Background
Trusts are estate planning tools used to designate assets to specific beneficiaries. They can hold a wide range of assets, including cash, real estate, stocks, businesses, and more. If a trust holds cash, that pool of cash is often considered a “trust fund,” although the definition of “trust funds” in particular is nebulous.
While some argue that the concept of trusts dates back to ancient Rome, trusts were further developed in medieval England. During the Crusades, when crusaders left for battle, they would often leave their land and other assets behind to “trusted” friends.
These days, however, there’s a common misconception that trusts are only for children of the wealthy. In reality, many personal finance experts argue that individuals of various net worths should consider establishing a trust.
How They Work
Three distinct entities are involved with setting up a trust: the grantor, the beneficiaries, and the trustee.
The grantor, or “trustor,” is the entity that establishes and funds the trust with their assets. They are typically an individual person or a business (see why a business might establish a trust).
The beneficiary is the intended recipient of the assets in a trust. There can be more than one beneficiary, such as when parents leave their assets in a trust to be divided among multiple children.
The trustee is a neutral third party whom the grantor appoints to manage the trust. This could be an individual, a bank, or another professional. Often, the trustee is the same person as the beneficiary. (Learn about the legal obligations of trustees here.)
Types
All trusts fit into one of two categories: revocable or irrevocable.
Irrevocable trusts are very difficult for the grantor to change or dissolve. But with a revocable trust, the grantor can alter or dissolve the trust at any time. While both types help beneficiaries avoid probate (the lengthy court process that administers a person’s estate upon death), they have some distinct pros and cons. For instance, revocable trusts are typically subject to estate taxes, whereas irrevocable trusts are not.
There are also “living” trusts, which the grantor creates during their lifetime, and “testamentary” trusts, which a grantor establishes in their will to be read after death. The most common type of trust in the United States is a revocable living trust.
Other types of trusts exist for more specific circumstances. For example, grantors can set up a special needs trust in order to provide a disabled dependent with financial assistance. A charitable trust lets grantors donate their assets to one or more charitable organizations while avoiding certain taxes; a pet trust ensures that an animal receives financial support and care if its owner can no longer care for the pet.
Misconceptions
Contrary to popular belief, recent Federal Reserve data shows that trusts are not just for the ultra-wealthy: The median trust fund contains roughly $285K, far from the millions of dollars that one might assume.
Many people of different socioeconomic classes decide to establish a trust to avoid certain taxes (what are the tax benefits of trusts?). For instance, when someone dies and leaves their assets to their beneficiaries in a will, those beneficiaries must pay certain taxes that the beneficiaries of a trust would help them avoid.
But despite trusts not being exclusive to the wealthy, some argue that they’re not for everyone, either. Some note that trusts can be somewhat expensive to set up, as the process typically requires paying for a lawyer’s time. That cost might outweigh the benefit of the trust for some. See more pros and cons here.
