A trust is an estate planning option that focuses mainly on the management of assets. Setting up a trust means appointing a third party to hold and direct assets on behalf of beneficiaries.
Having a trust can help with end-of-life planning but can’t be a substitute for other financial instruments like life insurance. Learn how a trust works, its pros and cons, the steps involved and why it’s important to consider setting one up.
What Is a Trust and How Does It Work?
A trust refers to a legal vehicle used for asset management. When you set up a trust, you designate another party to hold and manage your assets on behalf of your beneficiaries. It can also detail instructions on how you want them to be disbursed upon your death. Many individuals also create trusts to minimize the fees and responsibilities of their beneficiaries.
Before setting up a trust, it’s crucial to understand how it works and the various people involved. Below are the three main parties in a trust.
Also known as the trust creator, the grantor is the person who owns the property to be transferred. The grantor creates the trust and determines what assets to include. They also choose the beneficiaries. For example, if you’re setting up a trust, you take on the role of the grantor.
As the name suggests, the beneficiary is the person who benefits from the trust. They receive payments from the trust and pay any associated fees or taxes. That said, the trust agreement determines the rights of a beneficiary.
The trustee is the party overseeing the trust agreement. The grantor selects them, giving them the legal right to administer and manage the assets. A trustee is also responsible for protecting and growing the assets under the trust. However, they must meet the requirements specified in the trust agreement.
Key Differences Between Trusts and Wills
Trusts and wills are financial tools used for end-of-life planning. Although both types of documents determine how assets will be distributed to beneficiaries, they have specific differences.
A will typically must go through a court-approved probate process and is executed upon your death. You also retain control of your assets until your death. A trust, on the other hand, doesn’t require a court’s approval. It can be done privately and take effect while you’re still alive. Depending on your needs and situation, you can have a trust even if you’ve already set up a will.
It takes effect after the
It takes effect once the
It can be affordable to set up
Setting up a trust may require
A will cannot reduce estate
Depending on how a trust is
The estate must go through
There’s no need to go
Type of Record
A will is a public record.
A trust can remain private.
Many people think setting up a trust is only for the wealthy. But anyone who wants to make the transfer of their assets hassle-free for their heirs can benefit from it. Additionally, there are different types of trusts you can select. Each one caters to different needs and goals.
Below are some common types of trusts you may want to consider.
Type of Trust
What It Is For
A living trust refers to a trust agreement that starts taking effect while the grantor is still alive. It’s one of the two main kinds of trust.
The testamentary trust is another primary trust type. Unlike a living trust, this only takes effect after the grantor passes away. It also allows the grantor to set a predetermined time when their beneficiaries can access the trust assets. Also known as a will trust, this type is established through the grantor’s will.
Revocable trusts are created mainly to pass on assets without going through probate. A grantor can make changes to a revocable trust during their lifetime. It’s also possible to dissolve this type of trust.
Assets in a revocable trust are the grantor’s property until they pass away. The transfer of assets and agreement details only become permanent after the grantor’s death. The grantor may also name themselves trustee or co-trustee to maintain control over their assets.
An irrevocable trust can’t be changed. Once it’s established, it’s no longer possible to modify the trust agreement.
That said, an irrevocable trust can help with asset protection against creditors. It can also protect the assets from estate and gift taxes.
A bare trust, also called naked or simple trust, is the most basic type of trust. This is typically used by parents and grandparents transferring assets to their children or grandchildren.
Although the trustee is responsible for managing the assets, the beneficiary has the right to the trust’s assets, capital and generated income.
Charitable trusts are great for people who want to set aside part of their assets to benefit a charitable institution or charity.
There are two types of charitable trusts.
Special Needs Trust
A special needs trust, also known as a supplemental trust, is suitable for a grantor with a family member who has special needs or requires lifelong care. This type of trust ensures the trust’s assets will be used toward the beneficiary’s care after the grantor's death. It also helps prevent disqualification from government benefits.
With a spendthrift trust, the grantor can give specific instructions on how and when a beneficiary can access the principal trust assets. For instance, you can arrange the trust so beneficiaries receive a monthly stipend to cover basic living expenses. Another example is to restrict the beneficiaries to only benefit from the income earned by the assets.
Typically, a generation-skipping trust is used by grandparents who transfer assets to their grandchildren and skip the prior generation. Doing this can help heirs avoid estate taxes.
The Importance of Creating a Trust
There are various reasons why a person may consider creating a trust. Even with a will, it can be a beneficial estate planning tool for you and your heirs. Understanding the importance of having a trust and knowing how it can be advantageous for you can help you decide whether it’s suitable for you.
Unlike a will, a trust allows you to maintain control over your estate. You can determine how and when the trust assets will be distributed. For instance, you can include an age attainment provision to ensure that your children only get their inheritance when they reach a certain age. You can also include parameters on how the assets will be used.
Trusts don’t go through the probate process, allowing you to maintain privacy. Additionally, this prevents your beneficiaries from lengthy and costly court proceedings.
Securing potential tax savings
Depending on your trust, you can reduce or even eliminate estate taxes. You can also avoid paying additional gift taxes if you meet certain conditions.
Safeguarding your loved ones
Creating a trust ensures that your loved ones remain cared for after you pass away. It can also be an excellent option for distributing more complex assets. For instance, you can use it to split up a family business.
Some types of trust, especially revocable trusts, can also help your family if you suffer from a serious illness or disability. For example, you can have your trustee pay bills or make distributions on your behalf. Unlike wills, trusts take effect once the agreement is created and signed.
Who Benefits the Most From Trusts?
Many individuals shrug off the idea of setting up a trust, thinking it’s beneficial only for those with considerable assets. But certain situations make it an ideal option. For some groups, having a trust may be necessary to protect their loved ones.
Below are some of those who may benefit the most from trusts.
Setting up a trust is a good idea for unmarried couples as it allows them to protect each other in the event of one’s death or incapacity. One spouse can name their partner as the beneficiary. If they want to give their partner the legal right to manage their trust’s assets, they can appoint them as trustee.
A trust ensures that the grantor’s assets are distributed according to their plan. Parents, especially older adults, may consider creating a trust to protect their assets. Having trustees allows their assets to grow even if they can no longer manage their property. Additionally, they can add provisions to ensure they receive a specific portion of the generated income for a certain period.
A trust allows you to include guaranteed provisions. This can help financially protect minor children. You can set up a trust in a way that they can only access the funds after reaching a certain age. You can also add parameters on how the funds will be used, such as for your child’s college education.
People with disabilities
You can determine how the distributions will be used. This can be very helpful for loved ones with a disability. You can specify that the trust is disbursed for significant expenses, such as caring for a child with a disability.
Steps for Creating a Trust
Approximately 12% of people who don’t have an estate plan said the reason is not knowing how to get one, according to Caring.com. Many find the process of preparing a trust a bit overwhelming. Hiring a professional is the best option, although it’s possible to do it yourself. Either way, it helps to know the steps and factors to consider.
Below is a simple guide to help you get started.
Once you’re 100% sure that setting up a trust is right for you, you can proceed with setting up one. Consider the most important reason you want to have a trust, the goals you want to achieve and how you want to structure the trust.
The process may vary depending on the assets you want to include and your chosen beneficiaries. However, there are general steps grantors typically need to complete.
Gather all titles and deeds of the assets you want to include in the trust. This may include property titles and deeds, stock certificates, bank accounts, expensive items and life insurance policies. Create a list to avoid confusion.
Choose a service
Determine what type of service you want to set up a trust. You can do it yourself to save money. There are online tools that help individuals draft trust documents. Consider hiring a lawyer who has experience in crafting a trust if you can afford the additional expense. This is the best way to avoid running into issues.
Choose your beneficiaries. These can be anyone you want, such as your partner, family members or friends. You may also opt to name a charity to receive funds from the trust.
Decide on a trustee who’ll oversee the trust and manage the assets. You should also include a successor trustee to take over if the trustee can no longer fulfill their duties.
Decide the structure of the trust
The best type of trust focuses on your goals and circumstances. Outline the parameters on how and when you want assets to be distributed. Consider working with an advisor to create the best structure for you and your beneficiaries.
Draft the trust document
The last step is to write the document. Don’t forget to check state laws on trusts. In some states, only licensed lawyers can draft a trust. Others allow you to do it yourself.
Review the draft to ensure everything is in order. Then, sign the trust document and have it notarized.
Being a beneficiary is more than just receiving an inheritance. You must understand your rights and know the steps you need to take.
Ideally, beneficiaries should know the trust’s details before the grantor’s death. However, this isn’t the case for many. Follow the steps below to make the process a bit easier.
Prepare for the trust meeting
The trustee will discuss the trust details with you. In instances where the trust takes effect only upon the grantor's death, a death certificate may be necessary. Communicate with the trustee to know if there are other things you need to gather.
Meet the trustee/s
After the initial communication, the trustee may set up a meeting to review the details of the trust documents. You likely will need to bring any requested documents with you to avoid any issues. Before the meeting, it helps to research your rights as a beneficiary.
Clarify the details
Make sure you understand all details related to your inheritance. Ask questions. Check if there are stipulations on how and when you can access the assets.
Expect the assets
Clarify what you’re entitled to receive. Depending on the trust, assets may be distributed after a certain period. Some may also have age attainment provisions.
Manage your inheritance
It’s also important to be wise in handling your inheritance. Whether you’re to receive the inheritance outright or in the form of distributions, it’s important to think long-term. Determine how you can maximize the benefits.
How Much Does It Cost to Set Up a Trust?
The cost of setting up a trust may vary per person. That’s because of multiple factors, including differences in estate size, location, beneficiaries and complexity of trust stipulations.
Additional costs may also apply. For instance, the transfer of asset ownership requires you to pay filing fees. Counties or states may charge a one-time fee to update a deed.
Trust management also comes with costs, which typically last throughout the existence of the trust. One way of reducing expenses is to name yourself as the trustee. That said, ensure you have a successor trustee to take over after you die.
Hiring a lawyer to help you establish the trust also comes with expenses. The cost depends on how much the lawyer charges. Although choosing the DIY path can help you save money, working with a professional can reduce the risk of having issues.
Navigating Life Insurance and Trusts
As the grantor, you must fund the trust to ensure it meets the needs of your beneficiaries. One standard method to do this is to use life insurance.
Using life insurance for estate planning provides three major benefits — giving death benefits to beneficiaries, providing liquidity for the estate and supporting your loved ones financially. Using it to fund a trust can help you further maximize the benefits. For example, it can be an affordable way for parents to ensure that their minor children are cared for financially.
Types of Trusts That Are Best for Life Insurance
Although life insurance can fund a trust, it may not always be the best solution. It’s important to choose the right type of trust. Here are some types of trust wherein using life insurance makes sense.
A testamentary trust takes effect after the grantor’s death. It’s created through a will. This trust is easy to set up and can be funded using a life insurance policy.
Special needs trust
Grantors who have loved ones with special needs may use their life insurance policy to fund a special needs trust. With this, they ensure that their loved one will receive financial support after their death. If you’re using term life insurance, you may need to have a backup plan should you outlive the policy term.
Irrevocable life insurance trust (ILIT)
If you want to remove your policy from your estate, an ILIT may be right for you. This minimized your estate tax liabilities. It can also be used to provide liquidity for your estate and estate beneficiaries upon your death. An ILIT is funded with one or more life insurance policies during the grantor’s lifetime.
Benefits of Funding Your Trust With Life Insurance
Funding a trust using life insurance can be beneficial in certain situations. Typically, individuals use it to reduce taxes. Another advantage is the easy liquidation and monetary benefit.
A life insurance policy is generally easy to liquidate. That means it can help cover significant expenses upon the policy owner or grantor’s death. These include burial and funeral expenses, legal costs and estate taxes.
Life insurance policies have a monetary value. Additionally, a trust can lay out how the grantor wants to disburse the funds. This can help ensure long-term financial protection.
Death benefits from life insurance policies are typically tax-free. This reduces the burden left to the beneficiaries. Some types of trusts can also help avoid gift taxes.
Maintain government benefits
Choosing the right type of trust and correctly drafting it can help protect a beneficiary receiving government assistance. Since the trustee controls the distribution of the proceeds from the grantor’s life insurance policy, it’ll not affect a beneficiary’s eligibility for government aid.
Writing Life Insurance into a Trust
Typically, chosen beneficiaries receive the proceeds from a life insurance policy all at once. They have the freedom to choose how to spend it. Creating a trust may be right for you if you want to set parameters on how your death benefit will be paid out and distributed.
Here are some steps you need to consider.
Purchase a policy
You first need to find the best life insurance policy based on your needs, situation and goals. Start by getting personalized quotes from multiple insurance providers. Compare offers, rates and terms to ensure you get the most accurate coverage.
Discuss your plan with your insurer. In most cases, you don’t have to pay extra. Some providers also offer the option of transferring a policy into a trust.
Select a trustee
You need to figure out who to appoint as your trustee. They’ll administer the assets you place into the trust. Make sure it’s someone you trust. Some people name themselves as trustee.
Create a deed
This legal document outlines the terms of the trust and the stakeholders. A deed ensures that your death benefit payout will be used as you intended.
For many individuals, naming beneficiaries individually on their life insurance policies makes more sense than naming a trust. But for others, it’s more beneficial to choose a trust.
For example, your beneficiaries have credit issues. Naming the trust as your life insurance beneficiary helps protect them financially. It’s also a good idea if your beneficiaries are minors. You can use the trust to set restrictions regarding the use of the death benefit payout. Thus, ensuring that it covers the cost of caring for your children.
FAQ on How Trusts Are Taxed
Understanding trust tax liabilities can be confusing. Speaking with an estate planning lawyer can provide crucial information to avoid tax issues. Consulting a tax professional can also give you a better idea of how you should file trust taxes.
You can find answers to some commonly asked questions below.
Expert Insight on Setting up a Trust
A trust can be an essential estate planning tool. MoneyGeek asked industry experts to share insights you can use to navigate the process of setting up a trust.
- How can individuals determine if setting up a trust is right for them?
- When is it best to set up a trust?
- With various types of trust accounts a person can choose from, how can an individual determine which is the right option for them?
- What financial and money-management tips can you share with people thinking of estate planning?
- What resources or tools can you share with people interested in setting up a trust?
Principal Attorney of Klein Law Group
Attorney at Law, Owner of Breeden Law Office
Owner at Capital Intelligence Associates
Managing Attorney and Owner of The Law Office of Crystal M. Richardson PLLC
Licensed Insurance Agent and Managing Director
Attorney and Managing Member at Vandenack WeaverTruhlsen
Additional Resources on Trusts
A trust can be a great addition to estate and end-of-life planning. It ensures proper management and distribution of assets. However, the whole ordeal requires legal documents. There may also be multiple steps to accomplish. The following resources can help you better understand the process.
- American Academy of Estate Planning Attorneys (AAEPA): Get tips on estate planning. Learn about common estate planning mistakes individuals make and how you can prevent them.
- American Civil Liberties Union (ACLU): Find valuable resources to help you with estate planning. ACLU also has an estate organizer you can use to document important financial and estate information.
- American Bar Association (ABA): Learn more about estate planning through the ABA’s video series and get answers to frequently asked questions.
- FindLaw: Check out federal and state laws on estate planning, inheritance and taxes.
- HG.org: Learn about the fundamentals of estate planning in this online law information site. Find a law firm near you using the site’s search tool.
Life Insurance and Estate Planning
- Better Business Bureau: Research about insurance providers. Use the Better Bureau Business search tool to check insurance companies' trustworthiness ratings and review customer complaints.
- Coalition Against Insurance Fraud: Access links to state insurance fraud bureaus and easily report suspected insurance scams.
- USA.gov: Review federal laws and regulations on estate taxes and life insurance.
- 1-800-ATTORNEY: Get free legal advice by contacting a lawyer near you. This network service is available 24/7.
- LawHelp.org: Access legal forms and learn about state programs using this interactive map. The organization also offers information on court fees.
- LawHelp Interactive: Scroll through the dropdown menu and choose your state to access different forms and legal documents.
About Nathan Paulus
- Brookings. "Now, more than half of Americans are millennials or younger." Accessed November 10, 2022.
- Caring.com. "2022 Wills and Estate Planning Study." Accessed October 10, 2022.
- Merrill: A Bank of America Company. "Leaving a Legacy: A Lasting Gift to Loved Ones." Accessed October 10, 2022.
- Trust & Will. "2022 Estate Planning Study: Millennial Estate Planning Continues in a Pandemic." Accessed October 10, 2022.