How Do Trusts Help You Manage Your Wealth, and Which Type of Trust is Right for You and Your Family?

One very responsible way of protecting your survivors from such circumstances is by creating a trust fund. By choosing to establish a trust, you can help your family avoid expensive legal costs associated with your final will and testament — also known as probate — and estate taxes. But doing so is just the first step in providing for your family’s financial security.

Isn’t estate planning only for very wealthy individuals?

No. Most Americans, especially retirees, can benefit from establishing a trust fund if they have accrued some savings.

In this article, we will explain what a trust is, how it works, the different forms trusts may take, and ways you might benefit from a trust even if you consider yourself a person of modest means.

What is a trust fund?

A trust fund is both a legal entity and an estate planning tool. As a legal entity, a trust holds property and possession (an estate) for the benefit of another person (or persons), a group, or an organization. Those other persons could be siblings, children, or other family members. The organizations most often named in trusts are charities.

When it comes to minimizing your tax liabilities and protecting your heirs from creditors — or their own poor decision-making — there’s no tool more useful than a well-designed trust.

Who are the parties to a trust?

Generally, there are three parties involved in all trust funds: the grantor, the trustee, and the beneficiary.

What does a grantor do?

The grantor (also known as the trustor, and sometimes as the testator) is the individual who establishes the trust fund. Thus, the grantor also places things of value — cash, stocks, bonds, businesses, fine art, collectibles, etc. — into the trust. The grantor also determines how the trust should be managed, and they are free to name both its trustees and beneficiaries.

What does a trustee do?

The trustee is responsible for managing the trust and its income-generating assets. They must perform their duties as laid out in the trust documents and in accordance with applicable law. An individual, multiple trusted advisers, or an institution such as a bank can serve as a trustee.

What does a beneficiary do?

When the grantor creates the trust, they do so for a beneficiary or beneficiaries. However, the assets in the trust do not technically belong to this person or persons. Instead, they are managed by the trustee on their behalf.

The value in the trust is made available to the beneficiary according to specific rules or only if certain conditions have been met. For example, the grantor can award a monthly payment to the beneficiary. They can also stipulate that the beneficiary may only use the trust funds for some specific purpose, such as paying for their college tuition.

A beneficiary can also be a trustee, provided the grantor has approved this arrangement.

What is a living trust?

A living trust, also known as an inter-vivos trust, is made by a grantor during their lifetime.

In a living trust, the assets remain available to the grantor for their use while they are alive. A living trust thus allows the grantor to continue to draw benefits from those assets. Upon the grantor’s death, the beneficiary inherits those assets, but they remain under the trustee’s supervision.

Living trusts may be revocable or irrevocable.

What is the difference between a revocable and an irrevocable living trust?

A revocable living trust allows the grantor to dissolve or revoke the trust if they decide it no longer serves their purposes. They can also change beneficiaries or remove them entirely.

An irrevocable living trust requires the grantor to step aside and allow the trustee to manage the trust fund. Once created, an irrevocable living trust cannot be amended, modified, or revoked.

However, every rule has its exceptions. Some grantors establish irrevocable trusts that contain provisions permitting the trustee (or the beneficiaries) to revise the trust document under certain circumstances, such as a change in federal tax laws.

The primary benefit of an irrevocable trust is that it removes assets from the grantor’s estate, thereby diminishing the estate’s tax liability.

What are the advantages of establishing a living trust?

Living trusts deliver the following benefits.

• They eliminate the need for probate proceedings — and probate fees.
• They provide beneficiaries with immediate access to income and principal.
• They offer protection from estate taxes.

What are the disadvantages of establishing a living trust?

Because the grantor is still considered the owner of the trust’s assets, living trusts do not protect against creditor claims.

While the grantor is still alive and managing their living trust, they must pay taxes on the income it generates.

What is a testamentary trust? How does it work?

A testamentary trust is a trust established per the wishes expressed in the deceased’s last will and testament. Sometimes also called a will trust, the testamentary trust is irrevocable. Under the terms of a will trust, the trustee has the legal authority to manage and distribute the trust’s assets to the beneficiaries as directed in the will.

While a living trust goes into effect during the grantor’s lifetime, a testamentary trust only goes into effect upon their death. A testamentary trust also remains in effect until a triggering event named in the will occurs. This triggering event may be the beneficiary reaching a certain age, at which point they would receive the remaining assets, and the trust would be dissolved.

What are the advantages of a testamentary trust?

Testamentary trust distributions to beneficiaries are not taxed. That is, the trustee is not obligated to pay tax on these distributions. This applies to both income and capital gains. However, individual beneficiaries must report the trust distributions they receive to the IRS. This provision helps to preserve the trust’s principal.

Assets of a testamentary trust are not accounted for when pension eligibility is being determined. Thus, under current means-tested pension options, beneficiaries will still be eligible for the same pension amount even though they’re receiving income from an estate.

What are the disadvantages of a testamentary trust?

Although they offer some shelter from taxes, testamentary trusts are not impervious to taxation. Any income not distributed from a testamentary trust is taxed and must be paid for out of the trust itself. Moreover, your residence may be subject to capital gains taxes if it is being held in a testamentary trust.

Testamentary trusts can also incur hefty administrative fees. Ongoing charges, such as accountancy fees and tax preparation services, can deplete the value of the assets you have placed in your trust.

Do you have to have a will to set up a trust?

No. That said, paring a will with a trust can help you plan your estate more effectively. Any assets not placed in a trust are considered subject to probate. Therefore, if you fail to account for any assets in writing your will, a court may award them to heirs you may not have chosen.

Do you have to have life insurance to set up a trust?

No. However, if you have life insurance, you may place it in a trust. The policy’s death benefits would then be paid to your beneficiary or beneficiaries.

What other types of trust can I establish?

Unfortunately, we cannot provide in-depth coverage of every type of trust in this article. Nor can we discuss all of the legal particularities associated with each type of trust. But anyone looking to manage their wealth and provide for their family’s financial security should know about the following trust options.

• An irrevocable life insurance trust (ILIT) provides tax savings by excluding life insurance proceeds from the insured individual’s gross estate — provided the grantor lives for three years after they have transferred the policy to the trust. In other words, the life insurance policy is owned and controlled by the trust. This arrangement also offers advantages to beneficiaries. For example, the trustee can take measures to ensure that any policy payouts do not render the beneficiary ineligible for Social Security or Medicaid.
• Grantors who wish to fund a philanthropic venture or support the public interest may choose to establish a charitable remainder trust (CRT). Funding a CRT with appreciated assets, such as stocks or real estate, allows the grantor to sell the assets without incurring a capital gains tax. However, all CRTs are irrevocable, and any charity you fund must be recognized as a nonprofit organization by the IRS. That said, while the grantor is still living, the CRT can also generate income for themselves and their beneficiaries, usually in the form of a fixed annuity. The property managed by the trust is only donated to the charity upon the grantor’s death.
• A special needs trust allows a beneficiary with physical and mental disabilities to receive income without affecting their eligibility for Social Security, Supplemental Security Income, Medicare, or Medicaid. It should be noted that not every institution provides this kind of trust assistance, but it is an integral and important part of the trust offerings we provide here at Guaranty Bank & Trust.
• If you’re concerned that your heirs won’t be wise with your money, you can use a spendthrift trust to place restrictions on a beneficiary’s access to the trust principal. Essentially, the beneficiary cannot access the trust principal or promise it to anyone else. The beneficiary simply receives benefits from the trust through the trustee. Such an arrangement also protects the trust property from a beneficiary’s creditors.
• A bypass trust is also known as an AB trust because of its division into parts A and B. When the first spouse passes away, their share of the estate goes into the B trust: an irrevocable trust established solely for the surviving spouse’s benefit (otherwise known as a family bypass trust). The surviving spouse’s portion of the estate goes into a revocable A trust known as the marital trust. The frees the surviving spouse to sell, spend, or make a gift of the A trust assets in any way they see fit. Meanwhile, they can also draw income from the B trust. The main benefits of the bypass trust are its flexibility. Moreover, this arrangement also prevents estates from entering probate and can shield assets from taxation.

Summing up

A trust can be the right estate planning tool for those individuals who don’t necessarily have high net-worth but want to leave money to their children or grandchildren and control how those beneficiaries might use that money. Again, trusts are not just for the extremely affluent. Given the number of trust options available, this wealth management tool can help you make sure that financial security is part of the legacy you leave your surviving loved ones.

Among the ways you and your survivors can benefit from a trust include:

• Guaranteeing funds are available for your children or grandchildren by placing your assets in a legally protected trust.
• Safeguarding that money by giving you the authority to name specific beneficiaries and preventing others from not respecting your wishes after the fact.
• Ensuring that funds are available for many years to come by specifying how the trust’s principal is to be managed and its income disbursed.
• Ensuring funds are used only for an intended purpose designated by you, such as investing in a business or paying for a college education.

Trust services provided by Guaranty Bank & Trust

For over a century, Guaranty Bank & Trust has provided financial assistance — including estate planning — to Texans from all walks of life. If you have questions about managing your retirement, protecting your most valuable assets, or making sure that your family is taken care of financially for years to come, contact one of our friendly, caring, and collaborative Wealth Managers today.