What Is a Family Trust?
What Is a Family Trust?
A family trust, sometimes called a family trust fund, is a legal device used to avoid probate, avoid or delay taxes, and protect assets. This article will discuss the basics of the various types of trusts, what can be accomplished with each, and how they are created.
A trust is a legal arrangement, whereby a person transfers management (and actual ownership in the case of an irrevocable trust) of assets to a third party, who holds them and manages them for the benefit of others.
Here are a few basic terms you need to know to understand trusts:
- Grantor. The person who creates a trust.
- Beneficiary. A person or entity for whose benefit the trust was created. This is typically a spouse, child, grandchild, or other relative of the grantor; or a charitable organization chosen by the grantor. The grantor may also be a beneficiary.
- Trustee. The third party designated in a trust document to manage the assets of the trust. This can be a single person, two or more joint trustees, or a business entity such as a bank or a trust management company. The beneficiaries may also be trustees. In the case of a revocable trust, the grantor may also be the trustee.
- Trust Agreement. A document that sets up a trust (sometimes called a Deed of Trust or a Trust Deed). It will designate the trustee and the beneficiaries, and give the trustee directions as to how the assets are to be managed and distributed to the beneficiaries.
What Is a Family Trust?
What makes a trust a family trust is that it is set up to benefit relatives of the grantor. Its purpose is to benefit the grantor's family, which can include those related by blood, marriage, or law (in the case of adoption).
Types of Trusts
One way in which trusts are classified is by what type of document creates the trust:
- If the trust is created while the grantor is still alive, it is called a living trust or an inter vivos trust.
- If the trust is created in the grantor's last will and testament, it is called a testamentary trust. A testamentary trust, by its very nature, is an irrevocable trust. (Since the only benefit of a testamentary trust is to have assets responsibly managed for the beneficiary, this article only discusses living trusts.)
Another way that trusts are classified is based on the amount of control the grantor has over the assets in the trust. These two types are:
- Revocable Trust. This type of trust allows the grantor to cancel, or revoke, the trust. If it is revoked, the assets are transferred back to the grantor. Of course, once the grantor dies, the trust becomes irrevocable. A revocable trust is most often used to avoid probate.
- Irrevocable Trust. This type of trust precludes the grantor from getting the trust assets back, unless the trustee and the beneficiaries agree. The trust agreement will clearly state that it is irrevocable. Irrevocable trusts also avoid probate, and are used to gain additional benefits, such as to avoid taxes, protect assets from creditors, or allow the grantor to qualify for certain public benefits (such as Medicaid).
Therefore, the question is not one of family trust vs. living trust, or family trust vs. irrevocable trust. A family trust is simply a subcategory of the living trust.
A family trust can be either a revocable trust or an irrevocable trust; it can be both a living trust and an irrevocable trust and it can be both a living trust and a revocable trust.
Revocable Trust vs. Irrevocable Trust
A revocable family trust can accomplish three basic things:
- Avoid probate. This avoids the time and expense of a court process.
- Maintain privacy. By not going through probate, there will not be a public record in the probate court that shows what assets and debts you had at your death, and to whom those assets went.
- Protect assets for beneficiaries who may not be able to responsibly manage them. A trust can preserve assets for the benefit of a child who may be disabled, financially irresponsible, or in the middle of a divorce. It can even provide for the care of a pet.
A revocable trust can also cover the situation where the grantor becomes disabled, although a durable power of attorney can also accomplish this goal.
An irrevocable family trust has the same benefits as a revocable trust, but has the possible additional benefits of:
- Protecting assets from creditors. As title to the property is in the name of the trustee, the property cannot be subject to claims of creditors of either the grantor or the beneficiaries.
- Avoiding estate taxes. Since the grantor no longer has title to the property, when the grantor dies, the property is not included in his or her estate for state or federal estate tax purposes. This will only apply to people with a substantial amount of wealth.
- Helping enable qualification for Medicaid benefits, in the event the grantor requires skilled nursing care. (There are timing issues specific to when the trust is formed, due to the Medicaid "look-back" period that applies to the applicant's assets.)
Setting up a Family Trust
Setting up a trust, whether a family trust or any other type, is basically a two-step process:
- Create and execute a trust agreement document. This document will list the beneficiaries, name a trustee (or trustees), and set forth instructions for how the assets should be managed.
- Transfer assets into the trust. Deeds, or other title documents, must be executed to formally transfer the assets from the grantor to the trustee. A trust document is ineffective without the transfer of assets to the trust.