A trust is a legal entity created to hold assets on behalf of a beneficiary or beneficiaries. They’re usually created as part of your estate plan in order to give you more control over how you distribute your assets after you pass away. Whether the trust is in the form of a bank account or even just a simple legal agreement, trusts can be powerful tools for determining who gets what from your estate and when.
Additionally, trusts can provide other benefits like helping you avoid probate (the legal process of distributing your estate) or limiting potential estate taxes. But when it comes to choosing which type of trust is right for you, it can be difficult. With so many different types to choose from, one of the biggest challenges is knowing how each type differs, what goals a particular trust can help you accomplish, and whether you even need one in your estate plan in the first place. To help you get started on understanding the options available, here’s an overview of the three primary classes of trusts.
1. Revocable Trusts
A revocable trust can be altered—or even terminated—at any time during the trustor’s (person establishing the trust) lifetime. Because this class can be so flexible, revocable trusts are also known as “living trusts.”
Being able to make alterations to the trust can be beneficial if you experience unexpected changes later in life—whether they be health care changes, a late-in-life marriage/divorce, or something else. Revocable trusts can also be used to try to avoid having your estate subject to probate. Probate can be a lengthy, expensive and public process, so it’s not exactly an ideal route for your heirs when it comes time to administer your estate.
Utilizing a revocable trust can be especially effective if you own property in multiple states. For instance, if you own a home in Iowa and have a cabin in northern Minnesota, you may be subject to probate in both states when you pass away. However, if those two properties are owned inside of a revocable trust, you may be able to avoid probate entirely, thus making the process of administering your estate quicker and less costly.
2. Irrevocable Trusts
Contrary to revocable trusts, the terms of an irrevocable trust cannot be amended or terminated after the trust has been established. This includes any funds you place inside the trust, which means once they’re in there, they cannot be accessed until the terms of the trust have been met.
While the more rigid nature of this class of trust might not make it attractive at first, irrevocable trusts offer other benefits. For instance, if you put money into one of these trusts, you’ve relinquished control of those funds. This means that money is effectively removed from your estate, meaning it won’t be counted toward the rest of your assets and protect you from potential estate taxes.
There are many different types of irrevocable trusts, and a large number of trusts overall actually fall into this category. This class encompasses everything from common spousal trusts (trusts specifically established for the benefit of a spouse) to something like an irrevocable life insurance trust (ILIT), which is a trust that holds one or more life insurance policies whose death benefits can be paid out to your heirs or help cover the costs of administering your estate without incurring any taxes.
3. Testamentary Trusts
Rather than creating and funding a trust immediately, it’s possible to create a trust that goes into effect upon your death. Known as a testamentary trust, this type of trust is created through a will or revocable trust, and the terms of the trust are spelled out within the will. Testamentary trusts are often used as a tool that can help you create a trust for minor children or a surviving spouse. Even though assets used to fund a testamentary trust may be subject to probate, the flexibility this type of trust offers when you desire to control the assets for a period of time after your death may outweigh its costs.
Depending on your specific situation, there are certainly significant benefits to establishing a trust as part of your estate plan. However, they can also be quite expensive or complex, so talk with your financial advisor or an estate planning attorney to ensure a trust makes sense for your situation before adding one to your estate plan.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
CFP®, MBA, Series 7 Securities Registration,1 Series 66 Advisory Registration, † Life & Health Insurance License As a CERTIFIED FINANCIAL PLANNER™ professional, Jim brings an extensive retirement income planning background to the team. He regularly writes a personal finance column for The Des Moines Register’s Business...Read More