Learn About Trust Setup Options and Basics

Understanding the Basics of Trusts

A trust is a legal arrangement where one person (called the settlor or grantor) transfers property or assets to another person or entity (called the trustee) to manage for the benefit of one or more people (called beneficiaries). The trustee holds legal title to the assets but has a duty to manage them according to the terms outlined in the trust document. This arrangement has been used for centuries and remains one of the most common tools in estate planning.

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The basic structure of a trust involves three main parties, though sometimes one person can serve multiple roles. The settlor creates the trust and decides what assets go into it and what the terms will be. The trustee manages the assets and follows the settlor's instructions. The beneficiaries are the people who ultimately receive benefits from the trust during the settlor's lifetime or after their death, depending on how the trust is structured.

Trusts function differently from wills in important ways. A will is a document that only takes effect after someone dies, and it goes through a court process called probate. A trust can take effect immediately and can continue operating after the settlor's death without going through probate. This means trust assets can pass to beneficiaries more quickly and often with less public disclosure than assets distributed through a will.

The trustee has significant responsibilities. They must keep detailed records of all trust transactions, file tax returns if required, manage investments prudently, and distribute assets according to the trust's terms. Trustees can be family members, close friends, professional fiduciaries, banks, or trust companies. Choosing the right trustee is one of the most important decisions when setting up a trust.

Practical takeaway: Before exploring trust options, understand that trusts involve three parties—the person creating it, the person managing it, and the people who benefit from it. Recognizing these roles helps clarify how different trust structures work and which might match your situation.

Revocable Living Trusts

A revocable living trust is one of the most commonly used trust structures for personal estate planning. The word "revocable" means the settlor can change or cancel the trust at any time during their lifetime. "Living" means the trust is created and becomes effective while the settlor is alive. This flexibility makes revocable living trusts appealing to many people who want control over their assets while they live.

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When you create a revocable living trust, you typically transfer property into it—real estate, bank accounts, investment accounts, and personal property. While the trust exists, you usually continue to manage and control these assets. You can buy and sell property held in the trust, change investments, and access funds. In most cases, the settlor serves as the initial trustee, meaning you continue managing your own assets.

One significant advantage of a revocable living trust is that it can help avoid probate. When the settlor dies, assets in the trust pass directly to beneficiaries according to the trust's terms, without requiring court involvement. This process typically takes weeks or months rather than the six months to several years that probate can take. Because trust transfers happen outside of court, they also remain private rather than becoming part of the public court record.

Revocable living trusts offer other benefits. If the settlor becomes unable to manage their own affairs due to illness or injury, the successor trustee named in the trust can step in and manage assets without court involvement. This avoids the need for a separate guardianship or conservatorship proceeding. The trust continues operating smoothly even if the settlor is incapacitated.

There are some considerations about revocable trusts. Setting one up involves creating a detailed legal document and transferring assets into it, which requires attention and sometimes professional assistance. Revocable trusts do not provide protection from creditors during the settlor's lifetime because the settlor retains complete control. Additionally, revocable trusts do not reduce estate taxes, though other trust strategies may offer tax benefits.

Practical takeaway: A revocable living trust functions as a flexible management tool during your lifetime and can streamline the transfer of assets to your beneficiaries after death without probate. Consider this option if you want to maintain control over your assets while simplifying the eventual transfer process.

Irrevocable Trusts

An irrevocable trust is fundamentally different from a revocable trust because once it is created and funded, the settlor generally cannot change, modify, or cancel it without permission from the beneficiaries and sometimes a court. This permanence is actually the source of many of its benefits, but it also requires careful consideration before creation. Irrevocable trusts are typically used for specific planning goals rather than general asset management.

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One major reason people establish irrevocable trusts is for estate tax reduction. Assets placed in an irrevocable trust are typically no longer part of the settlor's taxable estate. For people with substantial assets, this can result in significant estate tax savings. As of 2024, the federal estate tax only applies to estates exceeding $13.61 million per person, but this threshold is scheduled to decrease significantly in future years. Irrevocable trusts can be particularly valuable for those with larger estates or those expecting their estates to grow.

Irrevocable trusts also offer creditor protection that revocable trusts do not provide. Once assets are transferred to an irrevocable trust, creditors generally cannot reach them to satisfy claims against the settlor. This feature makes irrevocable trusts useful for people in professions with higher liability exposure. However, creditors of the beneficiaries may still be able to attach trust distributions in some situations.

An irrevocable life insurance trust (ILIT) is a specific type designed to hold life insurance policies. Life insurance proceeds typically pass to beneficiaries tax-free, but if the policy owner's taxable estate is large enough, those proceeds can be subject to estate tax. An ILIT owns the policy instead, keeping the proceeds out of the settlor's estate and reducing estate tax liability. This is one of the most common applications of irrevocable trusts.

The main trade-off with irrevocable trusts is the loss of flexibility. The settlor cannot access the assets for personal use, cannot change the beneficiaries, and cannot modify the trust's terms. This permanence requires that the decision to fund the trust be thoughtful and based on long-term goals. People should typically only use irrevocable trusts when the benefits clearly outweigh the loss of control, often with guidance from professionals who understand both the legal and tax implications.

Practical takeaway: Irrevocable trusts trade flexibility for specific benefits like estate tax reduction and creditor protection. These trusts require commitment to permanent terms but can be valuable tools for particular planning objectives, especially for larger estates or special situations like holding life insurance policies.

Specialized Trust Structures

Beyond the basic revocable and irrevocable trusts, numerous specialized trust structures are designed for particular situations and goals. Understanding these options helps identify which structure might address specific needs. Each specialized trust has unique rules, tax implications, and purposes, so professional guidance is often valuable when considering them.

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Bypass trusts (also called credit shelter trusts or A-B trusts) are often used by married couples to maximize the use of both spouses' estate tax exemptions. When set up properly, these trusts allow a married couple to shelter roughly twice as much property from estate taxes compared to leaving everything to the surviving spouse outright. The structure typically divides assets at the first spouse's death, with some going to a bypass trust that benefits the surviving spouse without being included in their taxable estate.

Charitable remainder trusts (CRTs) are designed for people who want to support charitable causes while also receiving income. The settlor transfers assets to the trust, receives income payments during their lifetime or for a specified period, and the remaining assets eventually go to one or more charities. The settlor receives an immediate charitable income tax deduction and may reduce capital gains tax on appreciated assets transferred to the trust. These trusts require that assets eventually pass to qualified charities.

Special needs trusts (sometimes called supplemental needs trusts) are created to benefit people with disabilities without disqualifying them from means-tested government programs like Supplemental Security Income or Medicaid. These trusts hold assets for the beneficiary's benefit, and a trustee makes distributions for costs not covered by government programs. Structured correctly, the trust assets do not count toward the beneficiary's resource limits for eligibility in these programs.

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