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.