Types of Trusts

There are various ways you can direct your money or property to be passed on to others. You can set up joint bank accounts, hold joint and separate title to your home or other assets, designate beneficiaries for a life insurance policy and draft a will spelling out your instructions on how you want your assets to be distributed. Trusts are another way you can set aside assets for your beneficiaries, and, depending on your situation, they may have more estate-planning advantages.

What Is a Trust?
A trust is simply an agreement by which your assets are managed by one person for the benefit of others. Any type of property can be generally be transferred to a trust, including cash, stocks, bonds, a home or other real estate or an interest in a business.

Although trusts are often associated with estate planning, the various types of trust funds are designed to accomplish different goals. Trusts offer benefits such as personal and financial safeguards for your family and other beneficiaries, a means of controlling or administering your property and, in certain cases, postponing or avoiding unnecessary taxes.

Three players are involved in a trust: the grantor, a trustee and beneficiaries. The grantor provides the money or other property. The trustee, who can be a friend, relative, professional or institution, is responsible for managing and administering the assets and must act in the best interests of the beneficiary, according to the grantor's instructions. The beneficiaries receive the benefits of the trust, such as the property itself or the income generated by the property.

Types of Trusts
There are two broad categories of trusts: testamentary and living. Testamentary trusts are established in a will take effect upon your death. Living trusts are not established in a will, start during your life and may continue after death. Trusts can be revocable, meaning you can make changes at any time, or irrevocable, when you permanently relinquish the right to make changes.

Some people include a testamentary trust in their wills to reinforce how they want their property distributed. For example, with a testamentary trust, you could spread the payments from the trust over a period of time instead of distributing them all at once.

Testamentary trusts are commonly set up to meet the needs of minor children in the event that neither parent is living. These trusts can provide for regular payments until the child reaches a certain age, or the funds can be used specifically to pay for education or other expenses.

Since they are part of a will, testamentary trusts must pass through your estate before they can take effect. This could lead to a lengthy trip through probate court, depending on the soundness of your will and whether any family members challenge it. These trusts may also be subject to estate and inheritance taxes.

With a living trust, the grantor transfers assets into the trust during life. The grantor can also be the trustee. If the grantor becomes incapacitated, a successor trustee, named in a will or living will, takes over and manages the grantor's financial affairs.

Property held in a living trust does not normally go through probate, which allows it to be delivered to the beneficiaries more quickly. You must actually transfer title to the assets to the trust, and any assets left over at the time of your death can be covered in a "pour-over" will.

Some assets may be better off if they are mentioned in a "pour-over" will. For example, transferring a tax-deferred retirement account, such as an IRA or 401(k) into a trust could pose problems if you're still alive and the beneficiary is younger than the minimum distribution age, typically age 59 1/2. The assets in the tax-deferred account could be treated as a taxable distribution and could even be subject to the 10% early distribution penalty.

If you have a child or other person who is incapacitated and receives government benefits, you can set up a special needs trust. Normally an inheritance would reduce or eliminate the person's eligibility for benefits. But a special needs trust can pay for aspects of the person's care that are not covered by government assistance.

A spendthrift trust allows you to protect a beneficiary who may not be able to manage a large amount of money received all at once. This type of trust carefully controls how much money is released and at what intervals. The money in the trust could also be earmarked to pay certain types of expenses.

Couples may be able to save on estate taxes by setting up an AB trust, also known as a credit shelter trust. Instead of leaving property to the surviving spouse, each spouse leaves his or her property to the trust. This is helpful when the value of the couple's estate exceeds the federal estate tax exemption amount.

The surviving spouse can use the property in the trust, but he or she doesn't own it outright. This way, the property is not subject to estate tax when the surviving spouse dies. Each spouse names final beneficiaries, such as their children, who will receive the property remaining in the trust after they are gone.

Charitable Trusts
If you are a philanthropist, you can set up a charitable trust. These trusts can offer many tax advantages to the grantor, such as tax deductions for the charitable donations. You can also avoid capital gains tax by contributing property that has appreciated in value to the trust.

A charitable remainder trust provides an income stream for the grantor and his or her beneficiaries for a period of time. After their deaths, the remainder of the trust property would go to the charity the grantor designates.

The costs of setting up and administering a trust can vary considerably, depending on the type of trust and its duration. Attorney fees to set up the trust depend on the time involved in consultations and in planning and preparing the trust documents. Trustee fees vary, depending on the skill and expertise the trustee offers.

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