A trust is not just a vehicle for the mega-rich. Many people are discovering the benefits and advantages of having a trust fund. Want to know more? Here are some useful facts about the functions and features of trusts.
Trust Fund Defined
A trust is an estate planning instrument that holds your assets for the eventual transfer to a benefactor of your choice. The trust assets can be cash, property, securities, life insurances, businesses or a mixture of these. A trust can borrow money, pay taxes, run businesses and invest. Also, it can provide a safe haven from taxes, legal actions and probate.
How Do Trusts Work?
A trust involves 3 participants: the settlor, the trustee and the beneficiary. You would be the settlor, the person who initiates and funds the trust. The trustee is a neutral 3rd party who manages your assets in the trust account. The beneficiary of your trust could be your spouse, an offspring, a business associate, an organization or a charity.
When you die, your last will and testament becomes public record. This makes it vulnerable to legal and civil challenges. A trust works by keeping its contents and rules private. Only the trust’s participants know the details within the trust account. This protects it from external forces. Plus, the trust arrangement ensures that your wishes will be carried out.
Revocable vs Irrevocable Trusts
Many people define a trust account as a convenient way to transfer assets after you die. But, you can establish a revocable trust that permits you to pass on wealth during your lifespan. This living trust gives you the freedom to control your assets or terminate the entire arrangement.
Since it is inflexible, an irrevocable trust may appear to be inferior to a revocable trust. By giving up the power to alter your trust, you lose complete control of the assets committed to the irrevocable trust.
Revocable and irrevocable trusts have their strengths and weaknesses. The key difference comes down to their ability to shelter your assets from probate and estate taxes. The irrevocable trust wins this contest. It shelters your assets from both. Revocable trusts protect your holdings from probate but it offers little protection from estate taxes. However, it is important to remember that in today’s tax climate, only the super-wealthy pay estate taxes; only estates of a single taxpayer over $11.15 million and married taxpayers of $22.36 million are subject to inheritance taxes.
Types of Trusts
Between revocable and irrevocable trusts, there are several types of trusts one can open. It is important to remember the key distinctions between each of them. Your choice would depend on your desired purpose for the trust.
Charitable Trust
A charitable trust allows you to set up a means for giving within your estate plan. You can establish either a charitable lead trust or a charitable remainder trust. With a lead trust, you can set aside certain assets that select charities would receive after you pass away. The remaining assets would go to your beneficiaries. A charitable remainder permits you to receive income from your assets up until a specific period of time. After that time, the remaining assets or income would go to the charity of your choice.
Generation-Skipping Trust
For whatever reason, you may want to transfer your assets to your grandchildren. The IRS normally taxes this move after your childrens’ death. But this type of trust fund has a generation-skipping tax exemption. It permits the trust to transfer your assets to your grandchildren without paying estate taxes.
“A” or Marital Trust
If one spouse dies, a marital trust ensures the orderly transfer of assets and trust income to the surviving spouse without legal challenges. It provides the surviving spouse with lifelong protection from estate taxes. But, the marital trust doesn’t shield the surviving spouse’s heirs from estate taxes on the remaining assets they inherit. Again, estate taxes are only levied on the extremely wealthy with estates in the double-digit millions.
“B” or Bypass Trust
A bypass or credit shelter trust gives a wealthy married couple the ability to ease the estate tax burden on their heirs. After one spouse passes on, this irrevocable trust directly transfers to the surviving spouse. The trustee continues to hold and manage the assets. But they are separate from the late spouse’s estate. When the surviving spouse dies, the couple’s beneficiaries will not have to pay estate taxes. This type of trust takes full advantage of each spouse’s federal tax exemption.
Testamentary Trust
To use this option, you must establish a testamentary trust as part of your last will and testament. It ensures that your beneficiaries can only receive the trust assets at a specified time. Do you want to delay asset access to your beneficiaries until they reach adulthood? This trust provides you the ability to do that.
Spendthrift Trust
A spendthrift trust is another way to protect the integrity of your trust assets. Until the trustee distributes the assets, this trust prevents the beneficiary from selling or pledging any interests in the trust. This protects the trust funds from your beneficiary’s creditors.
Totten Trust
If you plan to gradually create wealth through a lifetime of contributions, a Totten trust allows you to gift your accumulated assets to a beneficiary after your death. This revocable trust requires you to deposit money into a bank or other financial institution for the purpose of post mortem gifting. After you die, the Totten trust fund skips probate. Also, it’s better than using a joint bank account to pass on assets to family. But, you can’t include real property in a Totten trust.
Special Needs Trust
You can set up a special needs trust for someone who is collecting government benefits. Social Security will not rescind the beneficiary’s eligibility unless:
- The disabled beneficiary has discretion over the amount and frequency of the trust distributions
- The beneficiary can revoke the trust
- The beneficiary could obtain these types of luxuries or benefits on without help
Parents can establish a special needs trust for their disabled children. They can use the trust money to pay for medical care and for daily needs without losing the government benefits.
How to Start a Trust
Typically, you would use a lawyer to help you set up your trust. A financial advisor can assist you in choosing the best ways to allocate your assets. Your trust would operate according to the rules of a deed of trust. The deed identifies the beneficiaries, the trustee and the administration guidelines of the trust. Unlike other estate planning tools, a trust allows you to dictate the manner and time of your distribution of assets to your benefactor.
The setup process requires you to sell your assets at the current market value. You can record the sale as a gift or a debt payable to you by the trust. Once you complete the transfer, any appreciation of these assets belongs to the trust.
If the trustee elects to keep asset income in the trust fund, the IRS designates this revenue as trustee income, taxable at 33%. Also, the trustee has the option of distributing income to the beneficiaries. This beneficiary income generally has a lower tax rate than trustee income.
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Is a Trust Right for You?
Establishing a trust fund can be beneficial for many reasons. Here are a few that may apply to you:
- To shield a benefactor’s assets from creditors
- To cement your financial plans while you are of sound mind
- To manage contestable assets like businesses, boats, mineral rights and copyrights
- To provide a planned income for your surviving spouse and secure trust assets for your offspring
- To properly manage your business assets for the eventual transfer to responsible parties
- To spare your benefactors of the hassles and expense of probate and estate taxes
Truths About Trusts
A trust is a contract between you and the trustee. You are putting your financial fate in the trustee’s hands. The trustee must be a fiduciary, meaning the professional is legally bound to act in your trust’s best interest. Make sure you choose a competent financial professional who has proper certifications to manage the type of assets in your trust account. If you’re still not sure whether your estate needs a trust, get answers for your specific questions from a qualified financial advisor with this search tool.