What is a trust and what are the different types of trusts?

By Bill

A trust agreement is a document that outlines the rules that you want followed for your property held in trust for your beneficiaries or heirs. The common objectives of trusts are to reduce the estate tax liability and to avoid probate. It is a fiduciary (a fiduciary is a person or organization that owes to another party the duties of good faith and trust; it also involves being bound ethically to act in the other parties best interest) relationship in which one party, known as the trustor, gives another party, known as the trustee, the right to hold property or assets for the benefit of a third party.

This legal arrangement is a very important tool for both business and personal planning. Different forms of trusts have been very common in the past few decades. However, many people still don’t have a coherent understanding of how they work and what their functions are.

How does a trust work?

In order to understand how a trust is able to perform its function, it is important to understand that a trust is a legal entity that is separate from the individual who creates it. In a sense, it can be thought of as a partnership or corporation that is regarded as distinct from its owner. The running of a trust is governed by rules which are set out in agreement between two parties when the trust is being established. One person, known as the trustor, puts money or some other property in the trust. The second person, known as the trustee, agrees to hold the property according to the rules set out in the initial agreement. The trust agreement defines clearly what the trustee is required to do with the said property. Rules are defined on how he or she is to hold it, the period for which he or she can hold it and which person or persons are to be the beneficiaries of the trust.

For example, you may wish to set aside $30,000 dollars for the future education of a newly born granddaughter named Amy. In this case, Amy is the beneficiary. Your friend, John, agrees to act as a trustee. The trust agreement says that John is to hold and invest the $30,000 until Amy is 21 years of age. At this point, everything that has been accumulated from these investments is to be paid to Amy after the trust agreement is ended.

In cases where a trustor doesn’t personally know someone whom he or she trusts as much as you trust your friend John in the above example, there are professional trust companies which will perform these services for a fee. It is even possible to be the trustee yourself. You can declare that you are holding the $30,000 for your granddaughter Amy, and the rules set in the trust agreement can dictate that the money and profits made from investment from that money truly belong to Amy and not to you.

A living trust can help you avoid probate. If your assets are placed in a trust, you do not “own” the property that has been placed in a trust, the trustee does. You control the assets if they were yours. When you die, only your property goes through probate.

Types of trusts

While there are many different kinds of trusts, the two basic kinds are revocable and irrevocable.

Revocable Trust - A revocable trust is created during the life of the trust maker, and can be altered, changed or revoked. These trust are often called living trusts. Revocable trusts are useful in avoiding probate, but are still not a good asset protection technique as assets transferred during the life of the trust maker will remain available to the creditors of the trust maker.

Irrevocable Trusts - Irrevocable trusts cannot be altered, changed or revoked. In these trusts, once a property has been transferred to the trust, nobody, including the trust maker, can take the property out of the trust.

Other kinds of trusts are:

•             Asset Protection Trust

An asset protection trust is designed to protect a person’s assets from claims by future creditors. Trusts like these are often set up overseas. However, it is not necessary for that trust to lie in a foreign jurisdiction. Asset protection trusts are structured so that they are irrevocable for a number of years and the trust maker is not a beneficiary during this time. The assets of the trust are returned to the trust maker when it is terminated at a time when there is little or no risk of creditor attack.

•             Charitable Trusts

These are trusts in which the beneficiary or beneficiaries are a particular charity or the public in general. They are usually established in estate plans in attempts to lower or avoid taxes.

•             Constructive Trusts

A constructive trust is also referred to as an implied trust. These are established by a court. Essentially, the court gets to decide if a trust agreement did or did not exist. Even in cases where a formal agreement did not exist, there is an implied intention on part of the owner on how the property was supposed to be handled by the other party.

•             Special Needs Trust

A special needs trust is set up for a person who is a beneficiary of government benefits. The purpose of a special needs trust is to prevent such a person from losing these benefits. These are legal under social security rules, on the condition that the beneficiary cannot control the financial amount of said benefits or the frequency at which they receive them. In cases where there is no special needs trust, the beneficiary could lose his or her government benefits if they receive gifts or inheritance.

•             Spendthrift Trust

A trust that is established for a beneficiary, which does not allow the beneficiary to sell or pledge away interests in the trusts, is known as spendthrift trusts. They are protected from the beneficiary’s creditors until a time when the trust is ended and the property distributed among the beneficiaries.

For more information on the different types of trusts, you can contact a trust and estate attorney. The attorney will help explain the different types of trusts and can also set up a trust for you.

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