A trust is a legal arrangement that allows you to effectively manage your assets and ensure that those assets are transferred to your intended beneficiaries when you pass. They can provide an efficient means of settling your estate, managing your assets, and reducing taxes.
What is a Trust?
A trust is a legally binding agreement between two or more parties concerning the management and transfer of assets. Formation of a trust requires a grantor, trustee, and at least one beneficiary.
The grantor is the person who creates and places their assets into the trust. They are turning over ownership of those assets for the trustee to manage according to the terms set forth in the trust.
The trustee’s job is to ensure that the grantor’s wishes are carried out. They must manage the trust’s assets in a fiduciary manner, meaning that the decisions they make concerning the trust must be in the best interest of the beneficiaries.
Lastly, the beneficiaries of the trust receive the benefits of the trust’s assets, or potentially the assets themselves depending on the type of trust.
What are the Benefits of a Trust?
There are many benefits that a trust may provide to both the grantor and beneficiaries.
One of the biggest advantages of a trust is that it allows you to efficiently transfer your assets when you pass. While many assume this is the function of a will, a trust is actually much better for this purpose.
That’s because, unlike wills, trusts are often not subject to probate because the grantor has already transferred legal ownership of their assets to the trust. So, assets placed inside the trust avoid the entire probate process.
Why is avoiding probate such a big deal?
Probate is a lengthy process that often takes months. First, the estate executor has to settle the estate. That means paying all the debts and taxes owed by the estate and coming up with a plan for distributing what’s left to the beneficiaries. The court also verifies ownership of all the assets in an estate and determines whether the will, if there is one, is valid. All that time, your family is left waiting.
It’s also expensive. There are court fees, attorney fees, and accounting fees. There could also be fees associated with appraising various assets.
Probate, being a court process, is a matter of public record. Your family will lose a great deal of privacy during a very personal experience.
A trust can also help you avoid estate taxes. Again, that’s because assets in the trust are no longer part of your estate – they are owned by the trust. Since estates are taxed at 40%, this could be a big benefit if you are otherwise subject to the estate tax.
Control is another critical benefit of placing assets in a trust. There are many ways that estates can be structured, but the bottom line is that you can create a trust to handle your assets in just about any way you see fit. Some examples include directing that the income from the trust goes to support a charity, or that children must meet certain age or educational milestones before receiving the assets.
While we often associate trusts with the ultra-wealthy, the benefits outlined above can be helpful to even those who don’t have large estates.
What Are the Drawbacks of a Trust?
The most prominent reason not to create a trust for your assets is the cost. Establishing a trust will typically cost somewhere in the range of $3,000 – $10,000. That expense may not be necessary depending on how complex your estate is, but could be a deterrent for some.
While not necessarily a negative aspect of trusts themselves, their tax benefits are sometimes overestimated. The reality is that the vast majority of estates are not subject to estate taxes at all due to the large exemption thresholds currently in place (as of 2021).
Types of Trusts: Revocable vs. Irrevocable
There are many different types of trusts. The most basic distinction between trust types is whether they are revocable or irrevocable.
The terms of a revocable trust can be changed, or the entire trust can even be dissolved, at the request of the grantor. Revocable trusts are popular because of this flexibility, but they do not offer all the same benefits as irrevocable trusts. The assets in a revocable trust can still be seized by creditors, and may still be subject to estate taxes.
An irrevocable trust is permanent, and cannot be changed or revoked once it is established unless all the beneficiaries agree to the new terms. Assets placed in an irrevocable trust become the property of the trust, and the grantor is typically not responsible for paying taxes on any income generated by them. They are also usually protected from creditors of the grantor since they are no longer legally owned by the grantor.
A revocable trust automatically becomes irrevocable when the grantor passes, and the terms in place at that time become the permanent terms of the trust.
FPC Wealth acts as a coordinator for our clients in all things financial – including estate planning. We are happy to answer any questions you have, or work directly with your estate planning team to help ensure you have the best plan in place to protect your loved ones in the event of a tragedy. Reach out to your advisor today with any questions!