What is a trust?

A trust is a legal entity that is set up hold money and other assets on behalf of a beneficiary or beneficiaries. Trusts are often set up to avoid probate and minimize estate taxes. With a trust, your heirs and beneficiaries may be able to gain access to these assets more quickly and with lower tax costs than with a will. Trusts may also enable you to avoid probate and the associated delays and fees.

Trusts have other potential benefits, including:

Control of your assets. You can set up a trust to precisely specify whom your assets are transferred to and when the transfers are made. Even in complex situations such as stepchildren and second marriages, you can control in detail who will get what and under what circumstances.

Privacy. Unlike probate, which is a public proceeding, a transfer of assets under a trust remains private.

What are some kinds of trusts?

There are two main types of trusts. A living trust is set up during your lifetime and is in effect while you are alive. A testamentary trust is set up in your will and created upon your death.

Living trusts can be either revocable or irrevocable.

With a revocable trust you can retain control of all of the assets and are free to change the trust, or even cancel it, at any time. If you name yourself as the trustee (or co-trustee) you have ownership of the trust and its assets during your lifetime. Although a revocable trust can help you avoid probate, it is usually subject to estate taxes and other taxes just like any other assets you own.

With an irrevocable trust, the assets are under control of the trust and you cannot unilaterally change the terms of the trust after it has been set up. With an irrevocable trust, however, the assets typically aren’t subject to estate taxes. Also, since you no longer own the assets in the trust, you don’t have to pay taxes on the income generated by the trust assets. The assets may also be protected from legal judgments against you.

There are many different types of trusts, to meet the diverse needs of people who set them up. One of the most common  types of trust are AB trusts, also known as credit shelter trusts. These are designed to provide benefits to a surviving spouse upon the death of the person who created the trust. The assets are actually transferred to the beneficiaries named in the trust (usually the couple’s children), but the surviving spouse receives income from the trust’s assets during the remainder of their lifetime.

A charitable remainder trust is a popular method of charitable giving. With a charitable remainder trust a person transfers assets to the trust and designates a charity as the beneficiary. Some of the assets are sold and the proceeds invested to provide income to the person who set up the trust. After a certain period of time, or upon the person’s death, the remaining assets are transferred to the charity and the trust dissolves. A charitable remainder trust enables you to reduce the size of your estate and the potential estate taxes. A disadvantage of charitable remainder trusts is that the person’s heirs get none of the benefit from the trust’s assets.

A wealth replacement trust is a way to overcome this drawback. A wealth replacement trust is similar to a charitable remainder trust. The assets are sold and the proceeds used to purchase a life insurance policy, naming the person’s heirs as the beneficiaries on the policy. Upon the person’s death, the policy pays out benefits to the person’s heirs and the trust’s assets are transferred to the charity.

For additional information

For more information about trusts and setting one up, see this article.