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How Trusts Work

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How Trusts Work

You’ve probably heard of a trust – the magical inheritance that only an elite few are entitled to. But the truth is, a trust is a financial tool that can benefit anyone who wants control over how they leave their estate to their heirs. It’s a set of legal documents that give beneficiaries ownership of different assets, including cash investments and life insurance policies. If you’re considering setting up a trust then you may want to first work with a financial advisor to get all of your questions answered. 

The Basics of a Trust

Trusts help individuals decide who will get a portion of their assets. They provide guidelines for how those assets should be passed on and can help individuals avoid the costs that go along with probating a will or going through the courts to transfer wealth.

The original owner of the assets within a trust is called the trustor or the grantor. The trustee is the person who’s responsible for making sure that the trustor’s wishes are carried out according to their instructions. The person or people who receive the assets are known as beneficiaries.

The specifics of setting up a trust will depend on the state you do it in. The mechanics of a trust in Louisiana or New Mexico may be different from in Maryland or South Carolina.

Types of Trusts

How Trusts Work

While there are many different types of trusts, they generally fall into two different categories: testamentary trusts and living trusts. A living trust is established during someone’s lifetime. A testamentary trust is written into someone’s will and is only established following the trustor’s death.

Living trusts can be revocable trusts or irrevocable trusts. Revocable living trusts let grantors retain control of their assets and make changes at any time. Irrevocable living trusts, on the other hand, become binding agreements once they’re executed and they can only be altered when the beneficiaries want to make adjustments to the terms and conditions.

Other types of trusts offer specific tax benefits. For example, generation-skipping trusts (or dynasty trusts), make it easy for trustors to pass tax-free money to grandchildren and other beneficiaries who are at least two generations below them. Once the value of the assets in their will exceeds the estate-tax exemption, a trustor with a credit shelter trust can pass the rest of their wealth on to their spouse tax-free.

Other Estate Planning Options

How Trusts Work

If you’re not interested in getting trust, there are other ways to bequeath your assets to your loved ones. While your assets could be taxed more heavily, setting up a will is often cheaper than setting up a trust. If you want your beneficiaries to use your assets to fund their education, you can put them in a 529 savings plan or a custodial account.

If you can’t afford to set up a living trust, you can also consider getting something called a Kiss Trust. It’s an inexpensive alternative to the traditional trust and the minimum initial deposit is relatively low. You can decide how the funds in the trust will be invested and multiple people can contribute to a trust for a particular beneficiary.

The Bottom Line

Proper planning can make setting up a trust a very valuable tool for your situation. Before you set up a trust, it’s a good idea to make sure that it can meet your needs. It’s also important to become familiar with your state’s trust-related laws. A financial expert and an estate planning attorney can make sure that your trusts are properly structured and your assets are protected.

Tips for Starting a Trust

  • Starting a trust can be a complicated process that requires a professional to both think through the potential consequences as well as to actually create it. A financial advisor can help you figure out what type of trust could benefit you and how to move your assets into a trust. Finding a financial advisor 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 goals, get started now.
  • Before opening a trust it’s important for you to identify the right type of trust so that you can receive the benefits you’re looking for.

Photo credit: ©iStock.com/Katie_Martynova, ©iStock.com/kupicoo, ©iStock.com/Kali Nine LLC

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