Trusts: What They Are and How to Set One Up

A trust is a legal arrangement intended to ensure a person’s assets eventually go to specific beneficiaries. The trust creator puts assets in the trust and authorizes a trustee to administer those assets for the benefit of the trust creator and/or beneficiaries. Some trusts can reduce estate taxes.

Trusts aren’t just for rich people. They can be an important part of estate planning and can provide peace of mind by ensuring your assets will go to the right people.

Certain types of trusts allow you to avoid having your estate go through probate, which is a court-supervised process of determining the validity of your will (if you have one) and distributing your assets after death. That process can take several months, and much of it is public record.

Trusts can be made by consulting with an estate planning attorney, using DIY estate planning software or using estate planning programs provided by your workplace.

» MORE: See our picks for the best online will makers

Trusts have three main players:

1. Grantor: The person who creates the trust and puts assets in it.

2. Beneficiary: A person who eventually receives some or all of the assets in the trust.

3. Trustee: The organization or person who administers the trust.

» Learn the difference: Wills vs. trusts

You can tailor a trust to your needs. As such, there are a variety of different types of trusts to choose from, but all trusts fall under two main categories.

1. Revocable trusts

Revocable trusts, also referred to as living trusts, are created during the grantor’s lifetime and are generally used for:

• Planning for incapacitation. If you’re diagnosed with a debilitating condition, you can get things in order before you’re unable to do so. When that day comes, the successor trustee takes over managing the trust assets for you.

• Avoiding probate. Assets in a revocable trust can bypass probate — the time-consuming process of settling an estate. Assets that pass through probate become public record, so bypassing probate can be beneficial if you’d prefer to keep the details of the trust private.

In a revocable trust, you (the grantor) can change the beneficiaries and assets as long as you’re alive and physically and mentally able to do so. You can even name yourself as the trustee and name a co-trustee or successor trustee. However, revocable trusts do not include any tax benefits or protection from creditors. For that, you may want to consider an irrevocable trust.

2. Irrevocable trusts

Irrevocable trusts are often used to minimize estate taxes for beneficiaries. In an irrevocable trust, you can’t change your mind. Once you put assets in the trust and name a beneficiary, it’s permanent. An advantage of irrevocable trusts is that you might be able to reduce your estate taxes because the assets in an irrevocable trust technically aren’t yours anymore. The trust owns them.

These trusts are typically used:

• To receive and hold assets after the grantor dies.

• To hold lifetime gifts for the grantor’s heirs or beneficiaries.

» See the differences: Revocable vs. irrevocable trusts

Other types of trusts

• Testamentary trust: Created by the terms of your will; unlike other trusts, it's only funded upon your death.

• Grantor retained annuity trust (GRAT): Allows the grantor to direct certain assets into a temporary trust and freeze its value, removing additional appreciation from the estate and giving it to heirs with minimal estate or gift tax liability.

• Education trust: Beneficiaries can only use the money for educational expenses.

• Spendthrift trust: When beneficiaries can’t make good financial decisions for themselves, the trustee decides how the beneficiary is allowed to use the money.

• Charitable trust: An irrevocable trust from which assets go to one or more charities. ^[0]

  Internal Revenue Service. Charitable Trusts. Accessed Feb 8, 2023.

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• Functional-needs trust: For families with children who have functional needs, these trusts set specific rules for how the money will go to the beneficiary.

• Qualified personal residence trust: An irrevocable trust in which you transfer a house to your heirs but get to live in it for a specified period first.

• Generation-skipping trusts: A trust in which you transfer money to grandchildren or other people who are at least 37.5 years younger than you.

Here are the five general steps to set up a trust.

1. Determine what kind of trust best fits your needs. It’s a good idea to consult with an estate planning attorney about your requirements.

2. Create a trust document. Your attorney will help you do this. Or, if you’re setting up the trust through an online DIY service, most companies will provide some online guidance to help you through the process.

3. Get it signed and notarized. Depending on your state laws, you may need multiple signatures from the grantor(s) and trustee(s), and you might also need witnesses during the process.

4. Open a trust account. Trusts can hold many different types of assets, including cash, stocks, bonds, mutual funds, real estate and other property.

5. Transfer assets into the trust. However, if the trust is established as part of an estate plan, you can designate the trust as a beneficiary so that the assets move to the trust once the grantor passes away.

There are a few ways to get help setting up a trust.

1. Consult with an estate planning attorney. Fees can vary widely, but professional guidance is often worth it. An estate planning attorney can draft your trust documents according to your requirements.

2. DIY. Some websites offer “do-it-yourself” trusts. They may be a low-cost option, but you may pay in time and effort.

3. Do it through work. Some companies offer discounted estate planning services as part of their employee benefits packages.

Trusts can be complex and intricate, so if you’re unsure about the best choices for you and your family, consult with a legal or financial professional before making a decision.

» MORE: ​​Last will and testament: What it is, how to create one

• Effectiveness: The main purpose of a trust is to transfer assets from one person to another. Trusts can hold different kinds of assets. Investment accounts, houses and cars are examples.

• Control: You can specify the terms of the trust, which means a trust can help you be strategic if you want to protect assets after a divorce, for example, or control when kids get your money, or control how people spend the money you leave them.

• Privacy: Assets in living trusts don’t have to go through probate. That process is public record, which can create drama if you’re disinheriting someone or making distributions that you don’t want to be public.

• Time: Probate can take several months. Trusts can avoid probate and get assets to your heirs faster.

• Potential tax savings: Some types of trusts can lower your estate taxes. However, most people don’t have to pay estate taxes, so talk with a financial advisor before setting up a trust. There's no reason to use a trust to avoid taxes you may not have to pay anyway.

• Cost: An estate planning attorney can do the paperwork involved in setting up a trust and transferring your assets into the trust, but hiring one can cost upward of $1,000. Online will makers are available, but many aren't able to create trusts.

• Time: You’ll need to spend time dealing with paperwork. You may need to have uncomfortable conversations about who gets what.

• May not be necessary for tax reasons: Some people can indeed save on estate taxes with certain trusts, but most estates aren’t subject to estate taxes in the first place.

» Get started Estate Planning: A 7-step checklist of the basics

This is a complicated area of the tax code, so be sure to consult with a qualified professional. Here are a few things to keep in mind:

Estate taxes. If you have a large estate, your assets may be subject to federal estate tax when you die. The federal estate tax ranges from rates of 18% to 40% and generally only applies to assets over $12.06 million in 2022 or $12.92 million in 2023. ^[0]

Inheritance taxes. Some states have inheritance taxes, which are different from estate taxes. The people who inherit the money pay the tax.

Income taxes. The assets in a trust might generate income, which could trigger income taxes or capital gains taxes. Who pays that tax depends on who legally owns the assets. If a charity gets the income directly, that donation might qualify for a tax deduction.

Time and effort. You may have some extra paperwork to do at tax time because trusts sometimes have to file their own tax returns.