Updated: July 3, 2024
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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.
Estate Planning in the US
Many Americans know the importance of estate planning, including setting up a trust. However, many still don’t have an end-of-life plan.
Financial assets and real estate given through wills, trusts and beneficiary assignments ranked third among the things people aged 55 and up consider important legacies to pass on to their heirs. This is one of the four legacy pillars, which include values and life lessons, instruction and wishes and personal possessions of emotional value or special significance.
Of those who don’t have a living trust or will, 40% said it’s due to procrastination and 33% said they don’t have enough assets to leave behind. Approximately 13% said setting up a will or trust is expensive. Meanwhile, around 12% said it’s because they don’t know how to get a will or living trust.
Most millennials (75.12%) opted for a will-based estate plan. Only 18.78% said they chose a trust-based estate plan. Millennials make up around 22% of the population in the U.S., making them the largest living generation in the country.
Although more than 50% of Americans think it’s important to conduct estate planning, only 33% have a living trust or will.
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.
Understand the roles in a trust — grantor, beneficiary and trustee — before you establish a trust. Each plays an important part in ensuring the trust operates as intended, safeguarding the grantor's assets for future use by beneficiaries:
Grantor
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.
Beneficiary
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.
Trustee
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.
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 open a trust even if you’ve already set up a will.
Wills | Trusts | |
|---|---|---|
Effective Date | It takes effect after the | It takes effect once the |
Cost | It can be affordable to set up | Setting up a trust may require |
Tax Benefits | A will cannot reduce estate | Depending on how a trust is |
Probate Requirement | 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 overlook the benefits of a trust, thinking that trust planning 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, you can select from different types of trusts. 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 |
|---|---|
Living Trust | 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. |
Testamentary 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 Trust | 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. |
Irrevocable Trust | 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. |
Bare Trust | 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 Trust | 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.
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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. |
Spendthrift Trust | 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. |
Generation-Skipping Trust | 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. |
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 establishing a trust and knowing the benefits of setting up a trust 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.
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.
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 kinds of trusts, 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.
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, creating a trust may be necessary to protect their loved ones.
Below are some of those who may benefit the most from trusts.
Unmarried couples
Setting up a trust is a good idea for unmarried couples because 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.
Parents
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.
Minor children
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.
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. The process of setting up a trust for a child or any beneficiary involves careful consideration of your goals and the legal frameworks that support these arrangements.
Hiring a professional is the best option, although it’s possible to do it yourself. You can set up a trust online using digital platforms that streamline the creation and management of trusts. Either way, it helps to know the steps and factors to consider.
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 to set up a trust.
Before you start a trust, gather all the titles and deeds of the assets you want to include. This may include property titles and deeds, stock certificates, bank accounts, expensive items and life insurance policies. Create a list to avoid confusion.
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.
The best type of trust focuses on your goals and circumstances. Outline the parameters on how and when you want assets to be distributed. CConsider working with an advisor to create the best trust structure for you and your beneficiaries.
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 trust documents. 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.
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.
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.
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.
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.
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.
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.
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.
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 where using life insurance makes sense.
Testamentary trust
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.
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.
Easy liquidation
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.
Death benefit
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.
Tax-free
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.
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.
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.
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.
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.
Understanding the complexities of how trusts are taxed, including the implications, can help you maximize the tax benefits of a trust. 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.
The type of trust will determine whether it has to pay income taxes. Generally, a trust is considered a separate taxable entity. However, grantor trusts are different. The grantor is responsible for paying income taxes.
A grantor trust is any trust in which the grantor maintains ownership for income tax purposes. They have a certain level of control over the trust assets. Both revocable and irrevocable trusts can be grantor trusts. That said, this should be detailed in the trust agreement.
A non-grantor trust is taxed as a separate legal entity. In such cases, the trustee files the tax returns.
A non-grantor trust maintains its taxpayer identification number. The return must include all incomes and expenses. If the trust distributes funds to beneficiaries, it will file them as distribution deductions.
Although many individuals create trusts to avoid taxes, beneficiaries may still be liable to pay certain taxes. For instance, income taxes should be paid if they receive distributions from a trust. The payout is considered part of the beneficiary’s gross income. Some types of irrevocable trusts may put the responsibility of paying trust income taxes on the trust.
Navigate through some commonly asked questions about trusts to clarify what they are, how they function and why they might be an important part of your estate planning.
A trust is a legal arrangement established to permit a designated trustee to oversee assets for the benefit of recipients, often providing trust benefits such as asset protection and estate planning advantages.
A trust fund refers to any set of assets — such as money, properties or stocks — held in a trust. A private trust typically manages these assets for the benefit of individual beneficiaries.
The term "trust fund" is often used in everyday language to refer to any wealth or assets held in trust, particularly those set aside for future use by beneficiaries.
A trust account holds trust funds or assets that a trustee manages for the benefit of someone else. It can be a bank or investment account. Setting up a trust account is part of creating a trust for a child or other beneficiaries.
A trust agreement or declaration of trust is a document that outlines the terms and conditions of the trust. It specifies how the trust is to be managed, names the trustee and beneficiaries and defines what is to happen with the assets within the trust during the life of the trust and after the trustor’s death. This document is essential for the legal establishment and operation of the trust.
A trust works by legally transferring control of assets to a trustee, who manages them for the benefit of the trust’s beneficiaries. One of the major benefits of having a trust is reducing estate taxes.
You should set up a trust to manage and protect assets, ensure they are distributed according to your wishes and potentially enjoy trust tax benefits.
When starting a trust, define your objectives, such as asset protection or estate planning. Next, choose the type of trust that best suits your needs — whether it's a personal trust or another form. Carefully select a trustworthy trustee who will manage the trust's assets and ensure they act in the best interests of the beneficiaries. Then, draft a trust agreement. Using online trust creation services can streamline the process.
The time to set up a trust varies based on complexity. A simple trust might take only a few days, especially if you create a trust online. More complex trusts, such as those involving numerous assets or stipulations, could take weeks or longer.
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.
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.
About Nathan Paulus
Nathan Paulus is the Head of Content Marketing at MoneyGeek, with nearly 10 years of experience researching and creating content related to personal finance and financial literacy.
Paulus has a bachelor's degree in English from the University of St. Thomas, Houston. He enjoys helping people from all walks of life build stronger financial foundations.
