What Is a Trust and How Does It Work?

You might want to leave a few things to specific people when you pass: sentimental objects, jewelry, savings, a pet, a vehicle or even a home.

If you haven't left instructions, your friends and family may struggle to figure out what to do. Even if you write a will, they may have to go through an expensive and time-consuming legal process to ensure your wishes are followed. And in the end, the court might rule that some of your assets go to someone else.

One reason to consider creating a trust is that you can write down a legally binding set of instructions and immediately pass on assets from your estate to the people you choose.

What Is a Trust?

A trust is a type of legal agreement between three parties: the grantor, the beneficiary and the trustee. The grantor (or trustor) creates the trust, the beneficiary benefits from the trust, and the trustee manages the trust's assets on behalf of the beneficiary.

If you don't have a will or trust, your estate—your assets and liabilities—are handled according to state law after you die. Trusts are a common part of estate planning because they give you more control over how your assets will be distributed. They can also help beneficiaries save time and money once they receive the trust's assets.

How To Create a Trust

Some people describe a trust as a legal container for holding assets, such as savings, investments and property. You can use the container to achieve different goals, depending on the type of trust you create. You may want to work with an estate planning attorney when setting up a trust to ensure it accomplishes your goals.

A common misconception is that only wealthy people need to create a trust. But unless you have a complex situation, relatively quick and inexpensive options are available, including several online services. Here's how it works at a high level:

• Choose a type of trust: For example, you could create a revocable living trust, a fairly common option for basic estate planning.
• Choose beneficiaries: You can name multiple beneficiaries—including family members, friends, charities and pets—and specify how you want assets distributed to each beneficiary.
• Choose trustees: You're allowed to be the trustor and trustee while you're alive. But you also want to name a trustee to take over the responsibility of managing the trust if you die.
• Determine the rules: You can create specific rules for when and how the trustee should manage and distribute the trust's assets. Perhaps you want them to invest the money conservatively and give a minor beneficiary a small stipend every month until they turn 18. Or you might want the trustee to distribute the assets and close the trust as quickly as possible.
• Move assets into the trust: Once the trust is up and running, you have to transfer assets from your personal accounts to the trust's accounts. To accomplish this, you may need to set up a trust account at a bank or investment company and then transfer funds. Additionally, you can name the trust as the beneficiary on your other accounts—you generally don't want to withdraw retirement funds to move them into a trust. You may also need a new deed to transfer real estate into the trust's name, although that process can vary based on state law.

The arrangement is a common part of estate planning because it gives you more control over what happens to your assets after you die. The trust also allows your estate to avoid probate, a potentially lengthy and expensive process during which a court decides how to distribute the assets from your estate. Probate records can also be public records, so avoiding probate could be helpful if you want to keep your affairs private.

Types of Trusts

There are two broad categories for trusts: living or testamentary, and revocable or irrevocable. Additionally, there are specific types of trusts you can create depending on your circumstances and goals.

Living versus testamentary trusts

The two main differences between a living trust and a testamentary trust are when the trust is created and whether assets in the trust avoid probate.

• Living trusts: You create a living trust, also called an inter vivos trust, and it's active while you're alive. Assets in the trust can be passed on to beneficiaries without going through probate.
• Testamentary trusts: You can create testamentary trusts—you might want one trust per beneficiary—as part of your will. The trusts are activated when you die, and your assets still have to go through probate.

A testamentary trust might be cheaper and easier to manage because it won't be active while you're alive, but it doesn't offer the savings and privacy that can come with living trusts.

Revocable versus irrevocable trusts

Testamentary trusts are always irrevocable because the trust doesn't get created until after you die. However, living trusts can be revocable or irrevocable.

• Revocable: A revocable trust is a trust you can manage and change while you're alive—it will become irrevocable when you die. The property you put into the trust is still considered your personal property.
• Irrevocable: You generally can't make changes or disband an irrevocable trust after you create it. The assets you put into the trust become the trust's property.

Both options allow you to pass on assets outside of probate and without disclosing the transfers in public records. They can also give you more control over how your assets get distributed than using a will on its own.

Additionally, people can create either type of trust to help protect their financial future. For example, if you're diagnosed with a debilitating disorder, you could name a person or organization who will manage your assets on your behalf.

However, the permanent transfer of assets leads to the big differences between revocable and irrevocable trusts.

Because assets become the irrevocable trust's property, creditors might not be able to go after them to cover your personal debts, your estate's debts or the beneficiary's debts. Irrevocable trusts can also offer a benefit for wealthy households who want to avoid estate taxes, but it's only relevant if you're passing on millions of dollars.

Other types of trusts

Some types of trusts are named based on the goal of the trust. For example:

• Joint trust: Two people can create a joint trust together and act as co-trustees. Often, spouses will use a joint trust for their shared estate.
• Spendthrift trust: You may want to pass on money to a relative or friend who doesn't have the best financial habits. With a spendthrift trust, you can name a trustee who will limit how and when the trust distributes money to the beneficiary.
• Pet trust: You could name a caregiver and set aside funds they can use to care for your pets if you die or become incapacitated.
• Charitable trusts: There are two types of charitable trusts and they both must be irrevocable trusts. Charitable remainder annuity trusts (CRATs) give an income stream to beneficiaries for a certain time and the remainder to charities at the end. Charitable lead annuity trusts (CLATs) give an income stream to charities for a certain time and the remainder to beneficiaries at the end.
• Special needs trust: Also called a supplemental needs trust, you can use this to name someone with special needs or disabilities as the beneficiary. The trust can help cover the person's expenses, and the money in the trust won't count toward the beneficiary's assets or affect their eligibility for public assistance.

Benefits of Using a Trust

We've touched on many of the benefits of using a trust already. But as a quick recap, the main benefits could include:

• Avoid probate: Living trusts allow you to pass on assets to beneficiaries without going through probate.
• Protect privacy: Avoiding probate will also keep the transfer out of public records.
• Control distributions: You can specify when and how you want the assets in the trust to be distributed to the beneficiaries.
• Safeguard assets: Assets in trusts might be shielded from creditors in certain circumstances.
• Minimize taxes: Wealthy individuals and households can use trusts to avoid estate taxes. There may also be tax advantages to using charitable trusts.

Considerations Before Creating a Trust

Trusts can be an important part of estate planning, but there are potential downsides to consider. You'll also want to be prepared to make important decisions when you create your trust. Consider the following:

• Why you want a trust: Your goals will determine the type of trust you should create and the rules of the trust. Hiring an estate planning attorney with experience creating similar types of trusts in your state could be a good idea.
• Beneficiary selection: You might be able to name a long list of beneficiaries. Consider what you want to leave to each beneficiary, when they should receive the assets, and how you want the trustee to manage the assets before distribution.
• Trustee selection: Your trustee is supposed to manage the trust in line with your instructions and assist the beneficiary. Many people choose a close friend or family member, but you can also choose an attorney or organization that offers professional management services. You can name backup trustees in case your first choice doesn't want or isn't able to take on the responsibility,
• Potential costs: In addition to the up-front cost of creating your trust, there may be ongoing management and tax filing requirements to consider.
• You may need to file a tax return for the trust: A trust might earn money from the assets in the trust's accounts. If it earns $600 or more in income that the grantor doesn't report on their individual tax return, the trustee may need to file a tax return for the trust.

• You may still need a will: A will can be an important and separate part of your estate plan. If you want to name a guardian for your children, you'll need to do that in a will rather than a trust. Additionally, a will can serve as a catchall for any assets you forgot to include or chose to keep out of your trust.

Once you create a trust, compare your options before opening trust accounts. At Synchrony, trusts can have high yield savings accounts and money market accounts, which can be safe places to grow the savings. If you're the grantor (creator) and trustee (manager) of a revocable trust, you can request an ATM card for the savings or money market account (or checks for the money market account) to easily access the funds.

Your Responsibilities After Creating a Trust

Your responsibilities will depend on the type of trust and how you plan to use it. If you're the trustee for a revocable living trust you've created primarily to keep your estate private and out of probate, you likely won't have many day-to-day responsibilities.

However, you may want to review it every few years to make sure the rules still align with your wishes. Additionally, you'll want to review the trust after major life events, such as a birth, death, marriage or divorce. Because it's a revocable trust, you can change or even terminate the trust at any time.

Work With a Reputable Estate Planning Professional

Preparing for your death isn't a pleasant prospect, and creating a trust can require a lot of paperwork. But it can be a helpful and flexible tool that allows you to spell out what you want to happen to your assets, helping your beneficiaries save time and money by avoiding probate.

Unfortunately, some people set up “trust mills" to steal clients' personal information or sell them unnecessary services. Do your research and ask for referrals, or look for an online service or estate planning professional with good reviews. You also might be able to schedule a free consultation to explain your situation and better understand what services the person or company can provide.

READ MORE: How to Discuss Your Estate Plan with Adult Children