What Is a Trust and How Does It Work?

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What Is a Trust and How Does It Work?

A trust is a legal entity, created to hold assets for a person referred to as a beneficiary. The person in charge of the trust is the trustee. The person who creates the trust is known as the grantor (or trustmaker, settlor, or trustor). How the trust is structured and what it does varies widely, as detailed in the aptly-named article “Trusts Explained” from U.S. News & World Report. Trusts are used in estate planning to reduce estate taxes, help avoid having certain assets go through probate, or assist in validating and settling an estate.

Simply put, trusts are used to transfer assets from one person to another person, or institution, such as a nonprofit or a bank. The grantor establishes the trust and funds it by retitling assets to be owned by the trust. The grantor also chooses one or more beneficiaries and a trustee or a group of trustees, who are in charge of managing the trust.

You might create a trust to benefit a charity and have it managed by a bank or another type of financial institution. If the trustee is an institution, it will name a trust administrator or trust officer, who is in charge of managing the trust.

Placing assets in a trust ensures they are managed as directed in the trust documents, even when you cannot manage them yourself. Assets in a trust do not go through probate, allowing heirs to access assets more quickly than if they were transferred using a last will.

Certain kinds of trusts, and there are many, can be used to remove assets from your estate to reduce estate taxes.

Revocable living trusts provide a lot of flexibility. The grantor may change the terms of the trust or even shut the trust down at any time. The grantor may also be a trustee, so as to maintain complete control of the trust during the lifetime of the grantor. A successor trustee is named to control the trust when the primary trustee dies or becomes incapacitated.

In exchange for this much control, the assets are still considered part of the grantor’s estate. To avoid this, use an irrevocable trust. This trust cannot be altered by the grantor once it’s established. The grantor may not change the terms of the trust or dissolve the trust. Assets are under control of the trustee only. Assets in an irrevocable trust are not considered part of an estate, not subject to estate taxes and the grantor does not have to pay taxes on income generated by the trust during their lifetime. Note: this description is “painting” with a broad brush as there are many legal and tax “moving parts,” when it comes to irrevocable trusts.

Wills and trusts are both used to direct how assets are transferred after death. Trusts can be used to manage assets on your behalf, if you become incapacitated as well as after your death. Trust documents do not become part of the public record, while wills do. Wills have to be validated by the court; trusts do not. Some people place most or all of their assets within a trust to keep their business private.

Trusts provide a great deal more control over your assets and maintain privacy for the family. You control how and when assets are distributed in the trust document. For instance, children can be given money over a controlled period of time, rather than all at once. You can also use trusts to pass assets along to a family member with special needs who is receiving government benefits using a special needs trust. Passing assets directly to such an individual could put all of their government support and programs at risk.

Speak with your estate planning attorney about trusts and how they may benefit you, your spouse and your family. They can provide you with even greater peace of mind than a will. Note: the above description of a trust is truly “painting with a broad brush,” since there are many legal and tax “moving parts” when it comes to irrevocable trusts.

Reference: U.S. News & World Report (Feb. 7, 2022) “Trusts Explained”

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