Wealthy people have long used trust funds to store their money and pass it on to the next generation. This includes billionaire Rupert Murdoch, whose trust as his family makes headlines Slaughter for control of his media empire. But it’s not just the super-rich who can benefit from the advantages of a trust. According to lawyers and wealth managers, trusts make sense for all types of estates – and are also becoming increasingly popular among the middle class.
To understand how trusts work, it’s helpful to know that their primary purpose is to ensure that your assets benefit the people you intend. Trusts can also help avoid probate – a legal process that can take months or even years – and in the case of the super-rich, they can help avoid inheritance taxes. A trust is created when the founder, also known as the grantor, transfers assets into the trust and then appoints a trustee whose job it is to ensure that the grantor’s wishes are carried out before and after his or her death.
There’s no specific income level at which it makes sense to look into trusts, says Kathleen Grace, certified financial planner (CFP) and CEO of Fiduciary Family Office. Rather, it depends on the situation of each individual, their assets and where they live. A real estate attorney is usually responsible for setting this up and the cost can range from a few thousand to hundreds of thousands of dollars depending on the complexity. It is also possible to set up a trust online for significantly less money.
That is, for those whose finances are fairly simple—say, someone who wants to split their retirement account and home between two adult children—Naming beneficiaries and drawing up a will is probably sufficient, says Jessica Majeski, CFP and wealth management advisor at Northwestern Mutual. When assets are more complicated or exceed a state’s probate threshold, or when there are minor children who cannot inherit the assets directly, trusts come into play.
“Everyone needs an estate plan,” says Denise McClain, a lawyer and director at Hirtle Callaghan, which offers investment advisory services including trusts and estates. “The level of detail that someone includes in their estate plan becomes more complex as their wealth increases.”
Trusts can be a “motivation tool”.
There are two main types of trusts: revocable and irrevocable trusts. As the names suggest, the former is relatively easy to change, but the latter is not.
“There is no such thing as which trusts are best,” says Grace. “It’s what’s best for that specific customer’s needs.”
A revocable trust simply means that the grantor can change or cancel the agreement at any time. It allows the grantor to continue to use the trust’s assets (perhaps by continuing to live in her home), but upon her death the assets are distributed according to the trust’s rules. Trust funds are helpful when there are minor children involved, McClain says. They allow the trustee to take care of the assets until they turn 18 or reach the age specified in the trust terms for receiving the assets.
“Families that don’t have as much wealth should have a revocable trust. You can provide your home title, your investment accounts, and your bank accounts,” says McClain. “It’s an efficient way to avoid probate violations.”
Irrevocable trusts are more complicated. Typically, you cannot change or add to them once they have been created. However, in certain circumstances you can do this by going to court. Assets placed into an irrevocable trust are technically removed from the donor’s estate, and the trust itself files its own tax return. This makes these options particularly popular for families to protect assets from inheritance taxes.
While you relinquish control after setting up the trust, you have complete control beforehand and can determine not only who gets what assets and when, but also how they receive them.
To figure out what type of trust makes sense for your situation, McClain suggests thinking about your “purpose.” Is it simply about reducing your tax bill? Are you making sure generations of your family are taken care of? Protect your assets for future charitable donations?
There are many types of irrevocable trusts, including the popular charitable trust. Under this arrangement, the grantor places assets in the trust and receives a partial tax deduction. They or their beneficiaries receive an annual amount of money, called a distribution, and at the end of the distribution period, the remainder goes to one or more specific charities. A charitable lead trust is the opposite: the designated charity receives money annually, and the rest goes to the beneficiaries.
And then there are incentive trusts, which allow grantors to specify conditions that must be met before a beneficiary receives funds or assets. For example, the beneficiary may be required to obtain a certain college degree, maintain a paying job, or remain sober. These are popular with grantees who are concerned about the possible negative effects of inheriting wealth, or to encourage what the grantee believes to be positive behavior.
“Most people wonder how much is enough to give to their children and how do I give them not only money but also the responsibility that comes with being good stewards of that money,” Grace says. “We see a lot of incentive trusts there, [so as] to use a trust not only as a piggy bank, but also as a motivational tool.”
Another popular type is a Spousal Lifetime Access Trust (SLAT), which allows one spouse to make gifts to a trust that will benefit the other spouse. SLATs allow the person who created them to maintain access to the assets and are therefore particularly popular at the moment exemption from federal inheritance tax— how much someone can pass on to beneficiaries without incurring gift and estate taxes — could drop from $13.61 million to about $5 million per person.
Who do you trust?
Once the type of trust is selected, McClain says the next important decision is who will be the trustee. This person or organization is charged with the custody and management of the assets in the best interests of the beneficiaries. Depending on when the trust is created and how long it exists, the trustee can serve for anywhere from a few years to the entire lifetime of the beneficiary.
With revocable trusts, McClain says, the donor and his or her spouse typically serve as their own trustees, with successor trustees named (and the trustees can be changed at any time). In irrevocable trusts, the trustee can be a friend, a family member, an attorney, a private trustee, or an outside trust company – and the trustee can only be changed depending on what is written in the administrative documents.
Fees vary depending on the agreement. An outside company or private trustee will usually have a fee schedule, while a good friend may not charge you any fees at all for managing the trust (although they are entitled to reasonable compensation). However, the friend may also not be able to spend much time researching the welfare of the beneficiaries.
“It is an honor to serve as a trustee, but it is also work. They are responsible for ensuring the assets are well managed and filing tax returns,” says McClain. “They need to have skills and understand how to manage a trust document or know that they can turn to others – lawyers, accountants, financial firms – to help them.”
Some US states are more popular than others when it comes to building trust. For tax savings or other reasons, donors may choose to create a trust in a state where they do not live or because some states allow permanent trusts.
Nevada has become a particularly popular state for establishing trusts because, for example, there is no state income tax on trusts and trusts do not have to be filed with a state agency or court (providing more privacy in high-profile cases like this). Murdochs’ current debacle) and it allows trusts to last up to 365 years, allowing assets to be passed down through generations without paying inheritance taxes. In Arizona, Trusts can last for 500 years.
If you don’t live in Nevada or one of the other popular trust states like Alaska, Delaware or South Dakota, McClain says you’ll likely need to hire a company there to act as your trustee so you can take advantage of the state’s laws.
“What is your purpose, who should it be for, how long should it last, and who do you trust to fulfill your desires,” says McClain. “If people think about those four things, that’s a good start.”