A family trust is a legal entity that you can use to pass on your money and assets to one or more family members. You might think that sounds a lot like simply leaving a will. However, there are some key differences between a trust and a will. The main difference is that a trust is typically managed (and the assets distributed by) a professional. They are not typically a part of your immediate family. This manager is known as the “custodian” or “trustee.” Family members who receive money and other assets from a trust are known as the “beneficiaries.” In this article we look at the benefits of using a family trust to distribute your wealth, and whether it makes sense for you set one up.
Revocable vs. Irrevocable Trusts
There are two types of family trusts – revocable and irrevocable. With a revocable trust, you can make changes to it anytime you want. For example, you can change which assets are part of the trust or how they are to be distributed. You can also cancel the trust any time you want.
In legal circles, revocable family trusts are often called a “living trust.” A living trust is created (and takes effect) while you are still alive. Once established, you transfer ownership of your assets (such as real estate, investments, or a life insurance policy) to the trust. You then name a trustee to manage the trust after you die pass away or become incapacitated. The big benefit of a living trust is that it enables you to avoid probate, which is a public process where a court decides how to distribute your assets.
As the name implies, an irrevocable trust cannot be changed or canceled after it is created. Once assets are moved into this type of trust, you lose all control and access to them. The trust becomes the owner of the assets and the trustee is placed in full control. There are multiple types of irrevocable family trusts. They are mostly used by very wealthy people who want to minimize (or avoid) taxes. Inheriting a large amount of assets (real estate, businesses, or cash) often results in a hefty tax bill. An irrevocable trusts can provide a way for you to reduce that tax bill while still passing your estate onto your heirs. Avoiding taxes is the only significant benefit of an irrevocable trust.
Benefits of a Family Trust
So what are the other benefits of having a family trust? The main benefit is that it provide a clear way to pass on your money, property, and other assets to family members. Family trusts also clearly dictate what each beneficiary gets and when they get it.
As mentioned, revocable trusts generally allow your estate to avoid probate. It will be much harder for anyone to challenge the terms of a family trust in the same way that they can challenge the terms of a will. When challenges arise in probate, the process can take more than a year. It also costs a significant amount of money. That entire mess an be avoided with a family trust.
Another benefit of a trust is that the details of your estate do not become public. This is a big motivation for the rich and/or famous. By avoiding the probate process with a family trust, you can protect the privacy of your estate holdings. An irrevocable trust has additional tax advantages related to avoiding estate and other tax penalties. Placing your assets in a trust is also a way to decrease your net worth as you age. You might do this in order to qualify for Medicaid (in the U.S.), for example.
Drawbacks of a Family Trust
In terms of drawbacks, family trusts do have some. For example, any income earned by the trust that is not distributed is taxed at the top marginal tax rate. Also, distributions made to minor children can be taxed at up to 66%. Trusts also cannot allocate tax losses to beneficiaries.
There are extra costs involved with establishing (and maintaining) a trust that you do typically won’t have with a will. Operating a family trust can be difficult if a personal disputes arise. There is no clear dispute resolution process with a family trust, and they cannot be challenged in court the same way that a will can. This can leave family members with very little recourse if they disagree with the distribution of assets from a family trust.
Creating a Family Trust
The good news is that the process to create a family trust is very straightforward. You start by drafting and executing a trust document. Then you need to make sure you move your assets into the trust. This includes transferring deeds, titles, and any other ownership rights.
The trust document will state what assets are included and exactly when (and to whom) they are to be distributed. Some assets, like the house you are still living in, are a little more complicated to add to a trust while you are still alive. You will most likely need to hire an estate attorney to review your family trust. They will make sure everything is in order. You want to ensure the trust you establish is a legitimate legal entity. Employing an estate lawyer comes at a cost. They can be expensive to use for family trusts. Then again, if you’ve accumulated enough assets to warrant a family trust, you can probably afford the professional assistance. The more complicated your finances and assets are, the more likely you are to need an estate attorney.
Should You Have a Family Trust?
Family trusts can be useful if you are wealthy, have considerable assets, a large family, or want to avoid publicity after your death. They are also helpful when it comes to avoiding taxes and family disputes. With a family trust, you are in total control. You can dictate exactly how you want your money and assets distributed. In some ways, they are like an extra ironclad version of a normal will.
However, family trusts have their pitfalls too. They can be expensive to establish. Some are rigid and inflexible, making it difficult (or impossible) to change your mind. They can leave your loved ones upset, depending on how you decide to distribute your estate. For most middle- and lower-class people, a normal will is sufficient to distribute your belongings. A family trust is usually only beneficial for those who are prominent and wealthy, with vast estates, and who want to shelter their assets from taxes and media scrutiny once they pass away.