Trusts play a big part in estate planning. What you don't know about them can hurt you and your beneficiaries' financial health and possibly your own.
A trust is a legal entity - just like a corporation or a person. It holds assets for a beneficiary. The beneficiary could be you or another person. A trust document states the purpose of the trust and how it's to be carried out. A trustee is the person (or entity) that carries it out. The grantor (e.g. you) creates and generally funds the trust. Trusts in estate planning play a major role as you shall see.
A trust can be revocable or irrevocable. Revocable means that the grantor can decide to revoke the trust and take all the assets back for his use. In fact, such a revocable trust is really an extension of the grantor and taxed as if all the trust assets and their income were his. The most well known type of revocable trust is the living trust. During your lifetime, this trust is transparent--it does not affect anything. But upon death, the living trust contains a set of instructions that states how assets are to be divided. As you see, the use of trusts and estate planning go hand in hand. Because of the interrelationship and trusts and estate planning and retirement planning, it is a good idea to have single certified retirement planner assist with the overall strategy.
Revocable trusts serve to avoid probate. Probate – the court process of transferring assets in a deceased's name by will or intestate - is a very public process. Trusts are not subject to probate – being a separate entity from the deceased – and can privately pass assets according to the terms of the trust. One of the objectives of trusts and estate planning is to retain privacy. The additional benefit of a revocable trust is that it allows the grantor to control the assets and income of the trust as he wishes while he's alive.
An irrevocable trust –once created by the grantor – is no longer under his control. It's controlled solely by the trust document and the trustee. In this case, it's taxed as a separate entity –unlike the revocable trust – and has an existence all its own. In our tax system, whoever has the ability to control an entity is taxed and responsible for what that entity does. The irrevocable nature of a trust breaks that connection relieving the grantor of any subsequent tax or control issues. However, in reality, the trustee is usually a friend, relative or confidant of the grantor over which the grantor has influence and thus, can still exert indirect control over trusts assets. In this case trusts and estate planning serve to separate control (which the grantor still exerts) from ownership. Assets are removed form the grantor's estate with favorable estate tax and asset protection consequences.
The legal separateness of an irrevocable trust allows key benefits. First, that the grantor determines how the assets he puts in it are to be handled and distributed to his assigned trust beneficiaries – according to how he writes up the rules of the trust document. Second, the trust as a separate entity, can survive him indefinitely allowing his wishes to continue beyond his death. Third, the beneficiary, the object of the trust, benefits from the trust. Last, the trust's legally protected from others (i.e, creditors) who may try to invade it or take the trust assets. Trusts in estate planning play these four major roles as just explained.
The use of trusts in estate planning have a clear objective to achieve. Examples of such trusts are:
o Spendthrift protection
o Charitable trust
o Life insurance trusts
o Asset protection trusts
o Bypass Trusts
o Qualified Personal Residence Trust (QPRT)
o Qualified Terminal Interest Property Trust (QTIP)
o Generation-Skipping Trust
o Irrevocable Life Insurance Trust ILIT
Trust planning, while seemingly complex, becomes easier to understand when you focus on the primary objectives of trusts--reduced taxation and creditor protection.