How Trusts Work – Estate Planning 101

by Darwin on June 25, 2012

Trusts are not just for wealthy people. A trust is a way to distribute funds to any cause or group with any conditions you choose without requiring your own active participation. Thus, trusts have become a popular way to leave funds to family members after the death of the grantor.

Trust fund 101

Each trust has a grantor, trustee, and beneficiary. The grantor (or donor) is the person who starts the trust and provides the original funding or assets for the trust. A trustee is the person who carries out the specific orders of the trust. Beneficiaries are those who receive the benefits paid out by the trust.

You can think of this much like the various corporate formations out there. A newly created trust is a separate entity, just as a business can be separated from an individual by filing a few legal papers.

There are two different types of trusts, living and after-death trusts, which are named based on the time the trust is formed. A trust can then be either a revocable or irrevocable trust. Revocable trusts can be modified by the grantor whereas an irrevocable trust can be modified only by the beneficiary or beneficiaries.

Why Form a Trust?

There are many different situations where forming a trust make sense:

    1. When you expect to pass on wealth to “less experienced” family members. Creating a trust makes it possible to pass on the bulk of your savings to loved ones with conditional boundaries. You have the right to set requirements on any disbursement from the trust after your death. You might set aside a large lump sum payment to your children on the condition that it is to be used for education expenses, for example.
    2. When you want to avoid probate courts and make assets available immediately. Probate can be time-consuming, expensive, and emotionally draining. Not to mention, probate is often complicated by problems like past divorces or money-hungry family members. Trust assets are kept outside of probate court rooms. Note that this varies from state to state based on state law, and that probate avoidance is generally a minor benefit for middle class savers who likely won’t have any large concerns in probate.
    3. When you want complete privacy. Trusts are private matters and not made public like a will is, giving the grantor some privacy in making their own financial planning maneuvers.
    4. When you need to make health planning issues. Trusts can be used to establish a plan should you become disable or incapacitated. You can use the trust to specify how your assets should be used to provide for basic medical care – you can even go so far to name a specific care facility and suggestions for payment for such services. For example, you might tell the trust to immediately sell the family home in the event you need long-term care. You might also require proceeds from the sale be invested in a stable value fund, which will be used to pay for your long-term care.

Do You Need a Trust at All?

Of course, trusts are not necessary to complete a transfer of assets from one generation to another.

Keep in mind that savings accounts, retirement plans (IRAs and 401Ks) and insurance is paid out to the named beneficiary without probate. These transfers will go through without question, even if the person named as a beneficiary on the account is different than the plan outlined in a will or trust. In effect, there is very little probate concern to be avoided for people who have a significant asset base in cash or retirement accounts. Real estate often transfers by right of survivorship, meaning that the ownership equity will transfer to the other partial owners (a spouse or co-investor) in the event one party dies before the other.

Small business owners arguably derive the most value from a living trust. Dividing up a small business after death through probate can be complicated, complex, and ultimately break up a successful family business. Putting the business in the trust, however, keeps the business out of probate and helps keep business assets whole so that it can continue to operate after the owner’s death.

Depending on your wealth, the competency of your heirs, and your particular health concerns, a trust can be a much better way to make long-term estate planning decisions. The high cost of legal advice, however, make living trusts an option only for those with significant assets or serious concerns with probate (family businesses, for example).

Administering a living trust is not inexpensive; take a look at this example discussion about living trust costs on the Wall Street Journal. In short, attorney and legal fees added up to more than $34,000 on a trust with only 6 beneficiaries.

{ 5 comments… read them below or add one }

Jeff @ Sustainable Life Blog June 25, 2012 at 4:14 pm

Always been curious about this – is this a good way to lower your tax load upon your passing as well? I notice lots of people (that I work with) put land into trusts – what is the benefit of this?


JT June 26, 2012 at 4:05 pm

It comes down to transfer issues. Land has few comparables and isn’t particularly liquid so its likely they’re carrying it for far less than what property taxes should be. Some states will reassess property at a higher price after sale or transfer. But, if you transfer real estate via trusts, the trust isn’t real estate, so it doesn’t get the reassessment.

I’m going to get to tax savings in another article. It’s a standalone kind of topic – I think you could spend years talking about tax law. Simple answer is yes, you can save tremendously on estate taxes with a trust. The long answer is come back next week. 😉


Financial Samurai June 26, 2012 at 6:11 am

Nice post JT. Let’s talk more about tax minimization please!


JT June 26, 2012 at 4:05 pm

Will do. Wanted to go over the basics first. Taxes will be the highlight of the next part.


A Blinkin June 28, 2012 at 4:42 pm

You say thay trusts are not just for wealthy people and I agree but at what net worth would you say people need to start thinking about a trust. Or if not net worth, what life event (having children) triggers this need?


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