Wealthy people have long used trusts to stash their money and pass it on to the next generation. That includes billionaire Rupert Murdoch, whose trust is making headlines as his family battles for control of his media empire. But it's not only the ultrarich who can take advantage of what a trust can offer. According to attorneys and wealth managers, trusts make sense for all types of estates—and are gaining popularity with the middle class too.
To understand how trusts work, it's helpful to know that their main purpose is to ensure your assets go to the people you intend. Trusts can also help estates avoid probate—a legal process that can take months or even years—and, in the case of the ultrawealthy, they can help avoid estate taxes. A trust comes into being when the creator, known as the grantor, transfers assets into the trust, and then names a trustee whose job is to ensure the grantor's wishes are followed before and after her death.
There is no specific income level when it makes sense to start looking into trusts, says Kathleen Grace, a certified financial planner (CFP) and CEO of Fiduciary Family Office. It depends instead on every individual's situation, the assets they have, and where they live. Setting one up typically involves an estate lawyer and can cost anywhere from a few thousand dollars to hundreds of thousands, depending on its complexity. It's also possible to set up a trust online for much less money.
That said, 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 creating a will is probably sufficient, says Jessica Majeski, a CFP and wealth management advisor at Northwestern Mutual. It is when assets are more complicated, or exceed a state's probate threshold, or when there are minor children who can't inherit assets outright, that trusts come into play.
"Everybody needs to have an estate plan," says Denise McClain, an attorney and director at Hirtle, Callaghan, which provides investment advisory services including trusts and estates. "The level of detail someone will include in the estate plan will become more complex as their wealth grows."
Trusts can be a “motivational tool”
There are two main types of trusts: revocable and irrevocable. As the names imply, the former can be changed fairly easily and the latter cannot.
"Which trusts are best, there’s no such thing," says Grace. "It’s what is best for that specific client’s needs."
A revocable trust simply means that the grantor can change or nullify the arrangement at any time. It allows the grantor to continue using the trust's assets (perhaps by continuing to live in their home) but, upon her death, the assets are distributed according to the rules of the trust. Trusts are helpful when minor children are involved, says McClain, allowing the trustee to care for the assets until they reach 18 or whatever age is stipulated in the trust terms to receive the assets.
"Families that don't have as much wealth, they should have a revocable trust. You can put in your house title, your investment accounts, your bank accounts," says McClain. "It is an efficient way to avoid probate."
Irrevocable trusts are more complicated. Typically, you can't change or amend them after they are formed, though there are some circumstances when you do so by getting a court involved. Assets put in an irrevocable trust are technically moved out of the grantor's estate, and the trust itself files its own tax return. That makes these especially popular options for families to shield assets from estate taxes.
While you give up control after the trust is formed, you have complete control beforehand to dictate not only who gets which assets and when, but how they get them.
To determine what type of trust makes sense for your situation, McClain suggests thinking through your "purpose." Is it simply to lower your tax bill? Ensure generations of your family are cared for? Protect your assets for future charitable giving?
There are many types of irrevocable trusts, including the popular charitable remainder trust. In this arrangement, the grantor puts assets in the trust, receiving a partial tax deduction in the process. She or her beneficiaries get an annual sum of money known as the distribution. Then, at the end of the distribution period, the rest goes to a specified charity or charities. A charitable lead trust is the inverse: The specified charity gets money annually, and then the remainder goes to the beneficiaries.
And then there are incentive trusts, which let grantors impose conditions that must be met before a beneficiary receives funds or assets. For example, the beneficiary may need to graduate from a certain college, maintain a paying job, or remain sober. These are popular among grantors who are worried about the potential negative effects of inheriting wealth, or to encourage what the grantor believes are positive behaviors.
"Most folks wonder how much is enough to give to their kids, and how do I give them not just money but the responsibility behind it to be good stewards of that money," says Grace. "That’s where we’re seeing a lot of incentive trusts, [so as] to not just use a trust as a piggy bank but as a motivational tool."
Another popular type is a spousal lifetime access trust (SLAT), which enables one spouse to make gifts to a trust benefiting the other spouse. SLATs allow the person who formed it to maintain access to the assets. This type of trust is especially hot right now, given that the federal estate tax exemption—how much someone can pass on to beneficiaries without incurring gift and estate taxes—may decrease from $13.61 million to around $5 million per individual.
Who do you trust?
Once the type of trust is selected, McClain says, the next important decision is the trustee. This person or organization will be tasked with holding and administering the assets in the best interest of the beneficiaries. Depending on when the trust is formed and how long it lasts, the trustee could be involved for a few years to a beneficiary's entire lifetime.
For revocable trusts, McClain says, the grantor and his or her spouse are typically their own trustees, with successor trustees named (and the trustees can be changed at any time). For irrevocable trusts, the trustee can be a friend, family member, attorney, private fiduciary, or outside trust company—and the trustee can only be changed depending on what's written in the administering documents.
Fees vary depending on each arrangement. An outside company or private fiduciary typically has a fee schedule, while a good friend may not charge you at all to manage the trust (though they are entitled to reasonable compensation). That said, the friend also may not be able to devote a ton of time to learning about the best interests of the beneficiaries.
"It’s an honor to serve as a trustee, but it is also work. They have the responsibility to make sure the assets are managed well, to file tax returns," says McClain. "They need to have skills and understand how to administer a trust document, or know they can reach out to others—attorneys, CPAs, financial firms—to help them."
Some U.S. states are more popular than others when it comes to trust formation. Grantors may chose to create a trusts in a state they don't live in to save on taxes, or because some states allow trusts to exist in perpetuity, among other reasons.
Nevada has become a particularly popular state for trust formation, for example, because it does not impose state income tax on trusts. It does not require trusts to be filed with a state agency or court (providing more privacy in high-profile cases like the Murdochs' current debacle), and it allows trusts to last up to 365 years, so assets can be passed on through the generations without paying estate taxes. In Arizona, trusts can last 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 will likely need to hire a company there to be a trustee so you can avail yourself of the state's laws.
"What's your purpose, who do you want it to be for, how long do you want it to last, and who do you trust to make sure your wishes are fulfilled," says McClain. "If people think about those four things, that’s a great way to start."
