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Trusts can be an important part of estate planning—and they're not just for the rich. If you want to pass on savings, investments, property and other types of assets to the people and charitable organizations you care about, a trust fund might help them save time and money.
What Is a Trust Fund?
A trust fund is a legal entity you can create and manage (or have someone else manage) on behalf of a person or organization that will receive the funds.
You can transfer different types of assets into the trust and designate it as a beneficiary on your retirement, brokerage and savings accounts—you can even put life insurance policies and your home into the trust.
In general, trust funds can offer several benefits:
- Efficiently and privately pass on assets: Unlike with a will, the assets in a living trust won't have to go through the court-supervised public process of probate. Transferring assets from a person's estate through probate can be time-consuming and expensive.
- More control over inheritances: When you create a trust fund, you can set the conditions for when and how funds will be distributed. For example, you might want to pass on money to your children, but only release a portion of the proceeds each year or restrict how they can use the money.
- Protect inheritance from creditors: Irrevocable trusts protect the assets from your creditors or other beneficiaries' creditors.
- Avoid estate taxes: Most people don't have to worry about estate taxes (the tax-exempt amount is over $12 million as of 2022), but it may be something worth considering if you have a large life insurance policy or valuable assets.
- Tax-advantaged charitable giving: If you plan on donating part of your estate to a charity, you may be able to use a trust to pass on the assets. You might even be able to get some of the tax deductions while you're alive.
But trusts can also be complex legal documents. You may want to consult with an estate planning attorney and accountant to see if a trust makes sense and make sure the documents are written correctly.
How Do Trust Funds Work?
There are three main parties in every trust:
- Grantor: A grantor (also called a trustor or settlor) is the person or entity that creates and transfers assets into a trust fund.
- Trustee: The trustee will manage the trust and its funds in line with the trust agreement and on behalf of its beneficiaries. You could be both the grantor and trustee while you're alive and can assign a successor trustee (an individual or corporate trustee) to take over if you're incapacitated or die.
- Beneficiary: The trust's beneficiaries are the people or organizations that will receive the assets.
While all trusts share these three common roles, you can create different types of trusts depending on your goals.
Revocable Trust vs. Irrevocable Trust
There are two main types of trusts:
- Revocable: Revocable trusts are primarily created to pass on assets without probate. They offer flexibility as you can make changes to the trust during your lifetime. However, the trust's assets are also still considered your property while you're alive.
- Irrevocable: An irrevocable trust can help protect assets from creditors and shield generational wealth from estate taxes. Once you create an irrevocable trust, you can't make changes (aside from a few exceptions), and the assets you transfer become the trust's property.
There are also living trusts and testamentary trusts. Living trusts are created and may start to take effect while you're alive. In contrast, a testamentary trust is generally created by your will and won't take effect until after you die.
Different Types of Trusts
In addition to the four broad categories of trusts, people create different types of trusts based on their specific needs or goals. Or, they may create a trust that has different trusts within it (subtrusts). Here are examples of common types of trusts that aren't only for the wealthy.
A charitable trust could be a charitable lead annuity trust (CLAT) or a charitable remainder annuity trust (CRAT). With a CLAT, the income from the trust's assets go to the charitable organization(s) you designate for a specific period and the remainder goes to the beneficiaries. With a CRAT, a beneficiary receives the income during the designated period, and the charitable organization(s) get the remainder at the end. In some cases, you may be able to get a tax deduction for the donations when you transfer assets to the trust.
Special Needs Trust
A supplemental or special needs trust is often created for a family member who has special needs and will need lifelong care. The trust can be set up to make sure the money will continue to go toward their care after the grantor dies. A special needs trust can also keep the assets from impacting the beneficiary's eligibility for Supplemental Security Income.
A spendthrift trust could be helpful if you want to pass on assets to someone who isn't great at managing money. You can give the trustee specific instructions for managing the trust. For example, maybe they're only allowed to give the beneficiary enough for basic living expenses each month or year. A spendthrift trust can also help protect the assets within it from certain creditors.
Other Tax-Avoidance Trusts
Many types of trusts are created to help protect assets from gift and estate taxes, including marital trusts, credit shelter trusts and generation-skipping trusts. However, these won't benefit most people or families because the estate tax exemption is about $12 million in 2022—and may increase with inflation. If you're married, both you and your spouse can pass on up to the exempt amount, and your estates won't pay federal estate taxes.
Consider the Rest of Your Estate Plan
People often think about estate planning as they age and after a major life event, such as a marriage, divorce or the birth of a child or grandchild. A trust can be an important part of your estate plan, but it's often only one piece of the puzzle. You might also want to consider how much life insurance you have and create a will for the assets that aren't part of the trust.
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