The concept of a family trust—also known as a revocable living trust—isn’t very well understood by many people. The differences between a trust and a simple will, for instance, are frequently confused.
While it’s somewhat more time consuming—and therefore, more expensive—to have a family trust prepared than a will, there are significant benefits of the trust for many individuals.
I have many clients that feel that they “have to set up a trust“. I think many want to avoid probate at all costs. Please keep in mind that probate is NOT a four letter word.
I don’t want to discourage you from setting up a family trust, but it’s not a requirement in every situation.
How a Family Trust Functions
A family trust is a legally binding document that covers an individual’s assets during one’s lifetime and specifies the terms of dispersing those assets after one’s death or incapacity.
The person establishing the trust—generally referred to as the grantor—transfers all of his/her assets so that the trust itself is the owner, not the individual.
In practical terms, the distinction is a technical one; the grantor will still have full control over and use of all his his/her assets.
A trustee—the person(s) who will carry out the terms—is appointed at the time that the trust is formed, but has no role until the grantor is deceased or incapacitated. The trustee can be a family member, close family friend or even a financial institution (think bank for brokerage firm).
I’ve had clients select all the above to be their primary trustee or successor trustee. Keep in mind that choosing a financial institution as a trustee will be the most costly.
The cost can be justified as these institutions specialize in these matters where a family friend may be burdened with all the responsibilities that trust brings on.
The terms of the trust—and the exact assets included—can be changed at any time. For example, if a new car is purchased, it can be added to the trust.
This is true with all significant purchases and sales of tangible property (homes, vehicles, etc.) and intangible assets (securities and other financial investments). Similarly, the identities of the trustee(s) and beneficiaries can be changed by the grantor at any time.
What also can be changed is how the assets are dispersed. For example, you could set up the family trust to disperse the assets at various ages of your surviving child.
The could get 1/3 of the income at age 45. The other 1/3 at 55. And the final disbursement at age 65. This is just one example of the thousands of possibilities of how a family trust can be set up.
Just to make sure I covered my bases, I reached out to a friend and colleague Adam Lawler of Adam B. Law Firm, LLC. Here’s what he had to add:
In my world, a “family trust” normally refers to a joint tenancy revocable trust (think husband and wife) as grantors (settlors), trustees, and beneficiaries (trustee and beneficiary during lifetimes). When just one individual is involved, it’s normally called a living trust, revocable trust, grantor trust, etc.
FYI- the initial trustee is almost always (99.99%) the grantor/settlor of that trust. The professional fiduciaries normally only enter the picture after death and if no competent kid, uncle, etc are around.
Types of Family Trusts
To make estate planning a bit more confusing, there are different types of revocable trusts. For example, an A-B trust is designed for situations where a married couple wants to provide ongoing support for the surviving spouse and also ensure that their children eventually will receive some portion of the estate when both spouses pass away. An A-B trust allows the surviving spouse to use the income generated from the trust, and when the second spouse passes away, any remaining assets are split between the children.
That is just one example of a trust you could choose to set up for your family. Here are other examples:
Benefits of a Family Trust
Among the numerous advantages of a family trust are:
- Avoidance of the probate process. If the grantor dies, the estate can avoid probate court, a substantial benefit over a simple will, where probate is commonplace for any assets not specifically enumerated.
- Avoidance of legal challenges of asset dispersal. A family trust is essentially airtight legally, another potential advantage over a simple will.
- Limitation of exposure to estate taxes, as part of a proper estate planning process.
- Simplicity and Flexibility. A family trust is a relatively easy document to prepare and account for, particularly with the help of an estate planning attorney. Transferring asset ownership to the trust is an easy task. The ability to amend and adjust the terms at any time makes it a very versatile vehicle.
- Control. The terms of the trust dictate exactly what will be done with your assets in the event you are incapacitated or deceased. The trustee must carry out your instructions to the letter, or face civil suits and possibly criminal prosecution.
Managing a Family Trust
Once a family trust has been established, it is important to properly manage and maintain it to ensure that it continues to meet its intended purpose. This section will cover some of the key aspects of managing a family trust, including the responsibilities of the trustee, making changes to the trust, and the tax implications of a family trust.
Responsibilities of the Trustee
The trustee is responsible for managing the assets held in the family trust and distributing them to the beneficiaries according to the terms of the trust. This includes managing investments, paying bills, filing tax returns, and communicating with beneficiaries about the status of the trust. The trustee is held to a fiduciary standard, which means they are legally obligated to act in the best interests of the beneficiaries.
Changes to the Trust
While family trusts are designed to be relatively permanent, there may be circumstances that require changes to be made to the trust. Common reasons for changes to a family trust include changes in the family’s circumstances, changes in tax laws, or changes in the investment landscape. Any changes to a family trust must be made in accordance with the terms of the trust and the applicable laws and should be done in consultation with an experienced estate planning attorney.
Tax Implications of a Family Trust
Family trusts can have significant tax implications, both for the grantor and the beneficiaries. Income earned by the trust is typically subject to income tax, and any distributions made to beneficiaries may also be subject to taxes.
Additionally, there may be estate tax implications when assets are transferred into or out of the trust. It is important to work with a qualified tax professional to understand the tax implications of a family trust and to ensure that the trust is structured in a way that minimizes tax liability.
Abusing Trusts for Tax Purposes
It’s also important to note the IRS is very aware of how individuals misuse trust to avoid pay taxes. Don’t operate under the assumption you’re smarter than the government on this.
Proper management of a family trust is essential to ensuring that it continues to provide the intended benefits for the grantor and beneficiaries.
By understanding the responsibilities of the trustee, the process for making changes to the trust, and the tax implications of the trust, individuals can make informed decisions about how to manage their family trust.
The Bottom Line – What a Family Trust Does
A family trust is a relatively simple and inexpensive, but potentially powerful legal vehicle, with many benefits for a wide swath of individuals.
The family trust essentially makes certain that your assets will be allocated as you wish, should something happen to you and makes certain that the beneficiaries that you designate will have access to their inheritance—in the manner you intend—quickly and fully. The peace of mind in that fact alone may be enough to recommend the process.
I hired a local attorney to draft our will and testamentary trust, but there are online options that are cheaper. One example is NOLO.
If you haven’t set up a will yet or are interested in a FREE Living Trust, give them a try.