Should You Create a Trust?
By Ric Edelman
People often create trusts to help them manage their assets. Here’s a quickie on the basics of a trust, along with a description of common uses.
A trust is created by the grantor (that’s you). The grantor writes the rules governing how the trust is to operate, what it is to do, and how and when to do it. If the trust is revocable, you can change the rules at any time. If the trust is irrevocable, you can’t. (Each form has advantages and disadvantages, including tax implications.)
When creating the trust, you appoint a trustee, who will have the job of managing the trust and its assets. (People often appoint themselves to serve as trustee.) The trustee must follow the trust’s rules, although, some trusts let the trustee use discretion in certain matters.
After you create the trust, it receives gifts from a donor (that’s also usually you, although you might permit your trust to receive gifts from others in addition to you or instead of you). The trustee collects the gifts and invests the money in accordance with the rules of the trust. As a result, the trust will find itself with three things: principal (the money it was given, also called the corpus), interest and dividends earned on the principal (called income), and profits (if any) from increases in value enjoyed by the principal (called capital gains). The rules you’ve written for the trust will determine who gets the income, capital gains and, ultimately, the principal. The recipient is called the beneficiary.
Some trusts have lots of beneficiaries. They can be family members, friends, or charities -- anyone you want, in any combination. Some trusts give the income to certain beneficiaries, while others get the capital gains, and still others get the corpus -- with the trust itself stating who is to get what and when (or under what conditions). It’s the trustee’s job to make sure all this happens in accordance with the provisions of the trust.
Because different trusts do different things, it’s routine for people to have more than one. In fact, having four or five trusts is not uncommon. In some cases, trusts are even created by other trusts or in a will!
Is a trust right for you? Your answers to these questions can help you decide.
- Are you worth more than $2 million? If yes, read about the Bypass Trust.
- Are you concerned about a family member who has a disability that limits his or her ability in any way? If yes, read about the Special Needs Trust.
- Do you fret that your heirs might squander the money you leave to them? If yes, read about the Spendthrift Trust.
- Do you own a lot of life insurance? If yes, then read about the Life Insurance Trust.
- Would you like a charity to receive a substantial amount of money upon your death? If yes, read about the Charitable Remainder Trust.
- Do you have children and expect your spouse to remarry after you die? Then read about the Qualified Terminal Interest Property (QTIP) Trust.
- Do you want to make certain that your assets are used for your benefit even if you are unable to manage them yourself? Do you want your assets to go directly to your heirs, avoiding the costs, delay, and publicity of probate? If so, read about the Living Trust.
- Do you want the bulk of your assets to go directly to your grandchildren? If yes, then read about the Generation-Skipping Trust.
Bypass trusts. Also called the credit shelter trust, marital trust, and family trust, this trust is designed to help a married couple avoid estate taxes. Each person may pass to heirs a certain amount of money at death with no estate tax. The bypass trust can increase this amount. Because tax laws vary year to year, contact us to learn the specifics for the current and upcoming tax years.
Special needs trusts.This trust provides financial support to a person who is disabled and unable to earn sufficient income to support him- or herself. To avoid the risk of interfering with the support that’s otherwise available from social services, this trust’s assets typically cannot be used for housing, clothing, or food.
Spendthrift trusts. Instead of leaving an heir a bucket of money that he or she may quickly squander, you place that inheritance into this trust. The trust would then distribute the inheritance to the heir later, perhaps when the heir reaches a certain age, or in the form of an allowance, or for specific expenses, such as college or medical expenses.
Life insurance trusts. For high net-worth individuals, owning their own life insurance is a big mistake -- because the death benefit is subject to estate taxes. To solve this problem, have a life insurance trust own your policy. Instead of paying for the insurance yourself, you’d give that money to the trust, which would pay the premium for you. The trust would be the beneficiary, and your heirs would be the beneficiaries of the trust. An additional benefit of a life insurance trust: Instead of beneficiaries automatically getting the insurance proceeds immediately upon your death, you can instruct the trust to distribute the money to the heirs more slowly (see Spendthrift Trust above).
Charitable remainder trusts. If you plan to donate assets to a charity after your death, you may find it beneficial, instead, to donate to a CRT now. By doing so, you get a tax deduction right now for your gift. You also can name yourself as the income beneficiary (giving yourself an annual income) and the charity gets what’s left after your death, tax free -- just as you’ve intended. If you’re concerned that making the gift to the CRT denies your children their inheritance, you can buy a life insurance policy equal to the size of your gift, naming your children as beneficiaries of the insurance, using some of the trust’s income to pay the policy’s premiums (see Insurance Trust above).
QTIP trusts. Say you die leaving a spouse, minor children, and assets. Further say your spouse remarries, then dies. Result: Your spouse’s new spouse gets all your money, and your children are left with nothing. (We’ve seen this happen too many times.) To avoid this scenario, consider the Qualified Terminal Interest Property Trust. Instead of leaving your assets to your spouse when you die, you leave your assets to the QTIP trust. The trust gives income to your surviving spouse for his or her lifetime. But when your spouse dies, the assets remain in the trust for the benefit of your children. Because your spouse doesn’t directly own the assets, he or she can’t convey them to a new spouse and his or her own heirs.
Living trusts. This tool is designed to pass your assets to heirs without going through probate. Also, it can help insure that your assets will be used for your benefit and welfare if you become unable to manage your own affairs.
Generation-skipping trusts. Such trusts, intended for truly wealthy estates, can preserve your assets for several generations while avoiding estate taxes. You can fund a GST with as much as $5.25 million (in 2013) for the benefit of your grandchildren and great grandchildren, and the assets will appreciate free of income and estate taxes. Such assets are also protected from creditors.
Originally published in Inside Personal Finance May 2004.