Many people don’t understand the benefits of trusts, how to go about forming one, or even at its basic form, what a trust is. Simply put a trust is a document that spells out the rules that you want followed for an asset held in a vehicle for your beneficiaries. Common objectives of trusts are to reduce estate taxes, to protect property in your estate, and to avoid probate.
A trust can be created while someone is alive, and survive after the person has passed. A trust can also be created by a will and formed after death. Once assets are put into the trust they belong to the trust, not the trustee, and remain subject to the rules and directions of the trust document. To put it in simply, a trust is a right in property/asset, which is held in a fiduciary relationship by one party for the benefit of another. The trustee is the one who holds title to the trust property, and the beneficiary is the person who receives the benefits of the trust. While there are a number of different types of trusts, the basic types are revocable and irrevocable. Let’s go through each one.
Revocable Trusts. Revocable trusts are created during the lifetime of the person who makes the trust and can be altered, changed, modified or revoked entirely. Often called a “living trust”, these are trusts in which the owner transfers the title of a property or asset to a trust, can serve as the initial trustee, and has the ability to remove the property from the trust during his or her lifetime. Revocable trusts are extremely helpful in avoiding probate. If ownership of assets is transferred to a revocable trust during the lifetime of the grantor so that it is owned by the trust at the time of the grantor’s death, the assets will not be subject to probate. Although useful to avoid probate, a revocable trust is not generally used for asset protection as assets transferred to the trust during the trust maker’s lifetime will remain available to the trust maker’s creditors. Typically, a revocable trust evolves into an irrevocable trust upon the death of the grantor.
Irrevocable Trust. An irrevocable trust is one which cannot be altered, changed, modified or revoked after its creation. You cannot take your property back after you transfer it into an irrevocable trust. The trust maker reserves the right to dissolve or change his revocable trust at any time, but an irrevocable trust is, for the most part, forever. Grantors can prevent assets from being misused by beneficiaries; assets can be held in trust and distributed with conditions. They can also be able to gift assets or remove them from the estate while still retaining the income from the assets.
Asset Protection Trust. An asset protection trust is a type of trust that is designed to protect a person's assets from claims of future creditors. These types of trusts are often set up in countries outside of the United States, although the assets do not always need to be transferred to the foreign jurisdiction. The purpose of an asset protection trust is to insulate assets from creditors. These trusts are normally structured so that they are irrevocable for a term of years and so that the trust maker is not a current beneficiary. An asset protection trust is normally structured so that the undistributed assets of the trust are returned to the trust maker upon termination of the trust provided there is no current risk of creditor attack, thus permitting the trust maker to regain complete control over the formerly protected assets.
Charitable Trust. Charitable trusts are trusts which benefit a particular charity. Charitable trusts are established as part of an estate plan to lower or avoid imposition of estate and gift tax. A charitable remainder trust (CRT) funded during the grantor's lifetime can be a financial planning tool, providing the trust maker with valuable lifetime benefits. Charitable Lead Trust (CLT) is a trust designed to reduce beneficiaries' taxable income by first donating a portion of the trust's income to charities and then, after a specified period of time, transferring the remainder of the trust to the beneficiaries. The tax-deferred nature of life insurance and real estate make those assets ideal for CLT structures.
Special Needs Trust. A special needs trust is one which is set up for a person who receives government benefits so as not to disqualify the beneficiary from such government benefits. This is completely legal provided that the disabled beneficiary cannot control the amount or the frequency of trust distributions and cannot revoke the trust. Ordinarily when a person is receiving government benefits, an inheritance or receipt of a gift could reduce or eliminate the person's eligibility for such benefits. By establishing a trust, the beneficiary can obtain the benefits from the trust without defeating his or her eligibility for government benefits. Usually, a special needs trust has a provision which terminates the trust in the event that it could be used to make the beneficiary ineligible for government benefits. Special needs have a specific legal definition and is defined as the requisites for maintaining the comfort and happiness of a disabled person, when such requisites are not being provided by any public or private agency. Special needs can include almost anything; the list is quite extensive. Parents of a disabled child can establish a special needs trust as part of their general estate plan and not worry that their child will be prevented from receiving benefits when they are not there to care for the child.
Spendthrift Trust. A trust that is established for a beneficiary which does not allow the beneficiary to sell or pledge away interests in the trust is known as a spendthrift trust. It is protected from the beneficiaries' creditors, until such time as the trust property is distributed out of the trust and given to the beneficiaries. This is a way to stop beneficiaries from spending through their money too quickly or irresponsibly.
Tax By-Pass Trust. A tax by-pass trust is a type of trust that is created to allow one spouse to leave money to the other, while limiting the amount of federal estate tax that would be payable on the death of the other spouse. While assets can pass to a spouse tax-free, when the surviving spouse dies, the remaining assets over and above the exempt limit would be taxable to the children of the couple, potentially at a rate of 55 percent (as of 2017). A tax by-pass trust avoids this situation and saves the children potentially hundreds of thousands of dollars in federal taxes, depending upon the value of the estate.
Forming a trust is a great way to protect your family's assets and to make sure loved ones are secure. If you want to protect your family and net worth from taxes, creditors, or even your beneficiaries, it makes a lot of sense to from a trust. You may decide that the complexity required for such a trust would benefit from the advice of an estate planning lawyer.