Many people set up trusts in order to manage their assets while they're living, and to transfer those assets at the time of their death. Trusts allow you to transfer ownership of property or money to a person who is designated to manage and distribute the assets according to your instructions, for the benefit of another.
Some trusts may provide significant tax advantages, while others are for the benefit of persons unable to handle their affairs. Other trusts provide income for a spouse or beneficiary who is not included among your heirs.
Don't Go There
Only certain types of trusts will help reduce taxes on your estate. Be sure to consult a lawyer who specializes in estate planning if you're setting up trusts with the intention of shrinking your estate.
The person who establishes the trust is called the “grantor.” The person who manages the trust is known as the “trustee,” and the people who eventually receive money or other assets from a trust are called “beneficiaries.”
Trusts also are necessary if you have minor children. You can specify in your will that any money left to children who are under a certain age, be placed in a trust for their benefit until they reach the age stated. You appoint a trustee, who will see that the money is properly invested and available for the child if necessary. When the child reaches the age stated in the document, the trust is dissolved and the child receives the remaining assets. In most cases, income tax on the money earned by the trust is taken out of the trust until the child reaches the age stated in the document. At that time, the child usually has to pay income tax.
There are many varieties of trusts, but all fall under two basic flavors: revocable and irrevocable. Revocable means changeable, irrevocable means it's beyond your control—it's not changeable. Within each category are various types of trusts. Let's have a look at some common kinds of trusts.
This type of trust is laid out in a person's will and established after his death. Until a person dies, the document can be changed, since the will can be changed at any time. However, once you die, the trust becomes irrevocable. The testator keeps control of the assets included in the trust during his lifetime, and can stipulate when beneficiaries should receive their money or property from the trust.
Testamentary trusts can help to reduce estate taxes at a second party's death (usually a spouse). Testamentary trusts can be funded directly with assets that come from a beneficiary designation, such as proceeds of a life insurance policy that names the trust as its beneficiary. Or it can be funded through assets that are subject to probate.