The importance of an estate plan cannot be overstated. For many families, that means having a standard set of estate planning documents (will, powers of attorney, healthcare directive) on file. However, some folks also stand to benefit from the use of trusts within their estate plan, typically in conjunction with their will.

Trusts inherently increase the complexity of the estate planning process and it’s important to talk to an estate planning attorney before settling on a trust-based strategy.

What is a Trust?

A trust is a legal entity that exists for the ownership, management, and distribution of assets. The IRS defines a trust as a relationship in which one person holds title to property, subject to an obligation to keep or use the property for the benefit of another.

To understand a trust, it’s best to start by defining the various parties involved.

• Trustor (a.k.a. Grantor or Settlor) – the person(s) who transfers (grants) property to the trust
• Trustee – the person(s) in charge of managing the assets of the trust for the benefit of the beneficiary(ies) after it is created and funded by the trustor
• Beneficiary – the person(s) or organization(s) that stands to receive assets from the trust according to the intentions of the trustor.

Trusts are formed under state law and each state has unique factors to consider when employing a trust so it’s important to work with an attorney that is licensed in your state and understands its complexities.

Benefits of a Trust

There are various reasons to employ a trust within your estate plan, and different trusts serve different purposes, but some of the most popular reasons to establish a trust are:

Avoidance of Probate – The process of distributing assets upon your death can be timely, more so in some states than others, especially if you die intestate. However, even with a documented will, your assets are distributed via probate, the legal process where your will is brought in front of a judge, which can create administrative headaches for your loved ones and is expensive in certain parts of the country.

Asset Protection – Certain types of trusts can protect your assets from creditors, lawsuits, or other judgments.

Flexibility and Control Over Asset Distribution – It’s common for parents to want to leave assets to their children. It’s also common for parents to not want their children to be gifted a million dollars immediately when they turn 18. Trusts offer flexibility in how assets can be distributed to beneficiaries.

Avoidance of Taxes – When used strategically, trusts can help a grantor avoid state and federal taxes by maximizing their lifetime exclusion.

Privacy – Probate cases are public records and can be accessed by anyone. For some families, that adds anxiety to an already difficult time, especially if there are inherently sensitive aspects of the estate plan, such as a disinherited child. Assets passed down via trust are not recorded publicly.

Strategic Charitable Giving – For those looking to leave a lasting charitable impact, trusts can help facilitate a tax-advantaged giving strategy.

Special Needs Planning – Caring for someone who can’t fully care for themself is difficult while alive. Making sure that care continues after the death of a parent or caregiver can be even more difficult, both administratively and emotionally. Trusts can help with the administrative portion.

Incapacity Management – Certain trusts can help in case you become incapacitated. A trustee of your assets can ensure medical and long-term care bills get paid, for example.

Revocable vs. Irrevocable Trusts

When electing to set up a trust, an important election you’ll have to make (with the guidance of your attorney) is whether the trust should be revocable or irrevocable. A revocable trust, or revocable living trust, as it’s name suggests, is the most flexible and can be changed, amended, or revoked by the grantor at any time up until death. In contrast, an irrevocable trust is intended to be rigid and final. Once created, an irrevocable trust cannot be modified without the consent of beneficiaries or court approval.

Revocable living trusts are often used to avoid probate while maintaining control of the assets. The grantor can make changes to the trust as they see fit as long as they are alive and capable. The assets within a revocable trust, for all intents and purposes, function no differently than if the grantor were to continue owning them personally. Because of this, revocable trusts are not as effective at avoiding estate taxes or protecting assets from creditors.

Irrevocable trusts, on the other hand, are often used for asset protection and tax avoidance as the IRS treats assets placed in an irrevocable trust as gifts at the time of funding in most circumstances.

Note on Testamentary Trusts:

A testamentary trust is a trust that is included within a will and is not funded until after the testator dies. Testamentary trusts are commonly used to manage assets for minor beneficiaries in the case of an untimely death of parents.

Common Trust Types

Before implementing a trust-based estate plan, talk to an attorney about which one(s) make the most sense for you and your family. While there is a seemingly endless list of trust types, many with numerous potential uses, there are a few that come up frequently in financial planning conversations.

Revocable Living Trusts – Already referenced above, revocable living trusts are flexible vehicles for asset management and eventual distribution. Revocable Living Trusts are especially common in states like California, where the probate process is often lengthy and expensive.

Credit Shelter Trusts – Also referred to as Bypass Trusts or A/B Trusts, a Credit Shelter Trust helps partners avoid unnecessary estate taxes and pass more assets on to their beneficiaries by ensuring each partner’s estate and gift tax exemption is used.

Qualified Terminable Interest Property (QTIP) Trusts – A QTIP Trust is a tool that is commonly used by blended families as it allows for a decedent to ensure their surviving spouse has access to assets for as long as that spouse lives while maintaining control over how the decedent’s assets are ultimately distributed after their spouse dies. In a second marriage, for example, a wife may want her assets to pass to her kids from a previous marriage but only after making sure her spouse is taken care of for life.

Charitable Trusts – There are a number of different types of trusts designed for charitable giving, each of which can help a person leave a lasting legacy and potentially avoid estate taxes. If you plan on gifting a portion of your estate, talk to an attorney about Charitable Remainder Trusts and Charitable Lead Trusts.

Special Needs Trusts (SNT) – Often drafted and funded upon the death of a parent or other primary caregiver, a Special Needs Trust helps make sure a disabled beneficiary continues to be cared for.

Ultimately, trusts can offer significant benefits in estate planning. For small business owners and those nearing retirement, trusts can be especially valuable tools to ensure your legacy is preserved and your loved ones are taken care of.

If you think your estate plan would benefit from the employment of a trust, talk to your estate planning attorney. Quantum works closely with our clients’ attorneys, accountants, and other professionals to ensure that your wealth is protected and your loved ones are taken care of.