The phrase "trust fund" might conjure images of a spoiled teenager, but trusts are powerful legal documents that many people should consider when estate planning. Some families' financial circumstances mean that wills or the probate process are insufficient for their needs.
Consider these five features that could make a living trust an important part of your financial plan.
1. Control and customization
Flexibility and control can be an attractive features of living trusts, especially for people with complicated estates.
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Living trusts dictate the distribution of someone's assets, and are created while that person, called the grantor, is still alive. The distribution can happen after death or before, depending on the grantor's wishes.
Living trusts come in two forms -- revocable and irrevocable. With a revocable living trust, the grantor who created it has the power to change the terms of the document or to get rid of the trust entirely (similar to being able to update your will). The grantor can change which person administers distributions of the assets in the trust (called the trustee) or the parties that ultimately receives those assets (called beneficiaries).
Conversely, irrevocable living trusts can't be altered by the grantor after they're created. Essentially, an irrevocable trust allows the grantor to still use their assets, while legally making them the property of the trust. For estate planning purposes, it can be beneficial to reduce the amount of assets you "own" while you're still alive. Regardless of the motivation for setting up an irrevocable trust, the document underlines a high level of flexibility and control that isn't provided by a will.
2. Minimizing taxes
Trusts can help people avoid or reduce taxation in some instances, while still ensuring that assets will transfer to desired beneficiaries. For example, a bypass trust is designed to meet the cash-flow needs of a surviving spouse, but it will transfer to the surviving spouse's beneficiaries, which are named in the trust, after his or her death without estate taxation.
Another example is a qualified personal-residence trust, which removes a home from an individual's estate. When that person passes away, the family can continue residing in that home without the property's growing value being subject to estate tax. In other words, it is considered to be worth whatever it was when it was initially placed in the trust.
For wealthy households, estate taxes often can't be eliminated entirely, and beneficiaries are often taxed on income they receive as distributions. However, living trusts can help minimize the burden on a grantor or beneficiaries.
3. Avoiding probate
Wills make the probate court process more efficient, which is often appreciated by the deceased's family. Trusts go further by skipping probate entirely for any assets held within.
Probate is a public process, and the results of that process show up in the public record. Some families prefer to have their inheritance remain private, so a trust is a helpful vehicle to accomplish that.
Skipping probate also makes funds immediately available to the beneficiary upon the grantor's death. Distributions from wills or life insurance policies can be held up for some time, which isn't ideal for covering final expenses or taking care of people who were dependent on the grantor. This can be especially relevant to dependent spouses or children of a grantor or families of a business co-owner.
4. Government benefits
Assets held in a living trust become legally owned by the trust, not by the grantor -- although the grantor still retains usage of the trust assets. This helps some families qualify for needs-based government benefits.
For example, Medicaid trusts are intended to reduce the person's financial burden for long-term care or nursing homes. With the proper planning, someone can place their assets in a trust and qualify for Medicaid assistance in the future. A trustee can still make the assets available for the grantor's benefit, but their liability for long-term care would be substantially lower.
Medicaid trusts aren't right for everyone, and there are some things to keep in mind. For example, Medicaid can come after some of your estate after you die. The best course of action before opening a living trust for a specific purpose is to contact an experienced financial planner or estate planning attorney.
5. Distribution during the grantor's lifetime
Living trusts can also distribute assets during the grantor's lifetime. In some cases, such as the Medicaid trust, that can be for the grantor's benefit. In others, the beneficiary can be the grantor's children, a charity, or some other party.
The grantor might gain personal satisfaction from seeing loved ones receive distributions in a structured way, rather than just giving them taxable gifts.
Living trusts often stagger an inheritance so that beneficiaries aren't receiving a lump sum at some unknown point in the future. This can help with planning, and it can also impose discipline for recipients who might make better financial decisions thanks to the terms of the trust and the trustee's decisions.
