Most of us realize that basic estate planning documents—including a valid will, durable powers of attorney, and a healthcare directive—are fundamental to any financial plan. But for persons with significant means, and especially for those managing or building a multigenerational financial legacy, these basic documents may not be adequate for the estate structure and needs.
Why would someone need anything more complicated than a will? Perhaps the main reason is because in order for a will to take effect, the maker of the will has to die. In other words, there may be advantages, in some situations, to asserting control and conditions for an estate before the estate owner’s passing. These might include:
- Concerns about future capacity. Someone facing severe health uncertainties might wish to direct how their assets will be handled in the event that they are no longer able to make their own decisions, though still living. A trust can be designed to stipulate their wishes, and it can take effect when the grantor is judged to no longer have decision-making capacity.
- Children or other loved ones with special needs. Creating a trust for the benefit of persons with special needs allows the grantor greater control over the amount of assets set aside for the beneficiary and also the timing and method for distributing the assets. The trust can also appoint a successor trustee (a person or entity who ensures that the terms of the trust are carried out) to direct the trust in the event of the grantor’s death.
- Dividing a complex estate. Certain types of assets—businesses, real estate, or collectibles, for example—are harder to divide evenly than cash or securities. When an estate has significant holdings of this nature, a trust can spell out exactly how the grantor wants the assets directed, to whom, and when.
- Controlling estate or inheritance taxes. When properly structured, certain irrevocable trusts can remove assets from the grantor’s taxable estate. Persons with significant estates may wish to utilize a trust to reduce the tax bill otherwise payable by their heirs and enhance wealth preservation. These assets can then be transferred to the heirs according to the terms of the trust. In some cases, the grantor may even choose to retain an income from the earnings generated by the trust’s principal.
- Protecting assets from creditors or lawsuits. Persons in professions prone to litigation—such as physicians or attorneys—may wish to protect personal assets from the claims of creditors or claimants in a lawsuit. A properly designed irrevocable trust can help to insulate assets from such claims: another advantage for wealth preservation.
- Creating a philanthropic legacy. Persons who wish to support a cherished cause or establish a lasting legacy often utilize trusts to hold and distribute assets according to their philanthropic aims.
And there are many more specific situations where a trust can provide advantages.
Trust Types
Trusts generally fall into one of three main types: revocable (or “living”) trusts, irrevocable trusts, and testamentary trusts. The principal differentiators are who controls the trust and when it takes effect. Revocable trusts remain under the control of the person who created the trust (the “grantor”) as long as they have capacity to direct it; the grantor can change or terminate (“revoke”) the trust at any time. An irrevocable trust, as the name implies, is no longer under the control of the grantor, but is controlled by the trustee (the person or entity named in the trust who is empowered to manage and direct the assets in the trust); an irrevocable trust generally cannot be freely changed or terminated by the grantor. A testamentary trust is usually created by the terms of a will and takes effect upon the death of the person who made the will (the “testator”).
Uses of Revocable Trusts
Living trusts can be used to hold and manage property during the grantor’s lifetime providing continuity of asset management in the event of incapacity. They also allow assets held in the trust to pass outside of probate. But the assets held in a revocable trust generally remain part of the taxable estate. Further, the principal advantage of a trust over a will is the degree of specificity it provides for the grantor. There are many different types of living trusts that can be used for various purposes, including charitable or philanthropic efforts, and providing income to the grantor. .
Uses of Irrevocable Trusts
Perhaps the greatest benefit of an irrevocable trust is that assets within the trust are excluded from the grantor’s taxable estate. Further, assets in an irrevocable trust are generally protected from claims by the grantor’s creditors or legal liabilities. Thus, a grantor might wish to set up an irrevocable trust for the benefit of children or grandchildren, thus removing the assets from the grantor’s estate (and reducing potential estate tax liability) and securing the assets for the future use of the beneficiaries.
Other Uses for Trusts
Both revocable and irrevocable trusts may be designed for a wide variety of uses. For example, suppose a person with significant assets has young children. They may wish to transfer assets into a trust that can be used for the benefit of the children, but the terms of the trust can limit access to the assets until the children reach a certain age or even until they accomplish certain goals, such as graduating from college. The grantor may also wish to appoint a trustee: a fiduciary person or entity that controls and manages the assets for the benefit of the child until certain conditions are met, as stipulated in the trust. Trust provisions like these can be especially beneficial for those who have children with special needs.
A trust can also be used to direct assets for philanthropic purposes. For example, persons with a strong commitment to a particular charity or other nonprofit institution may establish a charitable remainder trust: an arrangement whereby assets are transferred into the trust during the grantor’s lifetime but still provide income to the grantor from the assets’ earnings. Upon the passing of the grantor, the assets remaining in the trust are passed to the charitable or nonprofit entity.
Another situation where a trust may be preferable to a will is when the estate consists of a significant portion of illiquid assets, such as real estate, business interests, or collectibles. A trust can hold these assets during the lifetime of the grantor and upon the grantor’s death, the assets can be sold or distributed to the beneficiaries of the trust as desired by the grantor and stipulated in the terms of the trust. Family control of the assets can be maintained, according to the grantor’s wishes.
Trusts and Your Estate Plan
These are by no means all the ways that trusts can be used or all the types of trusts that can be designed. Because each situation is different, it’s important to obtain the counsel of a qualified estate planning professional who is familiar with the laws of your state of residence. However, having a grasp of some of the basics of trusts and their uses can save you significant time as you develop the estate plan that is right for your needs.
GEM Asset Management, as a fiduciary financial advisor and wealth manager, is committed to helping clients develop financial strategies that support their best interests. If you have questions about how trusts or other estate planning tools might fit into your financial plan, let us help you find the answers you need.
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