Client: “Do I need a trust?”
Me: “It depends. What would be the purpose?”
Client: “Oh, I don’t know, I just keep hearing about them and wondered if I needed one.”
Questions about trusts actually come up quite frequently during the financial planning process. Unless you’re a financial professional, such as a CPA, CFP, or estate planning attorney, you may have wondered the same thing — am I missing out on something by not using a trust? Used properly, trusts can benefit people from all walks of life, not just the wealthy and well-connected.
So, what is a trust?
I like the explanation of the ‘Lectric Library that says to “Think of a trust as a holding pen, a place where you put your assets before they are released to the people or organizations that you designate to eventually receive them. A trust is a legal entity and so are you.”
“Because you and the trust are separate legal entities, anything you transfer from you to the trust becomes property of the trust. The trust then holds the property for your benefit, or for the benefit of those whom you designate.”
To understand trusts better, you should be familiar with the three separate parties to a trust:
• The grantor is the creator the trust.
• The beneficiaries receive income and/or principal from the trust.
• The trustee manages the trust according to the trust document.
Note that the grantor, beneficiary, and trustee do not all have to be the same person, at least while the trustee is alive.
The trust document comprises the rules set up by the grantor to stipulate how the trust is to be managed. These rules instruct the trustee on all areas of administration, such as:
• How to invest and manage trust assets.
• Any limitations on trust activities.
• When and how to distribute principal (or trust “corpus”) and income earned.
• Who gets the distributions.
There are many different kinds of trusts and uses.
Five reasons to consider one:
1. For protection from predators. Say you want to leave property to a relative, and you want to ensure the beneficiary does not lose it in case of a legal action, such as a lawsuit or an unfriendly divorce. Because the trust corpus is owned by a separate entity, a properly-drafted trust will be untouchable by the legal system.
2. To protect someone from themselves. I have personally seen young adults’ lives shattered by inheriting money while they are still young and irresponsible.
A thoughtfully-drafted trust can cede authority to a reliable trustee to determine the optimal time to give money to beneficiaries. The trust document may stipulate specific requirements for distributing money, such as the completion of college, are met or may provide for the payment of basic living costs such as medical expenses.
3. For privacy and simplicity. You may have heard of the “Living Trust” or “inter vivos” trust. This is simply a trust created to hold your assets while you’re living. A Living Trust simplifies probate (the public inventorying of your assets) at the time of your death because trust assets are not part of your “probate estate.”
If you are considering whether you need a Living Trust, my favorite self-help legal website, Nolo.com, has an excellent article, “Why You May Not Need a Living Trust.” The article addresses both sides of the issue. A Living Trust is revocable (may be changed) while you are alive, but becomes irrevocable (permanent) at your death.
4. For disability planning. You may have a disabled relative whom you would like to provide for without disqualifying him or her from Medicaid or other government assistance. A “Special Needs Trust” (SNT) allows you to set aside funds for the care and benefit of a special needs person.
The key to an SNT is that distribution of funds is totally up to the discretion of the trustee. Because the beneficiary (the special needs person) cannot “demand” distributions, the trust is not considered an asset when the special needs person applies for government benefits.
5. For estate planning. Currently, the first $5.12 million of property per decedent is exempt from taxation, but if Congress doesn’t act by the end of the year, the federal estate tax exemption will drop all the way down to $1 million and the estate tax rate will jump up to 55 percent.
While we anxiously await any sign of action on this front during an election year, multiple marriages are another common reason to use a trust in estate planning.
If you and your spouse have children from previous marriages, a marital trust can be used by both parties to ensure that the remainder of the estate of the first to die goes to their children from a first marriage after the surviving spouse dies or remarries.
Trust law is complicated but that doesn’t mean that they are useful only for the polo pony set. To find out if a trust may be appropriate for you, consult a financial professional with experience in this area.
Johanna Fox Turner, CPA, CFP, RLP, is CEO of Milestones Financial Planning, LLC in Mayfield. She is president of Johanna Fox, CPA and publishes a free monthly financial newsletter (email email@example.com to subscribe). Contact Turner at firstname.lastname@example.org, 270-247-0555, 800-991-2721, or at www.milestonesfp.com.