Trusts Are Not Just For The Rich

An excellent vehicle for estate planning, whether your are rich or of just average or below average wealth, is a trust. Yet many people do not even know what a trust is, let alone how it can help them. This article delves into some basic information about trusts so you can work with your financial planner or read about it and decide if one is right for you, and which types to use for your situation.

First, many of you may be asking what a trust is. In a nutshell, a trust is a legal entity that owns things. The types of things it owns could be a bank account, a car, a house, stocks, bonds, gold, a business, or basically anything you can own yourself. Unlike a business which can also own things, a trust is not set up to produce an income. But it can have income (or losses) if the assets it owns throw off a profit (or loss).

Once a trust is created, the party placing assets in the trust is known as the "grantor", in that they grant the assets to the trust ownership. A "trustee" is a party who manages the assets in the trust according to the directives of the document establishing the trust.

There are many kinds of trusts, but those used by a family generally fall under two categories: revocable and irrevocable.

A revocable trust, also known as a living trust, allows the grantor to maintain control of the assets in the trust, and even revoke or end the trust if circumstances change. Often, the grantor and the trustee are the same person, but the trustee can be a different person, or even a company who specializes in managing trust assets. Because this trust is revocable, the IRS treats the assets as if they are still owned by the grantor for tax purposes, and income from the assets is reported to the IRS on the grantor's 1040 form.

An irrevocable trust may NOT be revoked or ended by the grantor once assets are placed in it, and nor is the grantor permitted to manage the assets. So the grantor is restricted from being the trustee. For tax purposes, since the grantor cannot control the assets, an irrevocable trust has its own tax ID number and if there is income to the trust, it is reported to the IRS on form 1041.

By far, the most common type of family trust is a revocable trust. While there are many considerations to one type over another, this article will not be covering that decision. If you need help deciding, a legal advisor who specializes in estate planning should be sought.

There are several reasons to have at least some, if not all, of your assets owned by a trust. The most common reason is probate.

Until it happens, either expectedly or unexpectedly, the legal process of probate can be nothing short of a nightmare when a person dies. The purpose of probate is to ensure that any debts owed by the deceased are properly and legally paid. In Colorado, probate is required if you own real estate, and or if you have assets exceeding $80,000. This is a low bar, so pretty much nearly everyone's estate will end up in probate court.

When your estate ends up in probate, the courts take control of your assets, preventing your heirs from transferring or selling them. Often, the heirs have to hire an attorney to work through this process, which can easily cost $10,000 for even small estates. Furthermore, the probate process can take 1 to 2 years! So while you thought you would immediately inherit a windfall when mom and dad passed away, because of probate you must wait another nearly 2 years!

A trust on the other hand does not die like parents do! A living trust can be set up to own the assets of your parents, and the parents can transfer/grant their home, bank accounts, and investments into the trust. The trustees can be the parents, and there could also be a trustee designated who is one or more of their children. When the parents die, they no longer own anything.....so no probate needed. Meanwhile the children as trustees of the trust control the assets, and can sell them off beginning immediately, or leave the assets in the trust per the trust instructions and become beneficiaries of the income, while utilizing the property still titled to the trust.

Another reason to have a trust is to protect family assets in the case of a divorce and ensure those assets are passed down the family line the way you intend. This is particularly important in today's world since 50% of marriages end in divorce. While nobody intends to get divorced when they get married, the fact that 50% do divorce is the relevant fact.

Suppose you have two children, Amy and John. Your intent as a parent is for your assets to be passed to your children, and later to their children. Now suppose John at age 23 gets married to Jessica. This is Jessica's 2nd marriage, and she has a 2-year-old child, Scott, from her first marriage.

If you were to die without a trust in this situation while Amy and John are still alive, typically 50% of your assets would go to Amy, and the other 50% would go to John. When couples are married, marital assets are considered jointly owned property, so John's wife Jessica also effectively inherits part of the estate. If John and Jessica get divorced (a 50% probability), Jessica will take what is essentially 1/4 of your estate, and will begin passing that down to her own children who are NOT your grandchildren! If the assets were instead held in a trust, John could have used the assets as a trustee while he was married, and since he doesn't own the assets, they are not considered marital property in a divorce, so Jessica gets nothing if she divorces! Furthermore, if Amy is also a trustee, she can effectively take control of the assets and use them to benefit her heirs since her brother John didn't have any children of his own.

Finally, another reason to have a trust is to help prevent abuse or waste of your hard earned assets by children or grandchildren who may suffer from an addiction or lack the necessary skills to properly manage a windfall.

It is a well-known fact that 95% of all lottery winners, even those who won 10s of millions of dollars, are bankrupt or destitute within 5 years of winning. If you consider yourself like 95% of the population, you would unknowingly fall within this group! The reason people are where they are in life has nothing to do with how much money they make. Instead, it has everything to do with how well they manage their own money, and these lottery statistics prove the point.

If you have a child you know mismanages money, a son perhaps who recklessly buys vacations, makes bad investment choices, or gives his money away buying drinks for everyone at the parties he attends, a trust can be set up to prevent this child from wasting the funds. Perhaps a clause is written in the trust that rewards the child for attending classes on financial management. Until then, another trustee is given control of the assets, a trustee who can withhold funds from John and instead protect and grow the assets that John would have otherwise wasted.

As a side note, the famed Cornelius Vanderbilt family, who was the first person in America to have a net worth exceeding $100 million in the late 1800s. His children and grandchildren were lavish spenders, and they ultimately lost all the family wealth in the 1929 stock market crash. Out of hundreds of descendants, the only recent Vanderbilts who are millionaires are Gloria Vanderbilt, the famed actress and fashion model and businesswoman, and her son Anderson Cooper who is well known as a CNN News anchor. In both cases, they built their own fortune. The Rockefeller and Rothschild families however successfully utilized trusts to preserve the family wealth for generations.

Getting back the examples, suppose now John is a known drug addict. Would it be beneficial for John to gain control of a lot of money where he can buy even more drugs or alcohol and potentially kill himself? Or perhaps John gets in a car accident while under the influence and is sued for the estate he inherited! Again, by having the assets in a trust with proper language, John would not be able to control or own the assets if he is an addict, where the assets are put at undue risk.

Establishing a revocable trust can cost as little as $3000 to $5000. If you subscribe to legal insurance through your work benefits, which usually costs just $7 to $10 per paycheck, these legal plans will often cover estate planning, which includes the drafting of a trust document and assistance in granting assets to that trust, including your home. With or without legal insurance which you can also obtained outside of an employer, an estate planning attorney is the typical place to begin considering and drafting a trust. If a trust is right for your situation, the attorney will already have a standard document created which can then be customized for your unique circumstances.

And if you are wondering, I use trusts. My own home is owned by a trust, and I control assets in other trusts. These were set up many years ago, and I occasionally review the documents to ensure my intentions are still the same should something ever happen (and will eventually happen) to me. So I do have my money where my mouth is!