Remember the Boy Scout motto, “Be Prepared”? That’s smart advice to follow if you’re camping in the wilderness.
But it’s hard to know exactly what that means when it comes to your money. Sure, you need enough life insurance to protect your family, and a well-padded emergency fund for when a leaky roof strikes — but do you know what would happen to your money if you passed away? Or how your kids would be cared for?
That’s where a trust comes in.
How does a trust work?
What is a trust? A trust is a legal arrangement that you can set up to help ensure your assets are managed according to your wishes, especially after your death. With a trust, one person (the trustee) agrees to hold assets for another person (the beneficiary). The trustee is responsible for managing the assets in accordance with the terms of the trust. The beneficiary has the right to receive all or part of the trust assets, as specified in the trust agreement. A trust can be a great way to help make sure your loved ones are taken care of in the future.
Trusts can be revocable or irrevocable. The two terms are fairly intuitive: irrevocable trusts cannot be changed by the grantor after they are executed, whereas revocable trusts can be changed or terminated while the grantor while they're alive.
Reasons to set up a trust
A common reason people set up a trust is to help ensure they have control over what happens to their money, property, investments and other assets after their death, similar to a last will and testament. But unlike a will, trusts typically don’t go through probate — which means they don’t become public record and don’t need to go through a court in order to be executed.
A trust can also establish parameters around the financial care of your minor children, as well as when and how they should receive their inheritance when they get older. For instance, if you want to pass your money to your kids but are afraid they’ll spend it unwisely, you can set up rules around how often they receive the money and what they can spend it on.
Setting up a trust
A trust is set up by a grantor, typically the person who is putting the assets into the trust and who establishes the rules and guidelines for how the trust operates. The grantor appoints a trustee — a person or an institution — to actually manage the assets on behalf of a beneficiary (the eventual recipient of the assets). The grantor and trustee can be the same person if the trust goes into effect while the grantor is still alive. After he or she dies, it would pass onto a successor trustee.
There are many types of assets that can go into a trust, including cash, real estate, investments, other types of property and business interests. You can also assign a trust as a beneficiary of a life insurance policy or a retirement account.
Types of trusts
There are many kinds you can set up, depending on what your goals are for your assets. But here are a few examples:
Living Trust. This is a common type of trust that’s used to help pass your assets along to your heirs, but it can also help you manage your assets while you’re living. You can be your own trustee, and then designate a successor trustee to take over in the event you become incapacitated or pass away.
A living trust can be revocable or irrevocable. Revocable means you can change or cancel any of the trust’s provisions. Irrevocable means that once you set up the terms of the trust, it can’t be changed (or at least not without a lot of headache). A trust can also change from revocable while the grantor is alive, to irrevocable after he or she passes away.
Special Needs Trust. This is a trust you can set up specifically to provide for family members with special needs. If you were to leave an inheritance directly to children or relatives with special needs, they could lose their eligibility for government benefits like Medicaid and Social Security. The trust can help ensure your loved ones have money to cover their care while protecting their access to those benefits.
Irrevocable Life Insurance Trust. This type of trust is designed to hold payouts to life insurance policies, which can help ease the potential estate tax issues that could arise if your death benefits passed directly to your family members. If you set up this type of trust, you would make payments to the trust, and then the trust would pay the life insurance premiums.
Generation-Skipping Trust. This is a trust that does a lot what it sounds like: It enables you to skip a generation of heirs, so you can pass your assets along to your grandchildren rather than your children.
Charitable Remainder Trust. If philanthropy is important to you, you could put your assets into a charitable remainder trust. The trustee is typically the charity of your choice, which would manage the assets for you so that you or your beneficiaries receive income from the trust. After your death, the charity would receive the remainder of the assets.
Is a trust right for you?
Trusts can be a great way to help retain control of your assets long after you’re gone, but the rules and tax implications surrounding them can get complicated. You’ll need an attorney to help you create one, but you should also consider tapping other types of estate planning and tax professionals to help you navigate the best way to set up a trust based on your goals for your money and your family.