The Business Dictionary defines a trust as a "legal entity created by a party (the trustor) through which a second party (the trustee) holds the right to manage the trustor's assets or property for the benefit of a third party (the beneficiary)." Basically, a trust is a financial arrangement between three parties that hold assets for a beneficiary.
There are many different kinds of trusts, but the general idea is a three-party ownership system wherein one party gives another party the rights to hold property or assets for yet another party (who benefits from the arrangement).
Parties in a Trust
As part of its definition, a trust is composed of three parties - the trustor, trustee and beneficiary. But what are these three parts and how do they operate? They are as follows:
Trustor: The trustor is the person who grants the trustee control over their assets, estate, or property, and who creates the agreement.
Trustee: The trustee is responsible for managing the trust that the grantor (trustor) has appointed them over. They are the person who is in charge of managing the property or assets the trustor gives them to keep, and are titled in the agreement.
Beneficiary: The beneficiary or beneficiaries are the people who received the benefits of the trust agreement. They are given the property or assets by the trustee from the trustor according to the terms of the agreement.
Common Types of Trusts
While the basic structure of a trust remains pretty much the same, there are several different types of trusts with different purposes and specifics. The five main types of trusts are living, testamentary, revocable, irrevocable, and funded or unfunded.
But even beyond those, there are dozens of kinds of trust funds. Each different kind has its own uses and purposes, but most follow the same basic structure of a traditional, three-party trust.
1. Living Trust
A living trust, sometimes known as an inter-vivos trust, is one made by a trustor (grantor) during his or her lifetime, with assets or property intended for the individual's use during their lifetime. This type of trust allows the trustor to benefit from the trust while alive, but passes the assets and property on to a beneficiary (using a trustee) upon their death. With a living trust, you are generally able to avoid probate court, provided the trust is funded.
2. Testamentary Trust
A testamentary trust, often called a will trust, is an agreement made for the benefit of a beneficiary once the trustor has died, and details how the assets must be endowed after their death. This type of trust is often instituted by an executor, who will manage the trust for the trustor's decedents after their will and testament has been created. And, a testamentary trust is irrevocable (cannot be changed or altered).
3. Revocable Trust
A revocable trust, like a living trust, is created during the trustor's lifetime. It is able to be changed, terminated, or otherwise altered during the trustor's lifetime by the trustor themselves. It is often set up to transfer assets outside of probate. In this case, all three parts of the arrangement (the trustor, trustee and beneficiary) are often the same person who can manage their own assets, but will be given over to a successor trustee and other beneficiaries upon the original trustor's death.
4. Irrevocable Trust
On the contrary, an irrevocable trust is one that a trustor (grantor) cannot change or alter during his or her lifetime or that cannot be revoked after his or her death. Because this type of trust contains assets that cannot be moved back into the possession of the trustor, irrevocable trusts are often more tax efficient - with little to no estate taxes at all. For this reason, irrevocable trusts are often the most popular as they transfer assets completely out of the trustor's name and into the next generation or beneficiary's name. However, a living trust can be either revocable or irrevocable based on its specifications.
5. Funded or Unfunded Trust
Funded or unfunded trusts are trust agreements that either have funds (assets) put into them or do not. These trusts can become funded at any point, either during the life or after the death of the trustor.
6. Credit Shelter Trust
A credit shelter trust, also known as a bypass trust or a family trust, is a trust fund that allows the trustor to grant the recipients an amount of assets or funds up to the estate-tax exemption. Basically, this allows the trustor to give a spouse or family member the remainder of the estate tax free. These kinds of trusts are often very popular due to how the estate remains tax free forever, even if it grows in size.
7. Insurance Trust
An insurance trust allows the trustor to combine their life insurance policy within the trust, keeping it free from taxation on the estate itself. This kind of trust is irrevocable and doesn't allow the trustor to change or borrow against the life policy itself, but allows the life policy to help pay for post-death expenses on the estate.
8. Qualified Terminable Interest Property Trust
A qualified terminable interest property trust is (first of all, a mouthful) a trust that allots assets to different beneficiaries at different times - often in the pattern of being directed to a spouse upon the trustor's death, and subsequently to children after the spouse's death. In this case, the children of the original trustor would receive whatever estate was left after the trustor's spouse's death.
9. Charitable Trust
A charitable trust is a trust that has a charity or non-profit organization as the beneficiary. In normal cases, this type of trust would be built up during the trustor's lifetime and, upon their passing, be doled out to a charity or organization of the trustor's choosing, avoiding or reducing estate taxes or gift taxes. A charitable trust could also be part of a normal trust, wherein the trustor's children or inheritors would receive part of the trust upon their passing, with the remainder of the estate going to the charity.
10. Blind Trust
A blind trust is a trust that is handled solely by the trustees without the beneficiaries' knowledge. These trusts are often used to avoid any conflicts between the trustees and beneficiaries or between beneficiaries.
Uses of a Trust
There are many different uses of a trust, whether it be to manage the trustor's assets during life or after death, or provide a less-taxed, easier way to endow estates to the beneficiary(ies). Depending on the terms of the particular agreement, a trust can also provide a way for trustors or grantors to benefit during their lifetime as well.
Additionally, trusts are often used to manage property, assets, or estates being held for a minor or person incapable of being financially accountable until that person be deemed able to manage the assets themselves.
What Are the Benefits of a Trust?
While there are many different kinds of trusts with unique features and benefits for each, some of the common benefits of a trust include reduced estate taxes, allocation of assets into the desired hands, avoiding court fees and probate, protection from creditors, or even protection of assets among family members themselves (for conflicts or underage recipients). You are protecting your wealth and financial legacy, but more importantly you have an opportunity to give back to your loved ones in a beneficial way. And because some common types of trusts help you avoid probate court, the assets within your trust may be able to get to beneficiary faster than expected.
Additionally, trusts can be used for privacy (to keep wills private) or estate planning. Still, one of the main benefits of setting up a trust remains the avoidance of high estate taxes or gift taxes.