Family Trusts:
A Helpful Guide

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What Are Family Trusts?

Family trusts are legal devices. As with any trust fund, family trusts transfer management or ownership of assets to a third party. A family trust is used to:

  • Avoid probate
  • Avoid or delay taxes
  • Protect assets

Image via Unsplash by jonecohen

Family trusts are set up to benefit a grantor's relatives. The purpose of this type of trust is to benefit the family of a grantor. Family can include anyone related by:

  • Blood
  • Marriage
  • Law (for example, adoption)

In addition to helping with estate planning, family trusts make sure that your assets are managed according to your exact wishes on behalf of your beneficiary or beneficiaries. Contrary to popular belief, family trusts are not just for the very rich. Anyone can set up a family trust to protect and provide for family members.

Basic Family Trust Terms to Understand

The following terms are used to describe trusts:

  • Beneficiary: A person/entity the trust benefits. Typical beneficiaries include:
    • Child
    • Grandchild
    • Spouse
  • Grantor: A person who creates the trust.
  • Trust agreement: The document that sets up a trust. This document is also sometimes called a Trust Deed or Deed of Trust. The trust agreement:
    • Designates the trustee
    • Designates the beneficiaries
    • Gives the trustee instructions about how the assets should be managed and distributed
  • Trustee: A third party designated to manage a trust's assets. Trustees may be:
    • One person
    • Two or more joint trustees
    • A business entity, for example, a trust management company or a bank
    • A beneficiary of the trust
    • The grantor, if the trust is a revocable trust

Benefits and Advantages of Family Trusts

Family trusts offer a variety of benefits. These advantages include:

  • Avoiding legal challenges: A family trust provides the advantage of being airtight legally as opposed to a simple will, which can be challenged. Family trusts can avoid legal challenges to asset dispersal.
  • Avoiding the probate process: This is another substantial advantage over a simple will, as the estate can avoid probate court with a family trust. Avoiding probate allows your assets to be distributed efficiently, avoiding the cost, publicity, and delay that probate court creates. Probate court can cost between 4% and 7% of an estate.
  • Limiting exposure to estate taxes : Family trusts are often part of proper estate planning since they limit potential estate taxes.
  • Limiting exposure to gift taxes: As with estate taxes, family taxes can reduce gift taxes.
  • Offering flexibility: Family trusts are very versatile, as you can adjust and amend the terms.
  • Offering simplicity: With the help of an attorney , a family trust is relatively easy to prepare and account for. Likewise, transferring asset ownership to a trust is relatively simple.
  • Offering a high degree of control: The terms of a family trust will dictate exactly what should be done with your assets if you become incapacitated or die. Trustees must strictly carry out instructions in a trust; if they do not, they will face civil suits and even criminal prosecution. By creating a family trust, you choose the conditions of how and when your assets will be distributed after your death.
  • Protecting your assets: A family trust better protects assets from creditors as well as lawsuits.

Additionally, family trusts allow you to name a successor trustee. A successor trustee will manage your trust after you die. This trustee can also manage your trust assets if you become unable to do it yourself.

Revocable vs. Irrevocable Trusts

Family trusts may be revocable trusts or irrevocable trusts:

Revocable Trusts

A revocable trust allows a grantor to revoke or cancel the trust, in which case the assets transfer back to the grantor. Once a grantor dies, a revocable trust becomes irrevocable.

A revocable trust accomplishes the following basic goals:

  • Avoiding probate: Probate is the judicial process of proving a will or settling an estate in court. Avoiding probate also avoids the expense and time of court processes.
  • Maintaining privacy: Because probate is avoided, no public record is created to show assets and debts at the time of death or to whom the assets went.
  • Protects assets for beneficiaries unable to manage assets responsibly: A trust can be used to preserve assets for a child who is disabled, in the middle of a divorce, or financially irresponsible. A trust can even provide for a pet's care.
  • Covers a situation where a grantor becomes disabled: Revocable trusts can do this, though durable power of attorney can accomplish this goal as well.

There are many types of revocable trusts. The most common type used as family trusts are living trusts, which take effect while the grantor is alive. The grantor will transfer to the trust ownership of assets such as:

  • Investments
  • Life insurance policy
  • Real estate

Irrevocable Trusts

Unless both trustee and beneficiaries agree, an irrevocable trust prevents a grantor from getting assets included in the trust returned. The trust agreement must state clearly if a trust is irrevocable. In addition to avoiding probate, irrevocable trusts allow for additional benefits, including:

  • Allowing the grantor to qualify for public benefits such as Medicaid: This benefit comes into play if the grantor needs skilled nursing care. However, there are issues with the timing of forming the trust that should be considered. Here is an article about the Medicaid Look Back Period .
  • Avoiding estate taxes: A grantor will no longer have title to a property included in this type of trust. As a result, the property is also not included in the estate for state or federal estate tax purposes. This typically only applies to people who have substantial wealth.
  • Protecting assets from creditors: Property under an irrevocable trust cannot be subject to claim of creditors of either beneficiaries or a grantor. This is because the property is in the name of the trustee.

Testamentary Trusts

Created through a last will and testament, a testamentary trust only takes effect during the probate process once a grantor has passed away. Since the grantor is not alive when the trust is created, testamentary trusts are automatically irrevocable trusts.

This type of trust is frequently cheaper and easier to create than a living trust, but will require assets to go through a probate court. As a result, the end cost of a testamentary trust may still end up being higher than that of a living trust.

How to Set Up Family Trusts

There are two basic steps involved with setting up a family trust. First, you must create and execute the trust agreement document. Your trust agreement document will:

  • List beneficiaries
  • Name a trustee or trustees
  • Detail instructions for managing the assets covered by the trust

Second, you must transfer your assets into the trust. This includes executing deeds and other title documents in order to formally transfer the assets involved from the grantor to the trustee(s). The trust document is ineffective unless the assets are transferred to the trust.

Common Types of Family Trusts

There are a variety of specific types of trusts families may choose, depending on the needs and wishes of the grantor. Some examples include:

  • Credit-shelter trust (also called bypass or family trust)
  • Generation-skipping trust (also called dynasty trust)
  • Irrevocable life insurance trust
  • Qualified personal residence trust
  • Qualified terminable interest property trust

Although they are relatively simple and inexpensive to create, family trusts are powerful legal vehicles that offer benefits for many members of a family. If you create a family trust, you help to ensure that your assets are allocated exactly according to your wishes.

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