In the first two parts of this series I discussed many of the misconceptions and blatant head-in-the-sand reasons people offer for not doing any estate planning and we discussed an overview use of a Will (Last Will & Testament). In the final part of the series I want to discuss one of the most misunderstood and maligned estate planning tools: Trusts.

When you mention a “trust” to most people that immediately conjures up visions of someone with GQ model looks and arrogant young people attending prep schools living off an old daddy’s money from a trust fund. That is very far from reality! Yes, there are those kind of people in the world. And trusts are more commonly utilized by people with large assets and wealth than the average person. But the truth is the middle class (however you define it) very much use trusts as both estate planning and life planning tools. There is no mystery about trusts (no magic about them either) and you don’t need an army of high paid crusty old lawyers to set one up (though I very much recommend speaking to an estate planning lawyer rather than doing it yourself).

To begin with, a trust is essential the same as a corporation in the sense that it is a separate legal entity with a “life” of its own. As a legal entity it can own assets, manage those assets, administer itself (done by the Trustee who can be an individual or a group of people), etc. And it has to comply with various legal requirements including income tax and having its own Tax Identification Number (TIN). This separate legal status is what makes trusts appealing and effective for many people.

(Note: As of writing this trusts pay Federal income tax at the corporate tax rate, not the individual rate of the trust owners. Taxation on the state and local level will vary by the specific state and locality. There are specific tax forms for trusts.)

There are several types of trusts. Far too many to list and properly discuss here. We already discussed a Testamentary Trust (a trust established by order of your Will when you die) in part 2 of this series.

Trusts basically fall into two broad categories: Revocable and Irrevocable.

A Revocable trust means the person who gives assets to the trust (the Grantor; There usually is only one granter per trust but doesn’t have to be) can take back those assets, in full or in part, at anytime for any reason usually with little or no legal and/or tax penalties (other than perhaps capital gains and cost basis issues). This appeals to people who don’t want to lose control of an asset forever.

(Note: A trust is a paper construct. Nothing is physically put into it (it’s not a box or a vault). Assets, property etc. is placed into the trust by re-titling or re-registering the ownership of the asset in the name of the trust like a house, car, boat, stocks, mutual funds etc. Or, cash can be given to the trust and the trust itself purchase assets.)

By contrast, with an Irrevocable trust (also known as a Living Trust when used for estate planning) once assets are placed into the trust for all intents and purposes that’s it. They can not be taken back by Grantor. There are a few exceptions but those usually invoke tax penalties and risk nullifying the overall benefits of having an Irrevocable trust. Therefore it is extremely rare to take back assets from an Irrevocable trust.

So why use a trust?

Basically it comes down to three main reasons: (there are others but these are the most common)

  1. Getting assets out of your name– When an Irrevocable trust is created any assets placed into the trust is no longer considered owned by you. Therefore, it is “safe” from being garnished or seized or otherwise attached if you should be found guilty of liability and court ordered to pay a hefty judgment award. Also, the income from the assets in the trust (if they generate income such as interest or dividends) is not considered as part of your own income since the trust has its own TIN and files its own tax return.And having assets out of your name also helps with Medicaid planning (point #3 below) and any other benefit or financial aid applications that consider the assets you own.Revocable trusts usually are not used for this purpose because courts can deem that if you can revoke giving assets to a trust you still have ownership of the asset and therefore it’s fair game for a judgment.
  2. Privacy and avoiding probate– With just a Will, when you die the Executor of your Will needs to go to court to have the will acted upon. Presuming all is in order and no one disputes the terms of the will the probate court will issue documents authorizing the Executor to take control of your property and assets, and distribute them according to your wishes in the Will. This is known as “Probating the Will” and the assets pass to your heirs by order of the probate court.(Note: For very small estates you may not need to go through an entire probate process. Many states have a “fast track” probate for people who have small estates below some set value.)However, since the Executor has to go to court this takes time and there is some expense. Further, probate court records are matters of public record. There is no privacy. For all intents and purposes the whole world can find out what your will says and what happened to your property.Many people don’t like this. They want to remain private (as well as speed up the process).Enter the trust.

    The trust remains in effect while the grantor is alive. Upon your death the trust ends and the Trustee must distribute the assets of the trust under the terms of the trust document. That means assets transfer to your heirs by matter of law (the trust document is a legal document) rather than by order of probate. As the administrator of the trust the Trustee can transfer (re-title or re-register) assets in the name of the heirs without the courts’ permission or approval. And that means a significant level of privacy as well as greater speed of the transfer.

    This is the same whether it is a Revocable or Irrevocable trust.

  3. Medicaid benefits planning – This is probably the most common use of a trust by the middle class. The regulations and issues regarding personal assets and Medicaid are extremelycomplex (typical government bureaucracy!)  and well beyond the scope of this article. Whole books and manuals are written on the subject and the laws and frequently change anyway.As a broad general statement, all assets and property you own (your worth) is counted againstyou when applying for Medicaid benefits. Often you will hear people say they (or a relative) have to “spend down” their assets before they can receive Medicaid benefits. (There are also some ethical discussions that sometimes arise and I am not going to debate in this article.)However, assets and property placed into a properly designed Irrevocable trust and held there for a certain amount of years are excluded (either in whole or in part by percentage) from your Medicaid personal worth calculation. There may also be other benefits (government or private) for which having assets outside your personal name will help you qualify for.

As previously stated I do strongly suggest seeing an experienced estate planning or elder care lawyer for setting up a trust. I have experience setting up and administering trusts (as a Trustee) and know well a word or phrase more or less can be very important. Generic internet services or shrink wrap software packages just can’t be tailored as well to the laws and regulations of where you live. The costs aren’t a lot in the big picture of planning and preparing your life.

Don’t let the popular image of trusts being only for “the rich” taint your view. A trust is a very good and affordable option for just about everyone. In many ways it is the ultimate expression of preparation for your family.