Understanding Trusts in Estate Planning

Trusts play an important role in estate planning, but they can be confusing to understand.  This is in part because trusts come in several forms, each with a specific purpose.

What Is a Trust?

As a general matter, a trust is a legal construct that allows one person (the trustee) to hold assets for another person or persons (the beneficiaries).  The trustee has a legal obligation to manage and use the trust assets in the best interests of the beneficiaries.

An advantage of trusts is that they are extremely flexible; you can include almost any provisions that you wish in the trust.

Here are some basics to help you assess the role of trusts in your estate plan.

Download here: Key facts about revocable trusts

Types of Trusts

There are three main types of trusts: revocable trusts, testamentary trusts, and irrevocable trusts. These trusts differ in how they are created, when they go into effect, and whether you can alter or revoke them.

Revocable trusts

Revocable trusts, also known as “living trusts,” allow your assets to be transferred to your heirs outside of probate, which is the court process that generally authorizes the transfer of your assets into the names of your heirs upon death.  Probate is also referred to as estate administration. 

With a revocable trust, you are usually both the trustee and the beneficiary of the trust during your life, and you can change or revoke the trust whenever you wish. 

Revocable living trusts are often referred to as “will substitutes” by lawyers because they serve a function similar to your will, in that they direct who will receive your assets upon your death.  Unlike a will, however, the assets distributed to your heirs don’t go through the probate process.  Because the assets avoid probate, the transfer of assets is almost always faster, easier, and less expensive with a revocable trust than with a will.

The probate process can be particularly burdensome when minor children are involved, so a revocable trust can be beneficial when leaving assets to young kids.  Assets that are left to children through a will can end up tied up in court for many months, which can be problematic if the money is needed to pay critical family expenses like your mortgage or rent, childcare, and school-related expenses.

Contrary to some reports, a revocable trust does not have any effect on your taxes, and it does not protect your assets from creditors.

Estate Planning

Why might you choose a revocable trust? Here are some situations to consider:

  • You want to ensure that your estate proceeds will be immediately available to your family. Without a trust in place, your estate may have to go through probate, a process that can take several months to several years. In the meantime, your family members could be put in a tough position if they can’t access your assets.
  • You would like to minimize the burden and costs of estate administration on your loved ones. A revocable trust can help to avoid costly and time-consuming court proceedings following your death. Establishing a revocable trust is one way to minimize the costs and complications of handling your estate, as the probate system may require the hiring of attorneys or other specialists.
  • You would like to choose a foreign executor for your estate. A person who lives outside of the United States and is not a U.S. citizen may not be eligible to serve as executor of your estate, but a revocable trust solves this issue and allows them to administer trust assets.
  • You own property in another state. A separate court proceeding may be required in each state where you own property, which can add costs and complexity to the estate administration process. A revocable trust can help to avoid this overly complicated process.
  • You would like the details of your estate to remain private.  During the probate process, the details of your property and the parties to whom it was left are not a matter of public information if you choose a revocable trust over a will.
Privacy for your loved ones is a key benefit that trusts can help procure Click To Tweet

Irrevocable trusts

As the name implies, an irrevocable trust cannot be altered by you after it has been executed. Once established, you lose control over the assets, are unable to change the terms, and cannot dissolve the trust without the permission of the beneficiary.

Knowing these restrictions, why would you choose this option? Because irrevocable trusts can serve as powerful vehicles to minimize estate taxes and to protect assets from creditors.

The federal estate tax exemption is currently quite high (between $6 million and $12 million depending on the year of death), so estate tax planning isn’t something that most parents have to worry about.  Even if your assets would be subject to estate taxes, think carefully before putting assets into an irrevocable trust.  If you need those assets in the future, you may not be able to take them out.   For this reason, the most common asset held by an irrevocable trust is a life insurance policy – which you generally don’t plan to use during your lifetime in any event.

Testamentary trusts

A testamentary trust, sometimes referred to as a “trust under will,” is included in the terms of your will and comes into effect after you have passed away.

Testamentary trusts are a common part of estate planning for parents with young children, because they allow a specified person (the trustee) to manage assets for your kids until they reach an age at which they are likely to make mature financial decisions.

In the absence of a trust for your kids, a court would supervise administration of the assets left to your children until they turn 18, at which point the children would have unrestricted access to their inheritance.  Court oversight of your kids’ inheritance can be burdensome, costly, and a violation of your kids’ privacy.  A testamentary trust can protect your children’s privacy, make things easier on the person who would be charged with managing the assets, and prevent your kids from squandering the money at a young age.

There are also benefits to leaving assets to your spouse in a testamentary trust.  Assets left to your spouse outright can be subject to a divorce action or a claim against their estate by a subsequent spouse or other children.  Leaving assets to a trust for your spouse can provide your spouse with flexibility to use the assets for himself or herself, while also making sure that the assets are protected for your own children.

For New Yorkers, leaving assets to a trust for your spouse can also minimize the effect of the New York estate tax on your family.

Estate Planning

Download our key facts about revocable trusts here

Final thoughts

Trusts are an important element of prudent estate planning. They can help to make things easier on your loved ones, protect your assets, and minimize taxes. 

Along with a will, power of attorney, and healthcare power of attorney, a trust is part of a comprehensive estate plan.  To see if a trust is right for your family, contact an experienced estate planning attorney in your state.

About the Author

Shannon McNulty

Shannon McNulty is the founder of The Savvy Parents Group and a lawyer in New York City who provides legal planning for parents with young children. Shannon received her J.D. from Georgetown University Law Center and her LL.M. in Taxation from NYU School of Law. She has also earned her CERTIFIED FINANCIAL PLANNER(TM) designation. You can learn more about Shannon and her firm at www.mcnulty-law.com.