.

You also have to specify who you want to benefit from the trust when creating the trust document. For example, this could be your spouse, children, grandchildren or other relatives. Or you might choose to set up a charitable trust, naming one or more charitable organizations as beneficiaries.

The final step in creating a trust is funding it. Funding a trust means transferring assets to the trust and giving the trustee the authority to manage them. The kinds of assets you can use to fund a trust include real estate, investments, heirlooms or antiques, life insurance, business interests and cash accounts. Depending on the type of trust you’ve established you may choose to fund the trust right away or transfer assets at a future date.

Types of Trusts

All trusts can be either revocable or irrevocable but there are many different types of specialized trusts you can set up. Here’s a quick rundown of some of the most common trust options:

  • A/B trust: This type of trust combines a marital trust with a bypass trust to minimize estate taxes for surviving spouses.
  • Charitable trust: A charitable trust can be established specifically for the purpose of charitable giving. You can set up charitable trusts to divide your assets between selected charities and other beneficiaries, such as family members.
  • Testamentary trust: A testamentary trust is created by a will and only takes effect after you pass away. This type of trust allows for the transfer of assets when you die and not before.
  • Special needs trust: A special needs trust can be set up to manage assets for special needs beneficiaries, such as a child or another family member. This type of trust allows the beneficiary to remain eligible for government assistance programs to help pay for their care and living expenses.
  • Life insurance trust: A life insurance trust is a trust that’s designed specifically to hold the proceeds from a life insurance policy. This type of trust is irrevocable and the trustee is charged with managing the proceeds from the policy on behalf of your beneficiaries.

Benefits of a Trust

Establishing a trust has certain benefits that you don’t get from having a will alone. For example, creating an irrevocable trust would offer the dual benefits of creditor protection and minimizing estate taxes. Assets held in an irrevocable trust couldn’t be attached to satisfy a creditor lawsuit. Since they’re considered to be owned by the trust and not you, you could also use an irrevocable trust to minimize estate taxes for your heirs.

A revocable trust allows for flexibility in estate planning since you can change the terms of the trust or terminate it completely at any point during your lifetime. Both a revocable and irrevocable trust could also allow your beneficiaries to avoid the probate process. Probate can be a lengthy and expensive process but depending on how your trust is structured, you may be able to avoid it altogether.

Drawbacks of a Trust

"Living Trust & Estate Planning"There are a few drawbacks to keep in mind if you’re considering a trust for estate planning. For one thing, setting up the trust can be complicated and time-consuming. You may need an estate planning attorney’s help, which could mean paying several hundred or even several thousand dollars in fees.

Aside from that initial cost, there are ongoing expenses associated with a trust. For example, there’s the trustee’s fee to consider if you aren’t acting as your own trustee. If you have significant assets in a trust, the management fees can quickly add up.

Finally, a trust may not be necessary if you have a simpler financial situation. Drafting a last will and testament and purchasing life insurance, for example, may be enough to meet your needs.

The Bottom Line

A trust is just one tool you might decide to include in your estate planning. Before setting up a trust, it’s important to consider the cost, the benefits and the tax implications. If you do decide to create a trust, check the laws and requirements in your state to make sure you’re following all the legal guidelines.

Tips for Estate Planning

  • Consider talking to a financial advisor about the benefits of trusts and whether it makes sense to create one. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goalsget started now.
  • There are other legal documents you may need to include in your estate plan besides a trust. A will is one; a financial power of attorney is another. You may also want to draft an advance health care directive to outline your wishes for medical care when you’re not able to make decisions on your own.

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