When it comes to passing on your finances and property to your spouse or your children, most people assume that the best way to do that is through a will. While a will is a great thing to have, when it comes to money, setting up a trust can actually be far more beneficial for a variety of reasons. Legally speaking, a trust is a financial arrangement that specifies that one or more people are to receive money and/or property once certain obligations are met.
The trust is held and managed by a trustee, who makes sure that the rules and conditions set forth by the trust are carried out accordingly. While this arrangement is very similar to a will, you have many more options with regards to who can be a recipient, who will manage your assets, and what rules have to be followed. Today we’ll go over the basics of a trust and why you should consider setting one up for your spouse or children.
Why Should You Get a Trust?
Typically, if you have a lot of assets or property that will be divided upon your death, you may want to set up a trust instead of, or in tandem with your will to ensure that everything is split exactly the way you want it. Here are the top three reasons to get a trust.
- Control of your Money: Unlike a will, you have much more options when setting up a trust. You can determine what obligations have to be met for payments to be given as well as dictate who receives money or property, and at what rate. For example, you can set up a trust to pay out money incrementally instead of as a lump sum, or set up protections to make sure that the money is not squandered. There are many types of trusts that you can set up, and unlike a will, you can create and control multiple trusts at the same time.
- Avoid Estate Taxes: One of the biggest reasons to use a trust instead of a will is that trusts are usually not subject to probate (verification) and in some cases may be tax-free. If you want more of your money to go to your beneficiaries than to the government, a trust is an ideal way to save money on taxes and avoid creditors.
- Privacy: Wills are usually a matter of public record, which is why they are subject to probate upon death. Since a trust is not public, many people choose to set up a trust to maintain privacy and reduce the amount of court fees that come with probate.
Types of Trusts
One reason that so many people choose to use a trust instead of a will is the fact that you have so many more options. Here are the most common types of trust.
Bypass
This trust will pay money out to your children, free from estate taxes. Typically this trust is used to ensure that children will still be beneficiaries in the event of a spouse remarrying or taking control of the estate. It is also used to award more tax-free money to your children if you plan on exceeding the current federal limit regarding inheritance.
Life Insurance
If you have a lot of life insurance, it’s actually better to use a trust instead of working with the insurance company directly. The reason for this is that you can have more control over how the money is awarded as well as keep the money tax-free. Insurance benefits are usually subject to taxes, but not if it’s part of a trust.
Charitable Lead (or Remainder)
If you want to make sure that part of your money goes to a charity, you can set up a charitable trust to ensure that that happens.
Spendthrift
If you’re worried about your beneficiaries spending their money too fast, you can choose a spendthrift trust to ensure that the money is only paid out incrementally, or once certain criteria are met.
Generation-Skipping
For people with a lot of wealth, a generation-skipping trust can help ensure a legacy of inheritance by guaranteeing money for future generations, such as grandchildren and great-grandchildren. Also, if you do not want to award money to your kids for whatever reason, a generation-skipping trust can ensure that they will not get paid.
Qualified Terminal Interest Property
QTIP trusts are set up to make sure that your children are taken care of even if your spouse remarries. This is slightly different than a bypass trust, in that it still awards money to your living spouse, but keeps special stipulations to ensure that your children still receive the principal balance.
Living Trust
If you want to be able to receive benefits from a trust while you’re still alive (say in the event of a disability or impairment), then a living trust is the way to go.
How Exactly Does a Trust Work?
Revocable vs. Irrevocable
When setting up a trust, you will have the option to make it revocable or irrevocable. If you want to keep control over the trust and be able to make changes as you see fit, then you will want it to be revocable. However, the downside to that option is that the money is still usually subject to taxes. If you want the money to be tax-free, however, you will need to make the trust irrevocable, which also means that you cannot make any changes to it once it has been authorized.
Components of a Trust
Although there are numerous types of trusts you can set up, each of them need the same ingredients for the trust to work. Here are the main components of any trust.
- Grantor: the person putting the money or property into the trust
- Trustee: the person managing the trust and making sure the rules and conditions are followed
- Beneficiary: the person receiving the money and/or property. You can have multiple beneficiaries for a single trust
- Property: the money or items that will be awarded to the beneficiary
If you have any questions about how trusts work or want to set one up yourself, contact your attorney, and he or she can get you started.