Trusts 101: Understanding an Important Estate Planning Tool
January 15, 2015 Tax Advisor


When people think about setting up a trust fund, they often think that trusts are only for the wealthy, which is not the case. Anyone can utilize a trust in their estate plan as an instrument to distribute assets effectively and efficiently upon death or to put stipulations on assets gifted to children. Many financial planners recommend setting up trusts as an estate planning vehicle for clients with assets greater than $100,000.

What is a Trust?

A trust is a legal agreement between two parties: the person who creates the trust (“grantor”), and the person, institution, or independent trust company responsible for administering the trust (“trustee”).  The trustee manages the assets placed in the trust for the benefit of a third party (“beneficiary”).

Why Should I set up a Trust?

There are many reasons to set up a trust including:

  • Trusts allow you to leave your estate to your heirs, in a manner that is not directly and immediately payable to your heirs upon death, through controlling distributions to your beneficiaries post-death. For example, per a trust agreement, minor children may not be able to access assets until they have reached a specified age or upon certain conditions being met, such as graduating from college.
  • Trusts offer greater privacy than wills since trusts do not go through probate; therefore, there would be no public record of the assets included in the trust. On average, probate can cost between 5-7% of an estate’s value, between attorney fees and court costs, and could take up to nine months to finalize.
  • Trusts ensure your wishes are adhered to after your death.  For example, a trust can enable you to support your surviving spouse upon death but require that the entire principal or remainder of your estate goes to your children after your spouse dies.
  • Trusts allow you to superficially stipulate how to divide up assets among heirs, such as closely held businesses.
  • If you become incapacitated, a trust can designate who would manage your assets during your lifetime, similar to a financial power of attorney.
  • A trust will guarantee that the assets you want to be designated to charity are distributed to charity upon your death.

Types of Trusts

There are different kinds of trusts, each tailored to meet a specific need.  The degree of flexibility and control vary under different types of trusts. Trusts are often classified by their purpose, duration, creation method, and by the relationship to the life of their creator.

Revocable Trust(also called a living trust or an inter vivos trust) can be revoked or dissolved by changing the terms at any time. It allows its creator to place assets in the trust and continue to manage the assets within the trust throughout the remainder of their lifetime.  The assets remain in your control and therefore your estate; however, assets in a revocable trust do not go through probate. Upon your death, the trust becomes irrevocable, and the trustee would be responsible for administering the assets per the terms of the trust.

Testamentary Trust (also called a trust under will) is created through a will and is effective upon death; however, the assets are not titled to the trust prior to death and everything will still go through probate.

Discretionary Trust gives the trustee authority to determine when and how much trust income should go to the beneficiaries.  This type of trust allows you to restrict spending to basic support such as food, clothing, education and health care.  The stipulations on spending are unique to trusts since you cannot put these types of provisions on a savings or checking account.

Life Insurance Trust holds a life insurance policy.  When proceeds from a life insurance policy that you own directly are paid out upon your death, those proceeds are included in your gross estate and subjected to estate tax. To remove the policy from your estate, you would surrender ownership rights to the trust, which means you can no longer borrow against it or change beneficiaries. As a result, the proceeds from the life insurance policy are removed from your estate and provide your beneficiaries with tax-free income.

Dynasty Trust is used to mitigate the impact of generation skipping transfer tax.  It allows you to set aside assets for your grandchildren and future descendants without paying gift, estate or generation skipping tax over each generation.

Charitable Remainder Trust is an irrevocable trust that enables the donor to give highly appreciative assets to his or her favorite charity and still derive lifetime income.

The Next Steps

Ensuring that your family is secure and your final wishes are carried out is a key planning consideration for any individual. Incorporating trusts into your estate planning strategy will provide financial reassurance in a way that best meets the needs of you and your family, according to your wishes. Trust planning can be a complex and emotional process and needs to be properly prepared and reviewed by your financial advisor and attorney.

If you have questions on setting up a trust or would like more information on your estate planning options, please contact us.

About the Authors

Jessica L. Tepus
Jessica L. Tepus
Senior Manager, Taxation Services


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