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What is a Trust?

definition

A trust is a legal tool where one party (the trustor) gives control of assets to a second party (the trustee), to be held or used for the benefit of a third person (the beneficiary).

🤔 Understanding a trust

Trusts are a legal tool that allow one to give control of property, stocks, bonds, or other assets to a second party — to be used for someone else’s benefit without giving the beneficiary full control over the assets. This allows the person giving the assets to support the beneficiary of the trust while placing restrictions on how they can use the funds they’ve been given. The trustee manages the trust to ensure that the rules of the trust are followed and that the money is used for the beneficiary’s benefit. A trust can also be used to streamline the inheritance process and potentially lower inheritance taxes.

example

One common use for trusts is by a parent or grandparent who wants to leave money to a child or grandchild. Rather than handing their child or grandchild a big check, the trustor places the money in a trust with stipulations on its use. For example, the beneficiary may only be able to use the money for education or may not be able to use the money until they reach a certain age.

Takeaway

A trust is like a safety deposit box that someone else holds the keys for...

The deposit box holds something valuable, but if you’re the beneficiary, you don’t have the key to open the box to get the thing that’s inside. Instead, you have to ask the trustee to open the box for you. The trustee will decide whether to open the box, based on the rules they were given by the person who originally locked the box.

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Tell me more...

What is a trust?
What is the purpose of a trust?
What is a Living Trust or a Testamentary Trust?
What is the difference between a revocable and irrevocable trust?
What is the difference between a funded and an unfunded trust?
What are the benefits of trusts?
What are the types of trusts?

What is a trust?

A trust is a legal tool that you can use to put money aside for a person’s benefit without giving them full access to that money. It gives you a way to place certain stipulations on the use of money or to make sure that funds are kept safe until the recipient is capable of handling and managing the money on their own.

To set up a trust, you, the trustor, draw up a legal agreement and give the funds to a third party, known as the trustee. The trustee holds the money and manages it, as you agreed in the legal document. The individual who will benefit from the money in the trust is called the trust’s beneficiary.

A trust is something that you might commonly set up as part of your will, for the benefit of your children, grandchildren, or anyone else you may wish.

There are many forms of trust, and they can be used for a variety of purposes.

In finance, a trust may refer to a type of closed-end fund.

What is the purpose of a trust?

A trust is a way to set aside money for a person’s benefit without giving them unrestricted access to the money. There are many purposes that trusts can fulfill.

One of the most common reasons to establish a trust is to pass ownership of assets without expecting the recipient to manage those assets. For example, if you want to give a grandchild who is under 18 a gift of stocks or other investments, you can use a trust and designate someone who knows how to manage those investments, such as the child’s parent, as the trustee. The parent can manage the account until the beneficiary turns 18 and can claim the money.

Trusts can also control access to money that you’re giving away. Imagine you saved money for someone’s education and want to make sure that the money is utilized in the way you intended. You can establish a trust for that person and require that the trustee only disburse funds for the payment of tuition.

You can also use a trust to reduce friction when you pass away and leave money to your descendants. Trusts can potentially be more resistant if someone tries to contest your will. If triggered before your death, they can also potentially avoid probate (the legal process where a court confirms the validity of a will), making sure your descendants get access to your money more quickly.

There are also trusts designed specifically for charity. You can use a charitable trust to designate certain assets for a charitable foundation, while maintaining the use of those assets during your lifetime. For example, you can place a painting in a charitable trust while keeping the painting in your home. When you pass away, the painting becomes the property of that charity.

What is a Living Trust or a Testamentary Trust?

A living trust is a trust that is created during the life of the trustor. They are designed and come into effect while the trustor is still alive. A trust established by a parent to hold stocks and bonds for a child until they are old enough to manage investments is an example of a living trust.

Testamentary trusts are trusts that come into effect when the trustor passes away. They are usually established based on conditions laid down in the trustor’s last will and testament, the document that gives them their name.

What is the difference between a revocable and irrevocable trust?

A revocable trust is a type of trust where the trustor can revoke or change the terms of the trust. This means that the trustor can add or remove beneficiaries, add or remove assets, or completely close the trust whenever they’d like.

Irrevocable trusts are the exact opposite. Once an irrevocable trust is created, it cannot be changed by the trustor. This gives them far less control over the trust, but it can have other benefits. For example, irrevocable trusts may offer different tax treatment than revocable trusts. Income earned by revocable trusts is often taxed as part of the trustor’s income. Irrevocable trusts can be taxed as their own entity, which can reduce the amount of tax owed.

The trustor of a revocable trust can potentially act as the trustee, but cannot act as the trustee of an irrevocable trust.

When the trustor of a living trust passes away, if the trust was revocable, it automatically becomes irrevocable. The trustor is no longer alive to make any changes to it.

The trustor of a testamentary trust can make changes to it whenever they’d like, as the trust does not come into effect until they pass away. Once a testamentary trust comes into effect, it becomes irrevocable.

What is the difference between a funded and an unfunded trust?

A funded trust is one that has had assets placed in it. An unfunded trust is a trust that does not have any assets in it.

In some jurisdictions, a trustor can establish a trust without placing any assets in it. The trustor can choose to fund the trust at a later date or to not fund the trust. An unfunded trust can be funded at any time the trustor wishes, including when they pass away. Unfunded trusts can be established by trustors who want to have the trust ready to be used, even if they cannot afford to fund it immediately. It simply lets them deal with the paperwork of setting up the trust ahead of time.

What are the benefits of trusts?

There are numerous benefits to using a trust.

One of the primary benefits is tax treatment. You can use a trust to pass additional money to your descendants when you pass, potentially reducing estate taxes. You can also use trusts to reduce your tax liability when giving gifts.

In addition, trusts can give you greater control over how your money is used. If you simply give money to a loved one, they can use the money however they wish. If you establish a trust, you can place restrictions on the use of the money. For example, you can require that the person be employed to receive money from the trust or that they enroll in higher education.

If you establish a trust before you pass away, it can help your descendants access their inheritance more quickly. Money in a trust can skip the probate process, which can be lengthy.

What are the types of trusts?

There are many types of trusts, but here are four common examples.

A spendthrift trust is a trust that is designed to benefit people who have trouble controlling their spending. The trustee has the authority to control how the beneficiary uses the money. It can also potenitally protect the funds in the trust from creditors should the beneficiary wind up in debt.

Charitable trusts are trust funds designed to help trustors donate money to charity. They can be for the benefit of one or multiple charities and give a trustor the chance to make charitable donations without immediately deciding the charity that will receive the funds.

A special needs trust can be established to benefit someone who is disabled. These trusts help pay for the beneficiary’s expenses while maintaining their eligibility for government programs.

A tax bypass trust can be used to help a deceased person leave money to their spouse while potentially reducing estate taxes. The trustor places money in the trust when they pass away, naming their spouse as the beneficiary.

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