Trusts and Your Estate Planning Options

A financial goal that many people share is the desire to leave a legacy for future generations. There are a variety of estate planning tools that can help protect your assets – physical property or investments – so that they can be inherited. 

What Is a Trust?

A trust is a legal entity created to hold assets for the benefit of someone other than the creator. Almost anything can be placed in a trust – cash, stocks and bonds, insurance policies, real estate, possessions etc. There are many different types of trusts, each with a different purpose; the type of trust you choose and what you put into that trust depends on your motivation for creating the trust. For example, a trust meant to generate income may be comprised primarily of investments whereas a trust meant to minimize taxes may include real estate. 

When you create a trust, you are known as the grantor. You then name people who will benefit from the trust – the beneficiaries. The trustee (or trustees) is responsible for administering the trust, as well as managing and distributing the assets based on the terms of trust.

Why Set Up a Trust?

A trust isn’t just for the children of the rich and famous. Trusts are actually versatile financial vehicles that can help protect assets and distribute them according to the grantor’s wishes. 

Protection

When assets are added to trusts, they are kept safe from creditors who may want to claim them after a grantor’s death or family members who may take actions the grantor doesn’t want (such as spending or selling to the detriment of other family members). Even if there is no ill intention, a trust can protect assets in the case of divorce or lawsuit. (It should be noted, though, that because grantor’s retain control over assets in revocable trusts, those assets are not protected from lawsuits during a grantor’s lifetime). Trusts also preserve assets for children if the grantor were to die when the children were minors. 

Intention

Trusts can be created to provide for specific situations. For example, they can set assets aside for specific purposes, such as education or starting a business. A common motivation for creating a trust is providing for the care of a dependent with additional needs that will last a lifetime, such as a physical disability or mental health condition. 

Distribution

Assets placed in a trust are generally distributed without having to go through probate. That means the grantor’s assets are given to the intended beneficiaries with a level of privacy and speed that isn’t common for those without a trust. They are also typically subject to more beneficial estate tax situations, meaning there is more for heirs to inherit. 

What Type of Trust Do I Need?

The type of trust that will work best for your situation depends on your goals.  Every kind of trust falls into one or more of these categories:

• Living or testamentary
• Revocable or irrevocable
• Funded or unfunded

Living Trust vs. Testamentary Trust

A living trust is a legal arrangement in which a grantor creates a trust during their lifetime to protect their assets then transfer those assets to the beneficiaries after the grantor’s death. It’s commonly created to help heirs avoid probate, which can be lengthy and costly. Ownership of assets within the trust are legally transferred to the trust (which may include fees), but living trusts often make distribution of assets go more smoothly and more quickly because courts are less likely to be involved.

Also called a “will trust,” a testamentary trust is created by a will and lays out how the assets are designated after the grantor’s death. In general, this type of trust does not allow beneficiaries to avoid probate. 

Revocable Trust vs. Irrevocable Trust

A revocable trust can be changed or terminated during the grantor’s lifetime. An irrevocable trust cannot be changed after it has been established without a lengthy approval process that may include going before a judge. Revocable trusts are more common because they allow for flexibility – for example, adding an additional grandchild as a beneficiary or removing a piece of property that has been sold. However, irrevocable trusts may offer some tax benefits and protection from creditors during a grantor’s lifetime. 

Funded Trust vs. Unfunded Trust

A funded trust is just that – funded by assets during the grantor’s lifetime. An unfunded trust has no assets; it can become funded upon the grantor’s death or remain unfunded (which defeats the purpose of establishing a trust).   

Revocable Living Trust

The most common form of trust is a revocable living trust. The grantor maintains control over the assets in the trust during their lifetime. By naming themselves as one of the trustees, the grantor has the ability to add or remove assets within the trust, change beneficiaries or even terminate the trust at will. 

In addition to being an inheritance vehicle, revocable living trusts are useful in the case of incapacity because it allows the trustee to make decisions about assets in the trust on behalf of the grantor (instead of the courts doing so). Trustees have a duty to administer the trust according to its terms and must act with the grantor’s best interest in mind.

Assets in revocable trusts also benefit from a step-up in basis when it comes to taxes, which could mean significant tax savings for heirs. 

Irrevocable Life Insurance Trust

A life insurance policy can play a critical role in your estate planning process; the death benefit can help pay for estate taxes or leave a legacy for your heirs. An insurance trust (ILIT) is an irrevocable trust set up with the life insurance as the asset and the beneficiary as the receiver of the life insurance payout. Though the grantor loses control over the policy, since the trust is the owner and the trust cannot be altered, there are some tax benefits – such as estate tax exemption for wealthier individuals – that may make this a beneficial avenue to explore. 

Professional Guidance

Trusts aren’t necessarily the answer for everyone. They can be expensive and time-consuming to set up and maintain. However, they could provide a wealth of benefits for your heirs. If you’d like to talk to a professional about if a trust is appropriate for your situation, contact a Farm Bureau financial advisor