The Basics of Trusts

The concept of a trust fund can seem intimidating and confusing. But what exactly is a trust? Simply, it’s a legal agreement between three parties:    

  • The trustmaker: This is the individual who creates the trust agreement. This individual is commonly referred to as a grantor, trustor, or settlor.

  • The trustee: This person or entity is responsible for managing the property that the trustmaker transfers into and titles in the name of the trust.

  • The beneficiary or beneficiaries: These people or entities receive the benefits of the property titled in the name of the trust.

The trustmaker transfers ownership of certain assets to the trust and the trustee. The trustee then manages those assets for the benefit of the beneficiary or beneficiaries.

Living Trust or Testamentary Trust?

A living trust is a trust that is created and becomes effective during the trustmaker’s lifetime. This is also referred to as an “inter vivos” trust.

This is an important distinction because some trusts do not take effect until after trustmaker has died. Trusts that only become effective after the trustmaker’s death are referred to as “testamentary” trusts. A testamentary trust is typically formed by the executor of the decedent’s estate when the decedent’s last will and testament names the trust as a beneficiary. The will directs that the decedent’s property should be moved into that trust upon his death.

Revocable Living Trusts

In most situations, the trustmaker, the trustee, and the beneficiary of a revocable trust are the same person.

The trust agreement may cite other beneficiaries as well, those who will inherit from the trust after the trustmaker’s death. The two most common reasons for creating a revocable living trust are (1) to plan for mental disability and (2) to avoid probate of the assets the trustmaker funds into his trust before his death.

The trustmaker can name someone else, referred to as a “successor trustee,” to take over should the trustmaker become mentally incapacitated. This avoids having a court name a conservator or guardian to take over the trustmaker’s financial affairs when the trustmaker is unable to do so.

Irrevocable Living Trusts

If the trustmaker forms an irrevocable trust, in most cases he cannot alos act as the trustee. The most common use of an irrevocable trust is to move assets out of the trustmaker’s name to the next generation for their use and enjoyment. This, in turn, reduces the value for the trustmaker’s estate for estate tax purposes.

Once property is transferred into an irrevocable trust, you lose ownership and control over that property and you cannot take it back. The trustmaker of a revocable trust reserves the right to dissolve or change that trust at any time, but an irrevocable trust is, for the most part, forever.

Other Types of Trusts

All living trusts are either revocable or irrevocable, but a living trust can be designed to meet other specific purposes as well within these frameworks:

  • An irrevocable life insurance trust (ILIT) only holds an insurance policy on the trustmaker’s life. The policy is owned by the trust so its proceeds are not generally included in the gross value of the decedent’s estate for estate tax purposes.

  • A special needs trust is set up to provide for a disabled beneficiary in such a way that it does not compromise his or her entititlement to Supplemental Security Income or Medicaid benefits.

  • A spendthrift trust gives the trustee discretion as to how and when distributions should be made to a beneficiary who is not financially responsible, or to safeguard the inheritance in the event the beneificiary divorces.

 

If you want to form a trust for a specific concern or reason, speak with an estate planning attorney. Almost certainly, there’s a trust out there to meet your needs.