DEFINITION of ‘Trust’
A fiduciary relationship in which one party, known as a trustor, gives another party, the trustee, the right to hold title to property or assets for the benefit of a third party, the beneficiary.
There are two types of trusts:
1. Living Trust (inter-vivos): A trust that is in effect during the trustor’s lifetime.
2. Testamentary Trust: A trust that is created through the will of a deceased person.
EXPLAINATION of ‘Trust’
For example, a trust can be used if a beneficiary is under age or has a mental disability that impairs the person’s ability to maintain his or her own finances. Once the beneficiary is deemed able to manage the funds or assets by the terms dictated under the trust, the beneficiary will receive possession of the trust. The trust is taxed on any funds not distributed to the beneficiary.
A trust is traditionally used for minimizing estate taxes and can offer other benefits as part of a well-crafted estate plan.
Since trusts usually avoid probate, your beneficiaries may gain access to these assets more quickly than they might to assets that are transferred using a will. Additionally, if it is an irrevocable trust, it may not be considered part of the taxable estate, so fewer taxes may be due upon your death.
Assets in a trust may also be able to pass outside of probate, saving time, court fees, and potentially reducing estate taxes as well.
Other benefits of trusts include:
- Control of your wealth. You can specify the terms of a trust precisely, controlling when and to whom distributions may be made. You may also, for example, set up a revocable trust so that the trust assets remain accessible to you during your lifetime while designating to whom the remaining assets will pass thereafter, even when there are complex situations such as children from more than one marriage.
- Protection of your legacy. A properly constructed trust can help protect your estate from your heirs’ creditors or from beneficiaries who may not be adept at money management.
- Privacy and probate savings. Probate is a matter of public record; a trust may allow assets to pass outside of probate and remain private, in addition to possibly reducing the amount lost to court fees and taxes in the process.
There are many types of trusts; a major distinction between them is whether they are revocable or irrevocable.
Revocable trust: Also known as a living trust, a revocable trust can help assets pass outside of probate, yet allows you to retain control of the assets during your (the grantor’s) lifetime. It is flexible and can be dissolved at any time, should your circumstances or intentions change. A revocable trust typically becomes irrevocable upon the death of the grantor.
You can name yourself trustee (or co-trustee) and retain ownership and control over the trust, its terms and assets during your lifetime, but make provisions for a successor trustee to manage them in the event of your incapacity or death.
Although a revocable trust may help avoid probate, it is usually still subject to estate taxes. It also means that during your lifetime, it is treated like any other asset you own.
Irrevocable trust: An irrevocable trust typically transfers your assets out of your (the grantor’s) estate and potentially out of the reach of estate taxes and probate, but cannot be altered by the grantor after it has been executed. Therefore, once you establish the trust, you will lose control over the assets and you cannot change any terms or decide to dissolve the trust.
An irrevocable trust is generally preferred over a revocable trust if your primary aim is to reduce the amount subject to estate taxes by effectively removing the trust assets from your estate. Also, since the assets have been transferred to the trust, you are relieved of the tax liability on the income generated by the trust assets (although distributions will typically have income tax consequences). It may also be protected in the event of a legal judgment against you.