Understanding Trusts

Choosing the right type for you

Understanding Trusts
October 22, 2013

Understanding what trust funds are and their potential benefits is essential for anyone who is trying to establish this financial service. Many people have the misconception that trusts are only for the rich. This is not the case: Trusts can be beneficial for anyone, especially for those who know what type of trust they should get based on their future needs.

How Trusts Work

The person who sets up a trust fund, called a grantor, settler, or donor, legally establishes an entity to hold onto his or her properties or assets. The entity being appointed to manage the trust, called the trustee, can either be a person hand-picked by the grantor or a specific department in the bank where the trust is being set up. A trust fund has a beneficiary — a person, a group of people, or an organization — that will benefit from the trust. In some cases, all three appointees of a trust fund can be the same person. In such cases, a successor beneficiary and trustee need to be appointed in case the grantor passes away or becomes incapacitated.

Why and How to Establish a Trust

It can be useful to establish a trust fund for a variety of reasons. For one, it is a great way to manage a person’s assets after he or she passes away, much like a will; but unlike a will, a trust won’t go to a probate process. It is also a more private option than a will and can reduce the amount of estate taxes that need to be paid. Perhaps the most important reason for setting up a trust is to provide for your family and loved ones, especially minors and those who are not so wise in spending their money.

Trusts can be set up in one of two ways: when the grantor is still living or after his/her death. A living trust, also known as inter vivos trust, is established while the grantor is still alive. An after-death trust, on the other hand, gets established after one’s death through a will. Most people choose to set up trusts while they are still living so they can establish their terms and have more control over the management of their assets.

Types of Trust Funds

In addition to knowing how trusts can be established, it pays to know the different kinds of trusts and which one to suits you best. There are two main types of trust funds: revocable and irrevocable trusts. A revocable trust allows the grantor to control a trust’s assets and gives him or her the ability to change or revoke the terms of the trust fund any time he or she wishes to. In contrast, once an irrevocable trust is set up, the assets placed in it are no longer the grantor’s and require consent from the beneficiary to make any future changes. The latter is often not preferable, but it does attract a number of people since the assets placed into such trusts are no longer subject to estate taxes when they appreciate in value over time.

Determining what kind of trust you want depends on your personal situation as a grantor. Typically, people prefer to have as much control as possible over their trusts while they are still alive. Of course, there are many other factors to consider, such as taxes and your specific circumstances.

There are various types of trusts that are applicable for specific situations, including a credit shelter trust, qualified personal residence trust, generation-skipping trust, qualified terminable interest property trust, and irrevocable life insurance trust.

A credit shelter trust applies to married couples who want to avoid paying estate taxes when passing their assets on to their children. Upon the death of the grantor, the assets in a trust are transferred to the beneficiaries. One of the key benefits of this type of trust is that the grantor’s spouse can still control and manage the assets and associated income.

A qualified personal residence trust is beneficial for people who wish to remove the value of their primary or secondary residence for estate tax purposes and only pay a smaller gift tax on it when it is passed to their beneficiary. Once the retained income period on their qualified personal residence trust ends, the ownership of the asset will no longer be theirs, so there is no need to pay estate taxes on it.

For grandparents who want to provide for their grandkids, a generation-skipping trust is a good option. The assets placed in this type of trust go to beneficiaries in the generation following that of the grantor’s children (usually grandchildren). This is usually done to avoid having to pay the estate taxes that apply when the assets go to the grantor’s children.

If you want your beneficiary to be your spouse, a qualified terminable interest property trust is ideal. The assets placed in this trust, along with the income generated from it, go to the surviving spouse. He or she can also control these assets and dictate how to distribute them in the event of his or her death.

Last but not least, an irrevocable life insurance trust can be established to avoid having to pay a ridiculous amount of money in taxes on life insurance. In the event of your death, the proceeds from the insurance policy are put into the trust, which, in turn, is available for your chosen beneficiaries.

Finding the right trust fund is a matter of knowing your current situation and what your ultimate goal is when establishing the trust. The choice is completely up to you, but knowing about each type can definitely help you make the most out of these financial services.

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