A trust is a legal creation that can own assets such as money, property, and stocks. When a person transfers assets into the trust, those assets now belong to the trust, not the person. This article names the basic types of trusts, as well as some common specific kinds. It then lists some of the ways a trust can be useful and says how to set up a trust.
What is a trust?
A trust is a legal creation that can own assets—money, property, stocks, and so on. When a person sets up a trust, they transfer ownership of selected assets to the trust. This is called “funding the trust.” Once they have done that, they are no longer the legal owner of the assets: the trust itself now owns them.
The person who creates the trust is called the trustor, grantor, settlor, or trustmaker. The person who looks after the trust is called the trustee. This can be a family member, friend, professional trust manager, or financial institution. Sometimes a trustee can be the same person as the trustor, but in other cases this is not allowed. Trusts often have more than one trustee.
When the trustor creates the trust, they name people they want to give the assets to. These people are called beneficiaries. They can be family members, spouses, friends, or (in some cases) even the trustor themselves.
What are the basic types of trusts?
There are 4 basic types of trusts. One category of trusts refers to whether or not a trust can be changed or ended.
- Revocable trusts. The trustor can change or end these trusts at any time.
- Irrevocable trusts. Once these trusts are set up, they usually cannot be changed or ended.
Another category of trusts refers to how separate the trust is from the trustor.
- Grantor trusts. These are trusts where the trustor (also known as the grantor) has control over the trust’s terms and/or assets. Any income from this kind of trust—for instance, returns on its investments or interest on the principal amount—will be taxed as part of the grantor’s income. In addition, creditors can often access the assets in a grantor trust, because the “wall” separating the trust from the person who created it is weaker. All revocable trusts are grantor’s trusts.
- Non-grantor’s trusts. These are trusts that are considered entirely separate from the person who created them, for legal and tax purposes. The IRS taxes the trust, not the trustor, and creditors cannot usually access the assets. Only irrevocable trusts can be non-grantor trusts.
What are some specific kinds of trusts?
While there are 4 basic types of trusts, they can be created for many specific situations. Some of the most common specific trusts are:
- Family trust. Provides wealth for family members over generations.
- Revocable living trust. Distributes assets to beneficiaries like a will, except a person makes it while they are still alive and is able to enjoy the assets until their death.
- Asset protection trust. Shields the trustor from creditors in the case of bankruptcy, divorce, a lawsuit, etc.
- Dynasty trust. Can be another term for an asset protection trust, or can be a family trust where only the interest and income from the trust, not the principal amount, is used over the generations.
- Gift trust. Allows the trustor to create a fund for giving gifts (money, property, etc.) in a more controlled and tax-friendly way.
- Life insurance trust. Houses a life insurance policy and manages the death benefit to control distribution and avoid taxes.
- Charitable trust. Benefits charitable causes, such as relieving poverty, advancing education, or promoting health.
- Special needs trust. Provides money for people with disabilities or those who are chronically ill without making them ineligible for government benefits.
How can trusts be useful?
Trusts are one of the key tools in estate planning. They have several purposes. They can give a person (trustor) more control over their assets; minimize estate taxes and probate fees; protect assets from creditors; reduce assets to qualify for Medicaid, Social Security income, or special needs benefits; and grow wealth over generations.
They give people more control over their assets.
When the trustor names their beneficiaries, they can also name conditions that the beneficiaries have to meet in order to get the money or other assets. For example, they could say that a beneficiary must reach a certain age, can only receive a certain amount of money every year, or must use the money they receive to get a college degree. These kinds of conditions can make it less likely that the beneficiary will mishandle the assets they receive.
They minimize estate taxes and probate fees.
Assets that have been transferred to a trust are no longer considered part of a person’s estate. Therefore, when the estate is taxed upon the person’s death, the taxes will only apply to the assets that are outside the trust. None of the assets in the trust will be included in probate fees.
They protect assets from creditors.
When a person has to pay money or sell assets because of a bankruptcy, divorce settlement, lawsuit, etc., they don’t have to count any assets in their trust, as these assets do not technically belong to them. Only irrevocable trusts offer this kind of protection.
They reduce assets to qualify for Medicaid, Social Security income, or special-needs benefits.
If a person’s income is too high or they have too many assets to qualify for Medicaid or other benefits that are normally given to people with lower incomes, they may transfer assets into a trust so that their personal income and net worth are low enough for them to qualify.
They grow wealth over generations.
Some trusts are set up so that only a certain amount can be used. The overall amount then continues to grow for future generations to benefit from.
How can a trust be set up?
Even the simplest kind of trust is a complex legal and financial arrangement. Therefore, all trusts need to be set up by an estate-planning lawyer.
If you plan to use a financial institution as your trustee, it is a good idea to meet with the person who will be managing your trust, called the trust administrator or corporate trustee, before you meet with your lawyer. This way you can discuss what kinds of assets you want to put into the trust and what conditions you might want to set for the beneficiaries.