When people hear the word “trust," they might often assume it's only for the people with high net worth. Isn't setting up a trust something you do when you have complicated finances and a need to make elaborate plans for your estate?
The truth is this: Trusts can be useful to nearly everyone during some season of life.
There are many different types of purpose-built trusts that can help you reach a wide variety of financial goals, which range from making sure your children's inheritance is managed responsibly to protecting yourself from creditors, donating money to a favorite charity, minimizing your tax liability, and ensuring that your special needs children or grandchildren get the professional money management they'll need later.
We talked with Robert D. Malin, a First Horizon Bank vice president and senior trust officer, about what you need to know about setting up a trust.
The Basics: Definitions and Trust Types
Why do people need to create a trust? What are some typical scenarios in which a trust is the right move?
Nearly everyone can benefit from a trust during some season of life. Sometimes, trusts are created in wills and do not come into play until death. Other times, trusts are created to serve in the present as a vehicle for managing assets.
Every trust contains a written document that directs or instructs the trustee (the person in charge of the fund) how to manage and distribute assets to the beneficiary (the person for whom the trust is intended).
The trustee's job is to follow the rules set out in the trust and the law by managing and dispersing trust assets to the beneficiary. First Horizon Bank regularly serves as a corporate fiduciary for trusts, which means we are obligated to act in the best interest of the beneficiary and look out for them every step of the way.
One of the most common trusts is a living trust. Individuals or couples use these trusts to consolidate assets and avoid the probate process. By using the trust vehicle, they have a more foolproof game plan for handling assets in the event of incapacity. Such trusts can also be a great tool to reduce the likelihood and magnitude of family conflict at death.
Living trusts also work well to handle incapacity. A power of attorney alone is not always good enough. Let's say a husband gets sick, and the wife is going to a brokerage firm asking for access to the husband's account. The brokerage firm might not accept the power of attorney, which may require a date in court to resolve it. If the brokerage account were owned by a living trust with both spouses as independent trustees, however, you would immediately be able to handle the account.
The classic example of a trust is to provide a structure to handle the distribution of money to minor children until they reach a selected age. Trusts can be set up in a structured fashion so that the money is managed responsibly.
Why would someone create a living trust vs. a testamentary trust vs. an irrevocable trust?
There are three common classes of trusts: a revocable trust or living trust, a testamentary trust and an irrevocable trust.
A revocable or living trust is created to hold your assets during life, avoid probate and act in lieu of a will at death. A testamentary trust might be found in a will or a living trust, but it serves to manage assets from your estate for your spouse, children or other beneficiaries. An irrevocable trust is formed during life and is typically used for tax planning, creditor protection and/or to provide for a beneficiary.
While mature customers may benefit from a living trust, young parents need to have testamentary trusts in their wills to ensure their children are provided for in a structured fashion. Others may establish irrevocable trusts to set aside assets for a spouse, a child with special needs or even for themselves.
Revocable Trust/Living Trust
A revocable trust is often referred to as a living trust or “will substitute.” Living trusts are part of an estate planning package of documents utilized for privacy and probate avoidance. To avoid probate, most of your assets, including real estate, bank accounts and brokerage accounts, must be transferred into the trust with legal guidance. Retirement assets are generally not transferred to the living trust for tax reasons.
This type of trust has three different phases:
- You are living and have capacity
- You are living while incapacitated
- Following your death
During phase one of the trust, your life goes on as normal. Your assets are generally owned by the trust, but you use them as you normally would.
Phase two begins upon your financial incapacity; that is, your inability to handle your financial affairs. Unfortunately, determining the loss of financial capacity is not always clear. The living trust should have a specific instruction for determining this, such as a signed affidavit from a doctor. Upon incapacity, the successor trustee you pre-selected steps in to manage assets on your behalf and pay your bills.
Phase three begins at your death, when the trust instructs the trustee how to disburse your assets (outside of probate court).
While a revocable living trust is a will substitute for probate avoidance, irrevocable trusts are typically used for tax planning or creditor protection purposes. Depending on the intended purpose, an irrevocable trust may be effective now or at death. When created and funded during life, they are usually separate documents. When effective at death, they are typically found within wills or revocable living trusts.
A typical irrevocable trust is used to manage assets for a spouse, children or grandchildren. While the assets are held in trust, they are protected from the beneficiaries' creditors and divorce.
In other situations, a customer may have a concern about protection from lawsuits or similar issues. Some irrevocable trusts are utilized to help protect the customer from such lawsuits, reduce taxes or provide for beneficiaries today (as opposed to at death).
Testamentary trusts, which come into effect at death, are used to ensure that your selected beneficiaries are provided for according to your wishes. Assets held in these trusts are protected from creditors, divorce and bankruptcy.
The trustee invests the money and/or distributes the money to your beneficiaries (e.g., children) as needed to provide them support while they are minors, potentially for a down payment on a house. The trustee will then distribute the remainder to them when the beneficiaries reach a pre-selected age of maturity or after a specified amount of time has passed.
Designed for Flexibility: How Trusts Work
What are some goals of establishing a trust?
A trust can be crafted and customized in any way you want. It's a very flexible tool for financial and estate planning. When you set up your trust, it's up to the attorney to write the trust documents based on your wishes and goals.
Trusts can be for people, charities, pets or purposes. Pet trusts or trusts for purposes can last up to 90 years. Many people want to make sure that if their pet outlives them that it will go to a loving home and won't impose a burden. You can do that with a pet trust. You can also create a purpose trust to, say, provide flowers for your loved one's grave site for up to 90 years.
Many people want to provide for somebody who is not mature enough to handle an inheritance on their own. A trust can be set up to take care of multiple people — such as multiple kids or grandkids – in a family.
Let's say you want to create a revocable living trust that will go to the benefit of your grandchildren upon your death, and you want it to be used specifically for their college education. The problem is, what if this grandchild develops a serious illness or injury and becomes incapacitated, and they need money for health care instead?
As part of writing that trust document and working with your attorney, you need to think about possible contingencies for how the money might be needed. You might need to decide a termination point for the trust: What age does the grandchild need to be in order to receive the money outright, such as 100% of the money at age 30? Or part of the money at age 30 and part at age 35?
What if the grandchild dies before the age of 35? What if the grandchild has children of his or her own? Will they inherit the funds? In case the grandchild dies without children, is there a charity you would like to donate the funds to instead?
Flexibility is key, as is making sure the trust document is thorough. This is where trust advisors should step in and help you prepare for possible contingencies.
You want to be specific, but also give enough latitude for the trustee to manage those assets in a way that fully benefits your beneficiary.
As trust officers, we administer whatever the document states. You don't want to be overly narrow or specific. We've seen all kinds of scenarios over the years, and families should be prepared for everything.
The rules of setting up trusts can vary significantly by state, depending on where you reside and the state laws for estate tax and other considerations. For example, in Tennessee, you can keep assets in trust for up to 360 years after someone dies.
How can a trust help with estate planning for real estate?
Trusts are especially important for estate planning related to real estate. In some states, the probate process is very expensive; a trust for your real estate assets can help minimize these costs for your heirs.
If an individual owns real estate outside of their home state of residence, creating a revocable trust and putting that real estate in the trust is very important. For example, if you die in Tennessee but own real estate in Florida and Colorado, the executor of your estate may have to probate the property in all three states. If you had established a revocable living trust, however, and deeded that real estate to the trust, there is no probate for any state.
Situations Where Trusts Are Most Helpful
What are some big-picture issues and opportunities where people need to think about setting up a trust? Is it a misconception that trusts are only for wealthy/high-net-worth people?
It's absolutely a misconception that trusts are only for wealthy people. There are a few key scenarios where you and your family might benefit from setting up a trust, even if you don't consider yourself "rich."
For example, anyone who has a special needs child should consider putting assets in trust for that child. That's a very important aspect of planning for individuals of all levels of wealth.
If you are a single person with no heirs, or if you live far away from your children or other close relatives and you're elderly, creating a revocable trust for yourself can help you get some additional support to manage your finances as you get older. You can set up a trust for yourself, in which a trust department can pay your bills, help manage your finances, and protect you and your assets from scam artists, in the same way a sibling or adult child would.
Trusts can also be useful for philanthropy. A charitable remainder trust can be set up to benefit one or more of your favorite charities. This sort of charitable trust lets you give money – a bit at a time – for the next 20 years, for example, to a qualifying charitable organization.
There are often tax-efficient ways to put money in a charitable trust while you are alive or upon your death. If your estate is larger than the federal exemption for estate tax (as of 2022, the exemption level is $12.06 million, and twice that for married couples), it is definitely to your benefit to think about trust planning.
Determining Your Trust Needs and Getting Started
How does the process of setting up a trust work?
From the moment someone walks into our office, we go through a process. First, we conduct some financial and/or estate planning to find out their overall needs and wants, and then we do some discovery. We talk about what they really want to do with this money or these assets, and figure out their situation.
Next, we make an estate plan flowchart to determine the right plan, meet with the family, do an estate plan assessment and refer them to an estate planning attorney to draft documents. We then work on evaluating the trust documents to ensure it provide full details on the trust's assets, as well as clear instructions for how to administer and manage those assets.
Any kind of assets can be put into a trust – mutual funds; a portfolio of stocks and bonds; residential or commercial real estate; and LLCs or corporations (although care must be taken with S-corps).
It all has to be in the best interest of the client – our goal is to evaluate risk tolerance, figure out how much money to distribute each year and think through the other details to suit the client's overall goals.
A Few Other Underrated Benefits of Trusts
Anything else that people should know about trusts?
People often think you have to have millions of dollars to have a trust, and that's not true. Or people have the misconception that corporate fiduciaries are too expensive – that's not true either: There's a value that we provide in administering these trusts, and it's often easier and more cost-effective to set up a trust than it would be to hire for all of these services separately.
For example, if you're managing money outside of a trust, you typically have to hire someone to manage the money, hire a CPA to do a tax return, or hire property managers for your real estate assets. A trustee can provide all of these services.
Trusts are often under-appreciated. They are powerful, versatile tools that give people a lot of capabilities to create a better financial future.
Are you ready to include a trust in your overall financial planning or estate planning strategies? There are many options for how a trust can help protect your loved ones and leave a financial legacy in a way that honors your wishes.