Trusts are legal arrangements for allocating assets. These agreements offer more restrictions and control than just gifting or willing your property. If you’re looking into estate planning, trusts may be valuable assets in your portfolio.
Here is a basic breakdown of the types of trusts you might encounter.
What is a Trust?
A trust is a legal agreement between three parties for the allocation of assets. The first party (trustor, guarantor, settlor) gives control of assets to the second party (trustee) for the benefit of the third party (beneficiary). Trusts can be useful when you want to avoid certain tax situations, prepare for potential incompetency, avoid probate, or place conditions on the use and allocation of your assets. There are a few common types of trusts to understand.
- Living Trust – A living trust is created and enacted during the trustor’s lifetime and becomes effective right away. Living trusts are outside of your will and so will avoid the fees and hassles of probate court. There are two main types of living trusts:
- Revocable – Revocable trusts remain the legal property of the trustor, and that person can change the terms or arrangement at any time. For tax purposes, this means that the trustor still owns the assets and will pay taxes on the property. Revocable living trusts let you work out the kinks to make sure the arrangement truly suits all involved.
- Irrevocable Trusts – These are not mutable and, once established, remove the legal claim to the property from the trustor. When you establish an irrevocable trust, you are essentially signing away your right to the assets. The trustee will manage the assets for the beneficiary under the terms of the trust, but the trustor/settlor is effectively out of the process. Make sure you have covered all your bases before signing an irrevocable trust.
- Testamentary Trust – This type of trust is laid out in a last will and testament and becomes effective upon the trustor’s death. Since it does not exist until the will has gone through probate, changes can be made throughout the trustor’s lifetime. This trust allows you to control certain aspects of your asset allocation after you are gone. One of the common uses for these trusts are to manage life insurance payments for underage or invalid beneficiaries. In some cases, the testamentary trust will be the best choice, but be aware that you will not be around to deal with any unresolved issues. Make sure the selected trustee is aware and willing to take the responsibility.
- Funded vs Unfunded – Trusts are just a legal agreement until they are funded. Unfunded trusts will not mean much down the line, so as soon as you are prepared, it makes sense to start funding your trust. Real estate property, bank accounts, investment assets, etc. can be used to fund a trust. Talk with an expert about the tax implications of your trust allocations.
When you hear the word trust you may think about rich kids, so-called trust fund babies, but trusts have much wider applications. You might be concerned about your minor children, your dependent relatives, or your adult child’s unruly fiancée, whatever the case may be, trusts are a great way to maintain control over who, how, and when your assets are allocated.