When considering what to do with a lifetime of belongings and accumulated money after death, the options can seem overwhelming. Even a simple, equal division among immediate relatives can become complicated when dealing with property such as a house. It must be fixed up and sold, or one person must be able to buy her sibling’s share in order to both keep the house and meet the terms of the will.
That time will be extremely stressful to the family. Trusts are often promoted as a method to avoid taxes, avoid probate, and make property transfers easy. While it is true that a properly set up trust can help a family get through this process without the stress and expense of probate, not all types of trusts bypass probate. Each comes with its own rules, advantages, and disadvantages. Whether or not a trust is right for a family depends on their needs and circumstances.
What is a Trust?
At its most basic, a trust is a legal agreement that one person, called a trustee, will hold and manage assets on behalf of someone else. Those assets can include real estate, cash, income from family businesses and more. Part of a trustee’s job is to distribute the cash or property held in trust according to the instructions outlined in the agreement. There can be more than one trustee and more than one beneficiary. The person whose assets and instructions make up the trust is called the trustor.
Testamentary Trust
A testamentary trust is part of a will and created by the will. As such, it does not become valid until after the person who created it dies. This type of trust goes through the probate process. In fact, the trust will not be funded until the will has been validated by the court and the probate process carried out according to state law. The advantage of this type of trust lies in the control it gives an individual over when and how assets will be turned over to beneficiaries.
For example, if a grandfather wished to provide for a grandchild’s education, the trust can be directed to hold onto and manage a specific amount of cash until the instructions in the trust agreement are met. Those instructions may include requirements that the beneficiary be a certain age before receiving funds, or that the grandchild must maintain enrollment in a four year college program to receive yearly disbursements.
Because this type of trust is dependent upon a will, it may be altered or cancelled.
Revocable Living Trust (Family Trust)
This type of trust is one that can bypass probate when set up correctly. The reason it can bypass probate is the same reason it is called a living trust: the trustor transfers assets to the trust prior to death. When that person dies, the assets don’t go through probate because they belong to the trust, not the individual. Some people are comfortable with doing this, and some are not. Depending on state law, the trustor may be able to set up the trust with himself as both the trustee and beneficiary, initially. This allows him to maintain control of all assets in the trust until such a time that he names other trustees and beneficiaries. Individuals who do this should take care to keep a revenue source outside the trust; releasing funds from the trust to purchase groceries can get a little complicated.
A living trust generally allows for the same types of controls and management as a testamentary trust. Remember, a trust is simply a legal agreement that a trustee manages property and money for someone else’s benefit. A living trust can also be revocable or irrevocable – meaning the trustor can legally reclaim everything from a revocable trust, but cannot with an irrevocable trust.
A revocable trust includes a set of rules by which the trust agreement can be altered, but generally can be modified when necessary. Like a will, a trust agreement can be contested. However, unlike a will, information pertaining to the trust is not public and only beneficiaries will know the terms.
Charitable Trust
Some property or assets may be given to the benefit of others via a charitable trust. Since it involves providing a portion of your estate to a charity, there are several tax benefits. Most commonly, people use a hybrid type of trust to provide both for their families and their favorite charities. One such trust is the Charitable Remainder Trust – named so because the charity receives the “remainder” after the trust has provided for other beneficiaries.
For example, a couple may decide to set up a Charitable Remainder Trust that will first provide for the surviving spouse, only disbursing the remaining assets to the named charitable organization after that individual’s death.
Insurance Trust
Proceeds from life insurance policies can be funneled into trusts, just as any other asset. These types of trusts are irrevocable, and the trustor must give up all rights to the policies or any income they generate.
Trust Pitfalls
Trusts are not without their own set of disadvantages. It takes time to set up a trust, and it costs money. Families who wait until the last minute risk getting forced into probate if the paperwork isn’t finished or the trust was not funded (a trust is not valid until funded). Anyone interested in using a trust as part of an estate plan should take care to prepare it in advance.
Families should also understand that tax breaks aren’t automatic features of trusts. Each type of trust must be structured correctly and managed by a savvy trustee before the trustor or beneficiaries will realize any genuine tax savings.
Sources:
Washington State Bar Association
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