Trust

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Trusts: Definition, How They Work, and Common Types

What is a trust?

A trust is a legal arrangement in which one person (the trustor or grantor) transfers property or assets to another party (the trustee) to hold and manage for the benefit of one or more third parties (the beneficiaries). A trust is a separate legal entity with distinct rights and obligations, and it can be tailored to control how assets are used and distributed during the trustor’s life or after death.

How trusts work

  • The trustor establishes the trust document, naming a trustee and beneficiaries and specifying terms.
  • Assets are placed into the trust (funded) or the trust is created as a legal agreement without transferred assets (unfunded).
  • The trustee manages, protects, and distributes trust assets according to the trust terms and in the beneficiaries’ best interests.
  • Trust terms determine when and how beneficiaries receive distributions (immediately, at a certain age, or upon specific conditions).

Core categories of trusts

Most trusts fall into one or more of these categories:

Common purposes for using trusts

  • Asset protection: shield assets from creditors, lawsuits, or family members who might otherwise dissipate them.
  • Control of distributions: specify how and when beneficiaries receive assets (useful for minors or beneficiaries who need oversight).
  • Care for dependents: provide for a person with disabilities or special needs without jeopardizing public benefits.
  • Privacy: unlike wills, many trusts avoid probate and keep the details of asset distribution private.
  • Estate and tax planning: minimize estate taxes, avoid probate, and implement complex distribution strategies.

Tax considerations: step-up in basis vs. carryover basis

  • Assets in a revocable trust are generally included in the trustor’s estate and receive a “step-up” in cost basis to their value at death, which can reduce capital gains taxes for heirs.
  • Assets in an irrevocable trust typically use carryover basis (original cost basis), which may lead to higher capital gains tax when sold.
  • Example (simplified): shares bought for $5,000 appreciate to $10,000. If inherited via a revocable trust, the beneficiary’s basis is stepped up to $10,000—taxable gain on a later sale of $12,000 would be $2,000. With carryover basis, the taxable gain would be $7,000.

Common types of trusts (brief descriptions)

  • Credit shelter (bypass/family) trust: preserves use of the estate tax exemption by placing a portion of the estate outside the surviving spouse’s taxable estate.
  • Generation-skipping trust: moves assets to beneficiaries at least two generations younger (e.g., grandchildren) with tax advantages.
  • Qualified personal residence trust (QPRT): transfers a home out of the taxable estate while allowing the trustor to live in it for a set term.
  • Irrevocable life insurance trust (ILIT): removes life insurance proceeds from the taxable estate, while providing liquidity to pay estate expenses.
  • QTIP (Qualified Terminable Interest Property) trust: provides income to a surviving spouse for life, then passes remaining assets to other beneficiaries (commonly children).
  • Separate share trust: allows different terms or distributions for each beneficiary within the same trust structure.
  • Spendthrift trust: restricts beneficiaries’ ability to sell or pledge their interest and protects trust assets from creditors.
  • Charitable trust: benefits a charity and can provide income to other beneficiaries for a period (e.g., charitable remainder trust).
  • Special needs trust: preserves eligibility for government benefits while providing supplemental support to a person with disabilities.
  • Blind trust: trustees manage assets without disclosing details to the beneficiaries (used to avoid conflicts of interest).
  • Totten/payable-on-death account: a simple arrangement for bank or brokerage accounts where proceeds pass to named beneficiaries without probate.

Benefits of an irrevocable trust

  • Removes assets from the trustor’s taxable estate, potentially reducing estate taxes.
  • Offers creditor protection and can limit probate exposure.
  • Requires relinquishing ownership and control of the assets placed in the trust.

Who controls a trust?

  • Trustor/grantor: creates the trust and, in revocable trusts, may retain control.
  • Trustee: manages and administers trust assets and follows the trust’s terms and fiduciary duties.
  • Beneficiaries: receive the benefits or distributions provided by the trust.

Cost and complexity

  • Trusts are legal instruments that typically require expert advice from an attorney or trust professional.
  • Costs vary with complexity: revocable trusts commonly range from under $1,000 to several thousand dollars to establish; irrevocable trusts often cost more due to complexity and ongoing administration.

Key takeaways

  • Trusts are flexible legal tools for controlling, protecting, and distributing assets during life and after death.
  • Choice of trust type (living vs. testamentary, revocable vs. irrevocable, funded vs. unfunded) affects control, tax treatment, privacy, and creditor protection.
  • Proper funding, careful drafting, and professional guidance are essential to realize the intended benefits of a trust.