The Planner's Perspective: The Basics - What is a Trust?
By Paul Morrone CFP®, CPA/PFS, MSA
If you Google ‘what is a trust’ you will get over a billion hits (I tried it, it was 1.070 billion), which is hard to digest in one sitting. You’ll see references to various trust types, of which there are many, each that serves a very specific purpose. There will be articles about estate taxation, charitable giving, life insurance, business succession and dynasty trusts as you scan the deluge of information available online about such a broad topic. Technicalities and advanced planning topics aside, what is a trust?
Simply put, a trust is a legal entity that holds title to property or assets for the benefit of a third party (a beneficiary). The assets are controlled, managed and distributed by a fiduciary called a trustee, who must act in the best interest of the trust beneficiaries while adhering to the requirements set forth in the trust document. The trustee has a key role in the trust administration, as it is their job to communicate with the beneficiaries, make distributions of income or principal and ensure ongoing compliance from a legal, tax and accounting perspective, among other things.
The average American may come into contact with a trust in one of two general ways: as the trust creator or as a trust beneficiary (usually after the passing of a parent or relative). While more commonplace in higher net worth families, there is no ‘minimum’ amount of assets needed to have trust and they are commonly used for practical purposes in addition to addressing more complex wealth management needs.
As a trust creator (settlor), an individual makes the conscious decision to draft a trust, either as a separate document or as part of their will. Often, a settlor may choose to use a trust to manage and distribute their hard-earned assets to surviving loved ones in a manner that they feel is prudent, rather than passing an entire inheritance to their heirs outright with no restrictions. This may help prevent a spendthrift child from squandering inherited money by limited their access to funds each year, think of a slow drip out of a faucet as opposed to having the money flow freely if it was left all the way on.
Other common reasons for creating a trust may be for estate simplification and consolidation, probate avoidance, asset/creditor protection and for estate tax planning at both the federal and state levels. Trusts are also used to hold and distribute assets for the benefit of minor children or grandchildren who are too young to legally own assets in their own name or are may be too immature to manage their finances prudently.
As beneficiary of a trust, your rights may be more limited as the trust document will dictate the amount of influence you can have on the management of the trust assets and even your right to demand distributions from the trust income and principal. Beneficiary payouts can be structured in many ways, but commonly they are aged based (i.e. X% of trust assets at age 30, X% at age 35 and the remainder at age 40), income based (i.e. distribute all the income generated by trust assets quarterly, or $X per month) or needs based (specifically for education, housing or healthcare).
Many contemporary trusts may also include a discretionary component that allows the trustee to distribute income or principal to provide for the health, education, maintenance and support of the beneficiary. The ‘maintenance and support’ requirements are intentionally broad, but usually this is interpreted to mean that the trust assets can be used to help a beneficiary maintain a certain lifestyle, not materially better one (ex. if they are used to driving a BMW, using the trust funds shouldn’t allow them to drive a Ferrari).
Above all, it is important to remember that a trust is not a substitute for a will, but a compliment to a will and should be executed in conjunction with your overall estate plan designed by a qualified estate planning attorney and financial planning team that understand the legal, financial and tax consequences of using a trust.
This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation.
US Wealth Management New Haven, LLC and LPL Financial do not provide legal advice or services.