Financial Jargon Defined: Trust

The world of finance and investments is notorious for its extensive use of jargon. With a goal to enhance financial literacy and make the world of money more transparent, we have our “monthly jargon” articles that focus on debunking financial terms that are often used sans explanation. This month, we address an estate planning term that is frequently misunderstood as a vehicle that is only applicable for high-net-worth individuals and families: trust. A trust involves a relationship in which one party, known as the trustor, provides another party, known as the trustee, with the right to hold title to specified assets for the benefit of a third party, known as the beneficiary. In other words, a trust is a legal vehicle that enables a third party – the trustee – to hold and direct assets in a fund, known as a trust fund, for a beneficiary. A trust significantly expands your options in terms of managing your assets, and this vehicle is leveraged to provide legal protection for the trustor’s assets to ensure those assets are appropriately distributed according to the trustor’s stated and legally documented wishes.

Trusts are also used to reduce or avoid inheritance and estate taxes in certain situations, especially if you do plan to pass your wealth on to your children and other loved ones. Because of this, trusts are at the crux of many estate plans, the latter also being a misinterpreted term thought to only be for the one-percent population; however, know that if you have any assets that will be passed on after you are no longer here, you need an estate plan, and most everyone falls under this category. Put simply, a trust is a beneficial estate planning tool for families and individuals of a variety of economic backgrounds to leverage.

Types of Trusts

There are many variations of trusts that all fit into one of the following categories: living or testamentary, revocable or irrevocable, and funded or unfunded. Let’s briefly define what each of these types entails.

• In a living trust, your assets are provided for your use and benefit during your lifetime, and then these assets are transferred to your beneficiaries upon your passing, and your selected trustee administers this process.
• A testamentary or will trust strictly dictates how your assets are distributed upon your death.
• With a revocable trust, you can adjust or terminate the trust during your lifetime, while with an irrevocable trust, you cannot change anything once the trust is established.
• A funded trust involves you, the trustor, funding the trust during your lifetime, while an unfunded trust simply includes the trust agreement but no funding.

Why Create a Trust?

Trusts are created by you along with your lawyer to clearly state and determine how and what amounts of all or some of your assets to transfer to a trustee (or trustees), the person or firm that holds, controls, and administers your assets to your beneficiaries. Trustees are trusted – per the title – to make financial decisions in the best interest of your beneficiary or beneficiaries and assume a fiduciary responsibility to your beneficiaries, meaning trustees are required to do what is best for the trust.

All trusts are different and unique to each person’s and family’s financial situation. The rules of a trust depend on the terms created within it. For example, a trust can be used to determine how your money should be managed and distributed while you are alive or after you are no longer here, and a trust can also be a way to provide for a beneficiary who is underage or has a mental disability that may impair his or her financial decision-making. In such instances, a trust functions to allow the trustee to control the assets under the trust with a fiduciary responsibility to the beneficiary until the beneficiary reaches a certain age or becomes capable of managing the assets on his or her own.

Benefits of a Trust

In addition to a trust providing a safe, controlled, and protected environment for your assets, a trust also helps to avoid taxes and probate, the latter referring to the legal process in which a will is reviewed to determine its validity and authenticity, the general administering of a person’s will, or the distribution of a person’s assets in the absence of a will. Additionally, if you do find yourself in the fortunate situation of being in the wealthy elite, a trust can help you control the terms and distribution of the inheritance you will leave behind for your beneficiaries to ensure the money is appropriately and respectfully utilized.

Overall, the main uses and benefits of a trust include:

• Determining how and to whom your assets are distributed and when your beneficiaries have access to them,
• Saving your beneficiaries from estate taxes and court fees,
• Protecting your assets from creditors,
• Protecting your assets in divorce settlements,
• Dictating where your assets should go if a beneficiary passes, and
• Helping your loved ones avoid the lengthy probate court process upon your passing.

Will vs. Trust

People commonly misconstrue the terms “will” and “trust.” A trust allows you to pass on and distribute your assets quickly and privately while settling your estate through a traditional will can be a lengthy process that necessitates the probate court process. In probate court, a judge with no ties to you or your family and loved ones has the final say on how and to whom your assets are distributed. While a probate process as a result of a will can last months and even years, with the potential to become a very public and distressing matter, a trust eliminates delays and keeps the process of your transfer of assets private and protected to ensure your beneficiaries are shielded from any unnecessary stresses and scrutiny.

Final Points

A trust can provide you with the utmost control of your assets and can protect your loved ones and beneficiaries when it comes to the fragile endeavor of safely transferring your assets. Lastly, keep in mind that trusts are versatile instruments that can be used and leveraged for an extensive variety of objectives to achieve your specific financial goals. Make sure to thoroughly discuss this estate planning vehicle with your financial advisor to determine how to effectively implement a trust within your financial life.