A trust is a financial agreement between two or more parties. In a trust, certain protections are upheld, and the trustor is ensured that their assets will be distributed to the correct recipients. The trustor, or grantor, is the one whose assets are involved in the trust agreement. Although trusts are often associated with the wealthy, many families may benefit from having a trust. Here are four things to know about trusts.
1. There Are Six Types of Trusts
Not all trusts are the same. The six different types are:
- Living, which means that the trust is drafted while the grantor is still living
- Testamentary, which means that the trust is created by someone named in the grantor’s will
- Funded, or a trust that contains assets
- Unfunded, or a trust that does not hold assets at the time of the grantor’s passing
- Revocable, or an agreement whose terms can be changed at any time
- Irrevocable, or an agreement that can only be altered with the permission of its beneficiaries, as is the case with a domestic asset protection trust
There are a wide variety of trusts, which is why they can be complicated and require the advice of someone who is well-versed in finance.
2. There Are Some Tax Benefits to Trusts
In general, assets given to beneficiaries via a trust are exempt from taxes having to do with gains, losses, or gifts, up to a certain amount. However, things can get complicated from there. For example, a recipient of trust money does not have to pay taxes on the principal, but they do need to pay tax on any income earned. A trustee needs to file IRS forms 1041 and K-1, which have to do with trust payments and earnings.
3. Trustees and Beneficiaries Are Different
Although the terms are sometimes used interchangeably, a trustee is not the same thing as a beneficiary. A trustee is a person designated to manage a trust, while a beneficiary is a person who ultimately receives what is in the trust. For example, a grandchild of the trustor may be the beneficiary, while an adult relative is named the trustee until the grandchild is old enough to make their own financial decisions and manage the trust on their own.
As the name indicates, a trustee should be someone who the trustor trusts with their estate and who can communicate with all parties involved with the estate. Sometimes, a grantor will choose a friend who they regard as very honest and smart to be their trustee over a close relative.
4. Trusts and Wills Differ
Wills are often more well-known and understood than trusts. However, they serve different purposes. For example, trusts come with a lower risk of going to probate court, and have more privacy controls than wills. Choosing between a trust or a will is a deeply personal decision for a family, and the choice should be made by the family and their financial advisors.
Consider these four facts if you are thinking about establishing a trust.
