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What is a trust?

What is a trust?

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Cynthia Paez Bowman
Updated August 22, 2022
6 Min Read

A trust is a more advanced estate-planning alternative to a will. A third party known as a trustee will hold your property and assets on behalf of your named heirs. Trusts are often associated with the wealthy, with the terms “trust fund kid” being used to refer to someone who lives off the funds received from one. However, trusts aren’t only useful to the wealthy. Anyone who would like to seamlessly transfer their assets without probate or interference from others contesting their final wishes could benefit from setting up a trust. 

How does a trust work?

You can create a trust as a legal entity to hold your assets. It’s basically a legal document that names your assets and appoints a trustee to manage them for your beneficiaries. Unlike a will that only takes effect after your death, you can designate a trust to work as soon as it’s created, if you choose.

There are four main parts to a trust:

  • The Grantor: Also known as the settlor or trustor, it’s the person who creates the trust.
  • The Principal: The assets held in the trust, including money and property.
  • The Beneficiary: The individuals designated to receive the assets in the trust.
  • The Trustee: The person(s) or entities (such as a company or bank) that agrees to hold and manage the assets in the trust.

A trust is far more flexible than a will. You could strategically shield your assets from taxes, continue adding wealth and property to the trust, set up charitable giving for generations and skip probate court and the fees associated with it for your beneficiaries’ sake. 

Working with an attorney (services like Trust & Will give you attorney access for a yearly fee) or a certified financial planner to set up a trust could help you iron out other details. For example, if you’re worried about your kids wasting or mismanaging the money you worked so hard to save over a lifetime, you could arrange for them to receive a monthly allowance — with conditions. The trustee could invest and manage the trust and dispense it as you wish.

What are the reasons to have a trust?

Some of the reasons why you may consider a trust to expand on a will include:

  • If you worry about your wishes being contested.
  • To save your beneficiaries from probate court and associated fees.
  • To protect the wealth you leave from creditors.
  • To protect the assets from future heirs’ divorce settlements.
  • You would like to name beneficiaries who aren’t blood relatives.
  • To arrange for a lifetime of care for heirs with special needs.
  • To ensure a smooth business continuation. 
  • To be provided for and financially protected by an objective trustee if you become disabled or incapacitated. 
  • To direct the assets generationally by designating who inherits from the trust after a beneficiary dies. (This approach is effective when there are second and third spouses and stepchildren involved.)

What are the disadvantages of a trust?

  • Trusts are more expensive and complex to establish.
  • You may need to pay for legal advice.
  • You’ll probably still need a will.
  • The assets may still be subject to estate tax.
  • You’ll need to give up control of your assets if you choose an irrevocable trust.
  • You’ll need to transfer titles and change ownership of your assets to your trust’s name.
  • Assets are still considered yours in a revocable trust and may not be protected.
  • A trust is not necessary if your assets are mainly held in retirement accounts or insurance policies, which are not subject to probate.

Common types of trusts

As mentioned, trusts are ideal for comprehensive estate planning. Their flexibility means there are many types that can be created. Some of the most-used types of trusts are:

Testamentary trusts

A testamentary trust does not take effect until after your death. It’s usually part of a will and becomes public after you pass. Testamentary trusts are typically funded after you die. Your will should include instructions to transfer your estate’s assets to the trust upon your death.

Living trusts

A living trust is effective immediately and while you’re alive, hence the name of “living” trust. It’s more private than a testamentary trust because only the grantor and trustee need to know which assets are held and what the terms of the trust are. A lot can happen in your lifetime. Your asset mix may fluctuate, your family may expand or your marital status can change. Living trusts are also known as revocable trusts, which means they can be changed to adapt to your life situation.  

"A" or marital trusts

“A” trusts are designed to provide for your spouse first, then your mutual surviving heirs. The assets are placed into a trust when a spouse dies and the income from the assets goes to the surviving spouse. Once the surviving spouse passes away, the remainder goes to the couple’s surviving heirs.

Spendthrift trust

You can set up a trust for a beneficiary you have doubts about. Perhaps you’re worried about leaving a cash lump sum for a 21-year-old. In a spendthrift trust, the beneficiary is not allowed to access or sell their interest. In addition, the assets are protected from the heir’s creditors or from divorce settlements until distribution. You could set up other terms, such as providing a monthly stipend until the beneficiary reaches a certain age. 

Charitable remainder trust

Some individuals are philanthropically-minded and envision leaving part of their wealth to charity. They may choose to establish a charitable remainder trust, which passes a certain amount of income to beneficiaries and allocates the rest to specific charities. 

Credit shelter trusts

According to the IRS, estates over $11.7 million per person, or $23.4 million per couple are subject to a 40 percent estate tax after the second spouse dies. A credit shelter trust is the most effective way to shield wealth for future beneficiaries. When an amount up to the IRS threshold is held in a credit shelter trust, a surviving spouse can receive a designated amount of money as income from the trust’s assets for life. Once the surviving spouse passes, the trust’s beneficiaries receive the remaining assets without having to pay any estate taxes.

Totten trust

A Totten trust can be created for free by depositing money into a bank or investment account in your name as the trustee for someone. The name on the account should include "Payable on Death To", “In Trust For" or "As Trustee For". It’s considered a revocable trust and the transfer is not completed until your death. Totten trust assets avoid probate. They’re a good way to transfer cash to beneficiaries without having to pay to set up a trust.

Revocable vs. irrevocable trusts

Revocable vs. irrevocable trusts are quite different. It’s all about control — when you designate your trust to be revocable, you can alter the terms or assets held in the trust. When you choose an irrevocable trust, you give up control of your assets.

Revocable trusts

Also known as a living trust, you’re typically the sole trustee and in charge of how to manage the assets and who gets them after you die. You can change the conditions and beneficiaries at any time while you’re living. However, you may be able to ensure your loved ones avoid probate court with a revocable trust, but you may still be subject to estate taxes if your assets exceed the estate-tax threshold. Once you die, the revocable trust is converted into an irrevocable one, since you are no longer around to manage the assets.

Irrevocable trusts

An irrevocable trust is more set in stone than a revocable trust. You’ll essentially need to give up ownership of the assets you place in the trust and won’t be able to change the terms and conditions — or the beneficiaries — unless you get approval from the trustee and existing named heirs. 

The bad news with an irrevocable trust is that the assets are no longer part of your estate. The good news is, you won’t owe estate taxes. Property in an irrevocable trust is not considered to be an asset of the deceased person, and it will not be included as part of their taxable estate. 

It may sound extreme to give up control, but if you have a large net worth, you could save a lot of money on taxes. In addition, the trustee should manage your estate in your (and your beneficiaries’) best interests, perhaps better than you could.

Is a trust better than a will?

When evaluating a trust vs. will, you will probably still need a will to detail out things such as guardianship of your minor kids or what assets should be transferred into your trust upon your death.

Most people plan for their death by drafting a will including their wishes. While a will is a valid way to leave your assets to the people you choose, it has its limitations. The will only goes into effect once you pass. And more importantly, it must go through probate, which can get lengthy and expensive if others contest it. 

If you have a growing number of assets you want to ensure they go to your loved ones without too much trouble, a trust may be a better solution. Your assets aren’t technically yours any longer — they’re the trusts’. This means that the trust cannot be contested by others, won’t be subject to probate and may not be considered a taxable asset of your estate when you’re deceased. It’s best to consult with a financial planner or estate attorney to decide on what type of trust is best and whether the savings are worth the effort of restructuring your assets.

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