Craig Lemoine, Ph.D., CFP®, Director of Consumer Investment Research
A trust is a mechanism of owning property. Trusts are often used to simplify and coordinate estate planning. Trusts can also be used to preserve wealth and small business assets or provide a meaningful path to charitable giving. Trusts can be used to protect family wealth from divorce, creditors or family members who overspend. Lastly, trusts can be a tool to pass family values through generations.
What Is a Trust?
Trusts may vary in form and function, but they have a similar structure. Trusts have a donor or grantor, who generally establishes the trust and places or gifts property into the trust. Once the property is titled or owned by the trust it is managed by a trustee.
The trustee is a person or organization (often a bank or trust company) who is charged with making decisions according to the intent and purpose of the trust.
Trusts also have beneficiaries. Beneficiaries are individuals or entities who receive a current or future economic benefit from the trust.
Trusts are generally broken down into living trusts (also called Inter Vivos) or testamentary trusts. A living trust is created during the lifetime of a grantor. The grantor will retitle or gift assets into the trust. A testamentary trust is created at death, generally through estate planning documents.
Consider this example:
Jamie (80) is worried about his daughter’s compulsive spending. Rather than name is daughter in his will, Jamie establishes a revocable living trust with his daughter as a beneficiary. Jamie transfers half a million dollars in stocks and bonds into this trust.
While Jamie is living, he can transfer property into and out of the trust or potentially change the beneficiary. At Jamie’s death the trust will become irrevocable. The trust will appoint a trustee to manage the assets and, alongside the trust document, determine when and if distributions will be made to Jamie’s daughter.
Jamie is the grantor and at his death a trustee will be appointed. Jamie’s daughter is a beneficiary but will not be able to directly access these funds. Funds held by the trust are not subject to Jamie’s credit, divorce or her propensity to overspend.
Revocable vs. Irrevocable Trusts
When the beneficiaries of a trust can be changed, the trust is called revocable. If the beneficiaries of a trust cannot be altered, the trust is referred to as irrevocable.
Living revocable trusts become irrevocable testamentary trusts at the death of a grantor. Irrevocable trusts have their own tax ID number. Where property can be transferred into a revocable trust without triggering a gift-tax event, property must be gifted into an irrevocable trust. These gifts may be subject to state or federal taxation.
How Trusts Are Taxed
An additional, defining characteristic of both revocable and irrevocable trusts are their treatment of income. With simple trusts, any income generated is considered taxable to beneficiaries. In complex trusts, the trust pays tax directly at the trust’s tax rate.
Complex trusts have additional distribution requirements than simple trusts. Trusts can determine how and when beneficiaries receive an economic benefit. Trusts can provide income to a beneficiary or pay principal distributions. Distributions are governed by the trust document and trustee.
Using Trusts for Asset Protection
Irrevocable trusts can provide a strong mechanism for asset protection because assets in a trust are not accessible by trust beneficiaries. With an irrevocable trust, assets are secured. Neither the donor nor the beneficiary can pull assets out of the trust at will. This separation between access and assets creates creditor protection for assets inside the trust.
Trust vs. Will
A will is a legal document that determines who will receive property at death. A will governs property that does not pass through titling or beneficiary designations.
A will is different than a trust. Where a will provides a guide to distribute assets at death, a trust provides a mechanism of naming beneficiaries and managing property after death. Wills can be written to include testamentary trusts, passing assets into a trust rather than passing them to an individual or charity.
Charitable Trusts
Trusts can be used to make gifts to a charity. Charities can be current beneficiaries of a trust or receive a remainder distribution at the death of a grantor.
- Charitable lead trusts allow a donor to establish a trust and a charity receives an economic benefit during the life of the donor. With a charitable lead trust, the donor generally names a family member or non-charitable beneficiary who will receive proceeds at death.
- Charitable remainder trusts allow a donor to establish a trust during their lifetime and a charity receives an economic benefit at the donor’s death. Both charitable lead and charitable donor trusts may allow an income tax deduction as well as removing assets from a donor’s estate.
Talk with a Professional
Trusts are tools that can be used for a variety of purposes. They can help protect property from divorce or creditors. Trusts can be used to freeze the size of a taxable estate, purchase life insurance or provide a legacy of generational wealth. Trusts are a formal legal document and should be drafted by a qualified estate planning attorney to compliment your estate plan.
Do you need a trust? The answer begins with your goals and ends with an understanding of your financial condition. Talk with your financial advisor, accountant and estate planning attorney to see if a trust is right for you.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
Craig Lemoine is not affiliated or registered with Cetera Advisor Networks LLC. Any information provided by Craig Lemoine is in no way related to Cetera Advisor Networks LLC or its registered representatives.
