How Trusts Work-A Primer: A Useful Tool for Estate Planning

Article excerpt

This article discusses trusts, including their particular characteristics and components, such as the grantor, the beneficiary, the trustee, the written provisions, and property. Each one has a significant importance in the operation and workings of the device. Trusts are either irrevocable or revocable. They are either inter vivos (created during lifetime) or testamentary (created upon death). Since trusts are income-producing entities, they must respond to the Tax Code.

An important reason for creating a trust is to avoid putting substantial amounts of income-producing property in the hands of a child or an adult who is not financially mature.

By having a basic understanding of a trust and what it can be used for, you will have a better understanding of the various roles that a trust plays in the estate-planning process.

The trust is an extremely flexible device that is free from the downsides of other estate-planning devices.

What Is It? A trust is a legal device that can satisfy a multitude of needs in personal financial planning. The written trust permits you to transfer the enjoyment of property to others, while leaving legal ownership out of their hands. Certain property interests created by trusts may be considered gifts and may be subject to gift tax.

Trusts may be created to avoid, defer, or decrease federal income and estate taxes; or to provide steady and controlled support for minors, incompetents, and other dependents. Trusts may be used in the business place. Employee benefit trusts and voting trusts are examples of this kind of use. To understand how a trust works you must first become familiar with the basic terms and the necessary requirements for establishing a trust.

The Grantor. The individual who creates the trust is known as the "grantor." The grantor decides what property will be transferred into the trust; the purpose of the trust; who the trustee will be; who the beneficiaries will be; the terms of the trust; and how the trust funds may be utilized.

The Trustee. The "trustee" is the owner of legal title to the property in the trust. The trust exists exclusively for the benefit of the beneficiary, with the trustee being responsible for the management of the trust assets, keeping them separate and accounted for. The trustee is entitled to a fee or commission for these services but receives no benefit from the trust, unless he or she is also a beneficiary. A trust may have more than one trustee. The trustee is designated by the grantor. However, if the grantor fails to designate a successor trustee, the court will name a successor.

The selection of the trustee can be in many instances the most difficult part of creating a trust. The trustee is responsible for carrying out the intentions of the grantor as expressed in the trust instrument. Therefore, the trustee must not only be willing and able, but must be familiar with the beneficiary and his or her needs. The trustee must also be qualified to handle all management, financial, and accounting duties necessary to administer the property of the trust in proper fashion.

The Beneficiary. The "beneficiary" is the individual or group of individuals who receive the primary benefits from the trust property. The primary beneficiary is usually entitled to any income the trust may earn. The "remainder beneficiaries" are those individuals or organizations who are entitled to the trust property (principal) after the entitlement of the primary beneficiary terminates in accordance with the terms of the trust agreement. If trust assets are mismanaged, the remainder beneficiary, can, in addition to the primary beneficiary, assert claims against the trustee.

Primary and remainder beneficiaries may have conflicting investment interests with regard to the use of the trust property. The primary beneficiary will normally seek to receive as high a return as possible in order to maximize the trust's current income. …