What Is a Trust?
A trust is a legal vehicle that permits a third party to hold and manage your assets on behalf of your beneficiaries. Trusts are often used to help avoid taxes and probate. Establishing a trust can be an important part of retirement and estate planning.
How Do Trust Funds Work?
A trust fund is a legal entity that allows you to put conditions on how your assets are distributed after you die. It also gives another party authority to handle those assets on behalf of your beneficiaries.
- Grantor or Trustor: The person who creates the trust.
- Trustee: The person or entity that manages the trust according to the grantor’s instructions.
- Beneficiaries: The person or people who inherit or benefit from the trust.
A trust is more complicated and less common than a will. But for many people — especially those with a net worth of $100,000 or more and real estate holdings — trusts are a fundamental part of retirement planning.
Trusts can either be revocable — meaning you can change its terms when you’re alive — or irrevocable, which means the trust terms are permanent. A living trust is created and holds assets when you’re still alive.
- Ensure that your assets are distributed according to your wishes.
- Bypass probate.
- Maintain privacy.
- Avoid or reduce inheritance and estate tax.
- Shield certain assets from creditors.
A trust can place specific conditions that must be met before beneficiaries can inherit assets. They can also specify exactly how and when money will be paid out.
For example, you can schedule distributions to align with important life events, such as graduating from college or marriage.
How to Create a Trust
An attorney establishes a trust, but you can name anyone as a trustee, or the person who makes sure instructions in the contract are carried out the way you want.
A trust is a legal document that holds ownership of assets.
- Real estate
- Bank and savings accounts
- Other financial accounts
- Jewelry and collectibles
- Virtual items, such as intellectual property rights
Simply drafting a trust does nothing. It must be “funded” before assets can pass to beneficiaries.
Funding a trust is the process of transferring your assets from your name to your trust. To do this, you must physically change the ownership of your belongings — such as the title to a car or deed to a home — from your name to the name of your trust.
You should also change any beneficiary designations on life insurance policies and annuities.
A trust is a legal entity, separate from you. That’s why assets placed inside can bypass probate, and often, estate tax.
Common Types of Trust Funds
All trusts can be classified as either revocable or irrevocable, but there are also specific types of trusts that serve different goals and estate planning needs.
- A-B or Bypass Trust
- An A-B trust divides into two upon your death. The “A” trust is created for your surviving spouse, and a second “B” trust is created for other beneficiaries, usually your children. The trust for your spouse is usually revocable, meaning he or she is in control and can make changes to it, while the B trust is generally irrevocable. A surviving spouse may act as trustee of a bypass trust or name someone else as the trustee.
- Charitable Trust
- A charitable trust lets you leave part or all of your estate to a 501(c)(3) organization of your choice. You can leave money, real estate and other assets. You can also receive specific tax benefits with this type of trust. A charitable remainder trust is irrevocable and provides an income stream to a named beneficiary. After a specified time, a public charity or private foundation receives the trust’s remaining value.
- Life Insurance Trust
- Life insurance trusts are irrevocable. Unlike naming a beneficiary on your life insurance policy, this type of trust shields the policy money from potential estate tax. It can also specify how you want the beneficiary to receive the money, and under what conditions.
- Special Needs Trust
- This type of trust is established to pass assets to a beneficiary with physical or mental disabilities. They are often created to ensure that the beneficiary doesn't lose government benefits because of a sudden inheritance. Special needs trusts can also be used to earmark proceeds from a lump-sum settlement on behalf of the disabled person.
- Spendthrift Trust
- You may be good at managing your money — but your beneficiary may not. A spendthrift trust protects a financially irresponsible beneficiary by limiting their access to the money. An appointed trustee serves as the gatekeeper, and the trust terms specify how much and how often a beneficiary receives payments — and under what circumstances.
8 Cited Research Articles
- Internal Revenue Service. (2020, February 3). Estates and Trusts. Retrieved from https://www.irs.gov/e-file-providers/estates-and-trusts
- Internal Revenue Service. (2019, December 19). Charitable Trusts. Retrieved from https://www.irs.gov/charities-non-profits/private-foundations/charitable-trusts
- Carlson, B. (2019, August 28). Wills Vs. Trusts: Which Is Best For You? Retrieved from https://www.forbes.com/sites/bobcarlson/2019/08/28/wills-vs-trusts-which-is-best-for-you/#1cdffa937abd
- Carlson, B. (2018, December 2). 7 Reasons It's Time To Update Your Estate Plan. Retrieved from https://www.forbes.com/sites/bobcarlson/2018/12/02/7-reasons-its-time-to-update-your-estate-plan/#27cbfd505ebf
- Civics 101: A Podcast. (2019, May 14). Episode: Life Stages – Death. Retrieved from https://www.civics101podcast.org/civics-101-episodes/death
- Reeves, J. (2017, January). The Ultimate Guide to Estate Planning. Retrieved from https://www.aarp.org/money/budgeting-saving/info-2016/the-ultimate-guide-to-estate-planning.html
- American Bar Association. (n.d.). Revocable Trusts. Retrieved from https://www.americanbar.org/groups/real_property_trust_estate/resources/estate_planning/revocable_trusts/
- CNN Money. (n.d.). Ultimate guide to retirement: What kinds of trusts are there? Retrieved from https://money.cnn.com/retirement/guide/estateplanning_trusts.moneymag/index2.htm