Most estate planners recommend that you get a living trust but do a poor job of explaining exactly what a trust is. If you have ever wondered: what is a trust? This post is for you. In this post, you will learn exactly what a trust is, how it works, and how to create it so that you can make informed choices about your estate plan.
A trust is simply an agreement between a person who owns some property to own the property for the benefit of someone else. For example, in the estate planning context, it is a written document saying that the owners of some property are holding the property for the benefit of their beneficiaries. Let’s look at how a trust works and how to create it.
How a Trust Works
In a typical estate plan, a trust is a written document that defines how property is owned and how the property can be used. Once it is created, the law treats it as a separate “person.” Under the law “persons” are not only living human persons.
Persons also include artificial persons, such as corporations, LLCs, trusts, and partnerships.
A Trust works a lot like a contract or a will. The person who creates it is called the “trustor” or the “settlor.” The trustor or settlor gets to decide what happens to the trust property.
A trust is managed by a person called a “trustee.” The trustee’s sole job is to manage the property for the sole benefit of the “beneficiaries.”
Once a trustor or settlor places property into a trust, the property is no longer legally owned by the trustor or settlor. Have you ever heard that a trust avoids probate? It can avoid probate because technically when the trustor dies, he or she does not own the property – the trust does.
After death, the trustee’s job is to do one of two things. One, the trustee holds the property inside the trust and makes payments to the beneficiaries. Two, the trustee takes the property out of the trust and gives it to the beneficiaries.
Since it is a legal person, it can be used for all sorts of interesting things. For example, avoiding estate taxes, protecting your property from creditors, and creating a lasting legacy for your family.
How to Create a Trust
I created this helpful infographic to illustrate how a trust works and how easy it is to create.
You can have one trustor or multiple trustors. For example, a husband and wife frequently create a single joint trust. In this example, both are referred to as the trustors or settlors of the joint trust.
Choose a Trustee
Next, you need to pick a person to be responsible for your property while you are alive. This person is called a “trustee.”
There are two types of trustees. The initial and the successor. The initial trustee is the person the trustors pick to manage the property while the trustors are alive. Frequently, the trustors will choose themselves to act as the initial trustee.
The successor trustee is always someone other than the trustors. A successor trustee takes over the management of the property when the trustors die or become incapacitated.
You can have more than one successor trustee. You can have multiple persons acting a “co-trustees” who have to jointly decide how to manage the property.
Be careful when selecting a trustee.
The Qualities of a Good Trustee
The qualities of a good trustee are:
- Financially Responsible
- Capable of Understanding Your Intent and Wishes
- Not Greedy
- Good with Numbers
- Makes Good Choices
- Not Addicted to Drugs or Alcohol
- Not Convicted of a Felony
Most people choose their children or other family members to act as their trustees. While choosing a family member to act as your trustee is perfectly fine, be sure that they have the qualities of a good trustee.
The most important thing to remember when selecting a trustee is: do not be arbitrary.
I have met with clients who wanted each of their children to act as co-trustees. Their reasoning is typically that they do not want any of their children to feel left out. While this is a perfectly understandable and great sentiment if can cause problems.
For example, if your children do not get along, they may not make good co-trustees. If one of your children is not good with money or has substance abuse problems, he or she should not act as a trustee (even as a co-trustee).
Pick the person you think will be the best trustee, who has most of the qualities that make up a good trustee.
If you do not know anyone like that, then you can always choose a professional fiduciary to act as a trustee. A professional fiduciary often works for a financial institution (like your bank) and charges a fee to act as the trustee.
Choose Your Beneficiaries
After you choose a trustee, you get to pick who will get the immediate benefit of their property while you are alive. Not surprisingly, these persons are called the “initial beneficiaries.” In a typical estate plan, the trustors act as the initial trustees and the initial beneficiaries.
If you act as the initial trustee and initial beneficiary of your trust, functionally nothing will change in your day-to-day management or use of your property.
The next step is to decide who will get the benefit of your property when you die.
You can choose anyone to be a beneficiary. Frequently, people choose their children, their grandchildren, their church, and even their pets to be their beneficiaries.
The only real risk is that you need to clear about your beneficiaries. For example, if you do not specifically identify your beneficiaries, it can be hard to decide who your property goes to when you die. I once helped a client administer an estate plan that named “my church” as a beneficiary. Of course, her children and trustees did not know that she went to church. So, it took a long time to figure out which “church” she meant.
Put Your Property Into Your Trust
The final step after writing your trust document, picking trustees, and choosing beneficiaries, is to fund your Trust. This means, putting your property into it.
This is the #1 mistake people make when creating a trust. They forget to put their property into the trust. An unfunded trust is just a fancy will. It needs to be probated.
Luckily there are certain procedures for can help if you die but forget to fund your trust. For instance, if you identify the property in the document itself, your trustee can file a Heggstead petition, which asks the court to order that the property be put into the trust. While this costs a little extra money, it can avoid a full and formal probate.
Funding your estate plan may sound complicated, but it is not.
Each item of property you own can quickly and easily be put into your trust. Here are some of the common trust properties and how you can put them into your trust.
- Real Property – Real Property can be retitled by filing or recording a new deed.
- Bank Accounts – Each bank has a document you can fill out to change the ownership of your bank accounts. You typically need a document called a “Certification of Trust” or an “Affidavit of Trust” in addition to whatever forms the bank requires.
- Life Insurance – You can fill out a new beneficiary designation form with your insurance company to name the trust a new beneficiary. Unless you are doing a special “Life Insurance Trust” your trust does not need to own the insurance policy.
- Personal Property – You can put all of your personal property (like furniture, cars, boats, clothing, art, etc.) into the trust by signing a “Bill of Sale” or an “Assignment of Personal Property.”
Once you have your property in the trust, it is considered “funded.” This means that all of the property you put into the trust can go immediately to your beneficiaries on your death. There is no need to open an expensive and complex probate.
As you can see, a trust is an extremely flexible and helpful estate planning tool. It costs more money upfront to create than a typical will. But it saves thousands of dollars after you die. If you would like to know exactly how a trust saves you thousands of dollars and years of work, read our article called “How to Probate a Will: Step-by-Step.”
There are always unique considerations when creating a trust. For example, there are many different kinds of trusts to choose from. The one that is best for you depends on your unique family situation, the kinds of property you own, and how much your estate is worth. For instance, if you have children from a previous relationship, you will need to plan differently than a person with no children of children from only one relationship.
Proper estate planning to essential to passing your legacy onto the next generation. If you would like to learn more about estate planning check out my informative article titled “Estate Planning Explained: How to Leave Your Legacy.”