Trusts have a reputation for being something that most people don't have to worry about, with most seeing a trust as a vehicle for the ultra-rich to protect their assets from taxes and other financial threats. In reality, though, trusts are tools that just about anyone can use to achieve worthwhile financial goals. Still, the legal complexity of the estate planning world has left many people uncertain about what a trust is, let alone how to use it. Let's take a closer look at trusts to try to answer the question of what they are and how they can help you and your family.
What is a trust?
In legal terms, a trust enables a person to separate the legal ownership of property from the beneficial enjoyment of that property. Put more simply, a trust gives responsibility for managing and preserving trust property to a person or entity called the trustee. Meanwhile, the beneficiaries of the trust are the ones who actually get to receive trust assets, according to whatever terms the trust establishes for distributions.
Behind that simple concept, though, trusts are available to serve a wide range of different goals. For instance, here are just a few of the many different types of trusts and how people use them:
- Revocable trusts, also known as living trusts, enable those who create them to ensure the proper management of their assets both during their lifetime and after their death. The person creating the revocable trust can change it at any time, but after death, the instructions set forth in the trust document guide the trustee's future actions. Many people use revocable trusts as an estate planning tool to pass assets to heirs without undue publicity or the need to go through a probate court proceeding, saving on costs and administrative hassle.
- Testamentary trusts are created in a person's will. They don't avoid probate, as a court proceeding is necessary to provide the initial funding for the testamentary trust. As a backup for situations in which the protections of a trust are useful, though, testamentary trusts allow for flexibility to handle different situations that can arise.
- Irrevocable trusts can be used to make gifts in a manner that provides subsequent protection from creditors and estate taxation. Irrevocable trusts are often used to hold high-value life insurance policies, with the trust setup helping to keep the insurance proceeds out of the taxable estate of the insured person.
- Special needs trusts can help family members with disabilities preserve their eligibility for government assistance while still making financial assets available for supplemental use as necessary to ensure the beneficiary's well-being. Special provisions ensure that any trust money used for the beneficiary won't jeopardize benefits available under programs like Medicaid and Supplemental Security Income.
- Charitable trusts allow you to make a gift to charity while still retaining an interest in the property you donate. Charitable remainder trusts involve your keeping a stream of income that continues for a set period or for the remainder of your life, with the charity receive any remaining funds at your death. These trusts can give you income-tax benefits from the value of the donation even though you still get income from the assets within the trust.
- Various other technical trusts are used for estate planning purposes. Credit shelter trusts are intended to preserve the estate tax exemption of a deceased spouse for future use, while a qualified terminable interest property or QTIP trust allows a spouse access to funds while preserving their eventual distribution to children or other heirs. A qualified personal residence trust or QPRT can allow you to transfer an interest in your home to family members during your lifetime in a manner that can produce extensive gift and estate tax savings.
As you can see, trusts are useful for a number of different situations. In essence, though, they all boil down to a single benefit: guaranteeing that your assets will be used as efficiently as possible to meet your wishes and provide for yourself and those you love.
Trusts aren't just for the rich. With many different purposes for trusts, you might well find that you could benefit from establishing a trust for yourself or your family.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.