What is a trust? What are the different types of trusts?

Question

What is a trust? What are the different types of trusts? Are some better than others? What are the different roles involved in a trust?

Answer 1

Trusts are a way of holding assets with a specific goal in mind.

At its simplest, a trust can be used to avoid probate, a sometimes lengthy process in which a will is made public along with the assets bequeathed. A trust allows for fast transfer and no public disclosure.

Depending on the current estate tax laws (the death tax) a trust can help preserve an estate exemption. e.g. Say the law reverts back to a $1M exemption. Note, this is $1M per deceased person, not per beneficiary. My wife and I happened to have assets of exactly $2M, and I die tomorrow. Now she has $2M, and when she passes, the estate has that $2M and estate taxes are based on this total, $1M fully taxed. But - If we set up trusts, that first million can be put into trust on my death, the interest and some principal going to the surviving spouse each year, but staying out of the survivor's estate. Second spouse dies, little or no tax due. This is known as a bypass trust.

Another example is a spendthrift trust. Say, hypothetically, my sister in law can't save a nickel to save her life. Spends every dime and then some. So the best thing my mother in law can do to provide for her is to leave her estate in trust with specific instructions on how to distribute some percent each year. This is not a tax dodge of any kind, it's strictly to protect the daughter from her own irresponsibility.

A medical needs trust is a variant of the above. It can provide income to a disabled person without impacting their government benefits adversely.

This scratches the surface, illustrating how trusts can be used, there are more variation on this, but I believe it covers the basics.

With the interest in this topic, I'm adding another issue where the trust can be useful. In my article On my Death, Please, Take a Breath I described how an inherited IRA was destroyed by ignorance. The beneficiary, fearing the stock market, withdrew it all and was nailed by taxes. He was on social security and no other income, so by taking small withdrawals each year would have had nearly no tax due. (and could have avoided 'market' risk by selling within the IRA and buying treasuries or CDs.) He didn't need a trust of course, just education. The deceased, his sister, might have used a Trust to manage the IRA and enforce limited withdrawals. Mixing IRAs and trust is complex, but the choice between a $2000 expense to create a trust or the $40K tax bill he got is pretty clear to me. He took pride in having sold out as the market soon tanked, but he could have avoided the tax loss as well. He was confusing the account (In this case an IRA, but it could have been a 401(k) or other retirement account) with the investments it contained. One can, and should, keep the IRA in tact, and simply adjust the allocation according to one's comfort level.

Note - Inheritance tax laws change frequently, and my answer above was an attempt to be generic. The current (2014) code allows $5.34M to be left by one decedent with no estate tax.

Answer 2

From a more technical point of view, a trust is a legal relationship between 3 parties:

• A Settlor (the person creating the trust and contributing property to it)
• A Beneficiary (the person or persons receiving a benefit from a trust, who may also be the settlor)
• A Trustee (a person or entity who holds legal title to the property, and who has a fiduciary responsibility to manage the property per the terms of the trust)

Trusts can take many forms. People setup trusts to ensure that property is used in a specific way. Owning a home with a spouse is a form of a trust. A pension plan is a trust. Protecting land from development often involves placing it in trust. Wealthy people use trusts for estate planning for a variety of reasons.

There's no "better" or "best" trust on a general level... it all depends on the situation that you are in and the desired outcome that you are looking for.

Answer 3

A trust is a financial arrangement to put aside money over a period of time (typically years), for a specific purpose to benefit someone.

Two purposes of trusts are 1) providing for retirement and 2) providing for a child or minor.

There are three parties to a trust:

1) A grantor, the person who establishes and funds a trust. 2) A beneficiary, a person who receives the benefits. 3) a trustee, someone who acts in a fiduciary capacity between the grantor and beneficiary.

No one person can be all three parties. A single person can be two of out those three parties.

A RETIREMENT trust is something like an IRA (individual retirement account). Here, a person can be both the grantor (contributor) to the IRA, and the beneficiary (a withdrawer after retirement). But you need a bank or a broker to act as a fiduciary, and to handle the reporting to the IRS (Internal Revenue Service). Pension plans have employers as grantors, employees as beneficiaries, and (usually) a third party as trustee.

A MINORS' trust can be established under a Gift to the Minors' Act, or other trust mechanisms, such as a Generation Skipping Trust. Here, a parent may be both grantor and trustee (although usually a third party is a trustee). A sum of money is put aside over a period of years for the benefit of a minor, for a college education, or for the minor's attaining a certain age: a minimum of 18, sometimes 21, possibly 25 or even older, depending on when the grantor feels that the minor is responsible enough to handle the money.