If you’re unsure of what a trust is and how it works, you probably don’t have one. And, if you don’t have a trust, you’re not alone. About 57 percent of U.S. adults don’t have an estate planning document like a will or a trust even though they believe having one is important.
What Is a Trust? How Does It Work?
If you haven’t stopped to consider how a trust might help ensure that your wishes are followed and your assets are handled, you could be making a critical estate planning mistake.
A trust is simply a legal agreement among three parties—settlor, trustee, and beneficiary—that provides instructions on how and when to pass assets to the trust’s beneficiaries. Let’s look at the role of each of these three parties, and then delve into how trusts work.
A settlor—sometimes called the “donor, “grantor,” or “trustor”—is the person who creates the trust and has the legal authority to transfer assets into it.
The trustee is the person who agrees to accept, manage, and protect the assets delivered by the settlor. The trustee has a fiduciary duty to administer the assets according to the trust’s instructions and distribute the trust income and principal according to the rules outlined in the trust document and in the best interests of the beneficiary.
A trustee can be one, two, or more people. A trustee can also be what is known as a “corporate trustee,” such as a financial institution (like a bank) or a law firm that performs trustee duties and charge fees for their services. There are no formal requirements for being a trustee and nonprofessionals frequently serve as a trustee for family members and friends.
The beneficiary is the person or entity benefiting from the trust. The beneficiary can be one person or entity or multiple parties. Also, trust beneficiaries don’t even have to exist at the time the trust is created (such as in the case of a future grandchild or charitable foundation that has not yet been established).
A trust can be either funded or unfunded. “Funded” mean that the settlor’s assets—sometimes called the “principal” or the “corpus”—have been placed into the trust. A trust is unfunded until the assets are in it (failing to fund a trust is a common estate planning mistake).
Trusts can hold just about any kind of asset: real estate, intangible property (like patents), business interests, and personal property. Common trust properties include farms, buildings, vacation homes, stocks, bonds, savings and checking accounts, collections, personal possessions, and vehicles.
Think of a trust as an “imaginary container” that holds and protects your assets. After the trust is funded, the trust property will still be in the same place before the trust was created—your land where it always was, your artwork on the wall, your money in the bank, your comic book collection in the den. The only difference is the asset will have a different owner: “The Jane Jones Trust,” rather than Jane Jones.
Transfer of Ownership
Putting property in a trust transfers it from personal ownership to the trustee, who holds the property for the beneficiary. The trustee has what is called “legal title” to the trust property and, in most instances, the law treats trust property as if it were now owned by the trustee. Each trust has its own taxpayer identification number, just like an individual.
But trustees are not the full owners of trust property. Trustees have a legal duty to use trust property as directed in the trust agreement and as allowed by law. The beneficiaries retain what is known as “equitable title”—the right to benefit from trust property as specified in the trust.
Assets to Beneficiary
The settlor provides terms in a trust agreement directing how the fund’s assets are to be distributed to a beneficiary. The settlor can provide for the distribution of funds in any way that is not against the law or against public policy. The near-limitless flexibility of trusts is a primary advantage for setting one up.
Types of trusts
A joke among estate planners says that the only limit to trusts is the imagination of the lawyers involved. It’s true, though, that the number and kind of trusts are virtually unlimited.
Let’s start by taking a look at the four primary categories of trusts:
Inter vivos and Testamentary Trusts
Trusts that are set up during the settlor’s lifetime are called “inter vivos” trusts. Those that arise upon the death of the settlor, generally by operation of a will, are called “testamentary” trusts. There are advantages and disadvantages to both types of trusts, and how one decides depends upon the goals and purposes of the settlor.
Revocable and Irrevocable Trusts
Inter vivos and testamentary trusts can be broken down into two more categories: revocable trusts and irrevocable trusts. A revocable trust can be changed at any time during the settlor’s lifetime. Second thoughts about a provision in the trust or about who should be a beneficiary might prompt modification of the trust’s terms. The settlor can alter parts of the trust or revoke the entire thing.
An irrevocable trust is a type of trust that can’t be changed by the settlor after the agreement has been signed and the trust has been formed and funded. The terms of an irrevocable trust can’t be modified, amended, or terminated without the permission of the settlor’s beneficiary or beneficiaries.
A revocable living trust becomes irrevocable when the settlor dies because he or she is no longer available to make changes to it. But a revocable trust can be designed to break into separate irrevocable trusts at the time of the grantor’s death for the benefit of children or other beneficiaries.
You might wonder, “Why make a trust irrevocable? Wouldn’t you want to maintain the ability to change your mind about the trust or its terms?”
Irrevocable trusts, such as irrevocable life insurance trusts, are commonly used to remove assets from a person’s estate and thus avoid them being taxed. Transferring assets into an irrevocable trust gives those assets to the trustee and the trust beneficiaries forever. If a person no longer owns the assets, they don’t comprise or contribute to the value of his or her estate and so they aren’t subject to estate taxes upon death.
Revocable living trusts
There is no “one size fits all” trust—different kinds of trusts offer different benefits (and drawbacks) depending on a person’s circumstances. Age, number of children, health, and relative wealth are just a few of the factors to be considered. The most common trust my clients use is a revocable living trust, sometimes referred to by its abbreviation, “RLT.”
A revocable living trust—created while you’re alive and that can be revoked or amended by you—has three advantages over other kinds of trusts:
Establishing a revocable living trust helps avoid costly probate—the legal process required to determine that a will is valid. Probate generally eats up about two percent (2%) of an estate, which can add up to a chunk of change you’d probably rather see go to your beneficiaries.
Avoiding probate also means avoiding other fees, such as court costs, that go along with it.
A revocable living trust not only eliminates the costs of probate, but the time-consuming process of probate as well. Here in Iowa, probate can take several months to a year, or sometimes even longer, leaving beneficiaries without their inheritances until the very end of the probate process. The transfer of assets in a trust is much faster.
Don’t want your 16-year-old niece to inherit a half-million dollars in one big lump sum? I agree it’s probably not a good idea.
A revocable living trust offers flexibility for the payout of an inheritance because you set the ground rules for when and how distributions are made. For example, you might decide your beneficiaries can receive certain distributions at specific ages (21, 25, 30, etc.), or for reaching certain milestones, such as marriage, the birth of a child, or graduation from college.
Despite the significant advantages of establishing a revocable living trust, there are drawbacks people should be aware of
For starters, trusts are more expensive to prepare than basic estate plan documents such as wills. However, the costs associated with sitting down with a lawyer and carefully putting in place a trust is, in my opinion, greatly outweighed by the money your estate will save in the end.
Creating a trust can also be an administrative bother at the start of the process because assets (farm, business, stock funds, etc.) must be retitled in the name of the trust. But, all things considered, this is a small inconvenience that is greatly outweighed by the smooth operation of a trust when you pass away.
You Can Trust me to Talk About the Best Trust(s) for You
Interested in learning more about trusts or questioning if you need one? Feel free to reach out at any time by email, firstname.lastname@example.org, or on my cell, 515-371-6077. If you want to simply get started on an estate plan (everyone needs at least the basic documents in place!) check out my estate plan questionnaire, provided to you free, without any obligation.
When I prepare estate plans for my clients, they typically include six key documents. For more complex estates, the plan may also involve trust and/or business succession documents. However, to make estate planning as simple and the least chaotic for your loved ones tasked with fulfilling your wishes, I also recommend drafting another document: a letter of instruction.
What Exactly is a Letter of Instruction?
Think of a letter of instruction like an easy-to-read-and-understand summary shortcut for your estate plan’s executors and representatives. Its main purpose is to help guide the person(s) settling an estate through the process, step-by-step, in plain, clear language. The letter can serve as a cheat sheet of sorts. It’s not legally required and certainly doesn’t take the place of a valid will, but it’s a meaningful nod to those you have tasked with handling your affairs.
Your letter of intent doesn’t have to go by any specific form or outline, so some people tend to use it as a way of giving personal instructions and giving details beyond what is articulated in your estate planning documents. A useful letter of intent can include the following information:
- Location(s) of:
- Important papers such as birth certificates, any divorce/marriage certificates, citizenship papers, etc.
- Estate plan.
- Titles and/or deeds to real estate and rental property.
- Recent copies of all financial statements like tax returns and other potentially important legal documents.
- Safety deposit boxes and the respective keys.
- Tangible property that may not be readily accessible
- Names, passwords, account numbers, and PIN numbers for financial accounts.
- Social security number.
- Contact information for:
- Instructions for the care of any pets. (You may also want to establish an animal care trust.)
Regular Updates & Safe Storage
Like your other estate planning documents, the letter of instruction should be reviewed annually and updated as needed. Because the letter of intent includes confidential personal information it should be stored in a secure place that can also be accessible by your estate plan’s executor.
But First, an Estate Plan!
Before you go about drafting a letter of intent, it’s important to place a priority on executing an estate plan that helps you meet your goals and define your legacy. My free, no-obligation Estate Plan Questionnaire (the first of the six key estate planning documents) is a great place to get started. Otherwise, contact me by phone or email with any questions and to discuss which estate planning strategies may be best for you and your family.
A planned gift is literally what is sounds like. Sort of. The term refers to the process of creating a charitable bequest now that will take effect later. In other words, during your lifetime you plan for a gift that will be given a future date—usually at or upon your death. A planned gift is best accomplished as part of an overall estate plan and it is usually delivered through a will or trust.
While you can make provisions to give a specific dollar amount, there are many different types of planned gifts. You can make a planned gift of real estate, life insurance, and retirement plans, or tangible property (such as artwork). You can also remember organizations with planned gifts of charitable remainder annuity trusts (CRATs), charitable remainder unitrusts (CRUTs), Net Income with Makeup Charitable Remainder Unitrusts (NIMCRUTs), FlipCRUTs.
For now, let’s go over exactly what planned giving is; the benefits of planned giving; the kinds of charities you need to consider when making a planned gift; and the kinds of gifts that qualify for a tax deduction.
Who gives? Donors and benefactors
In July 2018, Warren Buffet donated about $3.4 billion to five charities, including the Bill & Melinda Gates Foundation—itself headed by the country’s most generous philanthropic couple who gave it $4.8 billion. Facebook founder Mark Zuckerberg and his wife, Priscilla Chan, donated $1 billion to their charitable foundation.
It’s fun to read about the super-rich and their bountiful bequests, but you don’t have to be a modern-day Rockefeller or a member of the one percent to donate to charity or create a planned gift. Indeed, ordinary people with ordinary means can bequeath gifts that make an extraordinary difference.
In 2016, a legal secretary in Brooklyn, New York, who had worked at the same law firm for 67 years, bequeathed $8.2 million to, among others, New York City’s Henry Street Settlement and Hunter College to help disadvantaged students. Sylvia Bloom, who worked until she was 96 years old, saved her fortune through frugal living and savvy investing.
People make planned gifts for any number of reasons:
- Streamline estate planning and closing;
- Make a meaningful contribution to a cause or organization that reflects their beliefs and values;
- Create a legacy that will have lasting impact into the future;
- Gain income and tax benefits.
There are three types of planned gifts:
- Outright gifts that use assets instead of cash;
- Gifts that return income or other financial benefits to you in return for a contribution;
- Gifts payable upon your death.
Who receives? Planned giving beneficiaries
Organizations love planned gifts. After what are known as “major gifts”—the six-figure endowment, the priceless Old Master painting, the stretch of valuable coastline—planned giving makes up the largest chunk of donations a nonprofit receives. Planned giving helps nonprofits weather fluctuations in other kinds of charitable giving and income, such as yearly donations and gift shop sales. It can alleviate the possibility of dipping into an endowment or cutting back on services and programs. Planned giving is also a way to develop and sustain relationships with donors — and in an increasingly competitive giving environment, nonprofits can’t afford to ignore planned giving programs. Even though organizations don’t immediately receive a planned gift, it is worth the wait.
The reality is that nonprofits can no longer simply ask donors to pony up with cash by writing a check. Donors expect and often demand an array of choices when it comes to helping their favorite nonprofits. Many if not most nonprofits have programs in place to accept planned gifts. But if you’re interested in donating an asset your favorite nonprofit isn’t accustomed to accepting, your best bet is to connect it with an experienced nonprofit attorney to make your gift a reality.
Not all nonprofits are the same when it comes to giving
When we talk about “charitable giving,” it is usually when referring to a particular kind of nonprofit organization. Specifically, organizations formed under 501(c)(3) of the Internal Revenue Service tax code.(Click to the IRS website to check if a possible beneficiary is a qualified 501(c)(3).) A 501(c)(3) can come in many different forms: foundations, charities, churches, community organizations, schools. They all have one thing in common in that they are formed to benefit the general public, not individuals, not for the mutual benefit of their members (such as homeowners associations, and not for political coalitions).
Be aware, however, that not every nonprofit is a 501(c)(3) organization. There are actually 29 types of nonprofits in the U.S. federal tax code, but when it comes to planned giving you can only take a tax deduction if you donate to one that the IRS has conferred 501(c)(3) status. Contributions to non-501(c)(3) groups, charities, and organizations can be valuable to recipients and make you feel good as well. It’s just that the federal government is not going to give you a tax break for your donation. Knowing what you can and can’t claim helps you maximize the potential tax savings that the charitable tax deduction to a 501(c)(3) offers.
Before we discuss what kinds of giving qualify for a tax deduction, here are some that don’t qualify:
Promises and pledges
Let’s say you made a charitable pledge of $150 to a 501(c)(3), but only gave $50 that particular tax year. You can only deduct from your taxes the $50 that you actually donated that year. Once you donate rest of the pledge (the remaining $100) you can deduct that amount for the tax year in which this occurred.
While it is important to be involved in the democratic process, monetary support is not considered charitable giving. Monies given to political candidates, campaigns, parties, and political action committees (PACs), as well as money spent to host or attend fundraising events, or to purchase advertising, lawn signs, and bumper stickers are not considered charitable giving.
Fundraising and special event tickets
I’m sure you can’t count the number of times you’ve bought raffle or lottery tickets, bingo cards, and partook other kinds of games of chance. These classic and popular fundraising methods support charities and are fun to imagine winning, but you can’t claim a deduction for them.
Personal benefit gifts
The IRS considers a charitable contribution to be one-sided. This means if you receive something in return for your 501(c)(3) donation — from a tote bag to a T-shirt, from a side of beef to a three-course meal — only the amount above the fair market value of the item/service is deductible. Let’s say your neighbor’s child is selling popcorn to raise money for a scouting troop. You buy a bag of popcorn for $10 whose retail value is $6. This amounts to a $4 charitable donation. Similarly, you purchase a $75 ticket to a fundraising dinner sponsored a favorite charity. The dinner would cost you $30 at a restaurant, so your charitable deduction would be $45.
Gifts without proof
Cash placed in your church’s collection plate, dropped into the Salvation Army’s Red Kettle, and handed to a student for a cupcake at a bake sale…these are all worthy donations, but you can’t just guesstimate how much you’ve given and deduct the amount from your taxes. Of course, I believe, you gave, but the IRS demands documentary proof of all cash donations, no matter the amount in order for you to claim the deduction. Proof might be bank records such as a canceled check, a receipt from the nonprofit organization, or a pay stub if the donation was made through a payroll deduction. For single cash donations of more than $250, the IRS requires a statement from the organization.
Gifts to individuals
I’ve seen many successful crowdfunding campaigns to support any number of good causes. Let’s say a friend is raising money for her child’s expensive medical procedure through an online site and you make a donation to help her reach her goal. Or, perhaps your nephew is raising money for a mission trip over the summer and you write him a check for $25. Unfortunately, contributions earmarked for certain individuals (despite their economic, medical, educational or other needs) are not deductible according to the IRS. However, if you donate to a qualified organization that in turn helps your friend or nephew, that contribution would be deductible — although you can’t designate your donation to be directed to that person. Again, a contribution can’t be given directly or indirectly to a specific individual and still be tax-deductible.
Bountiful opportunities for charitable giving
It may seem like there are a lot of kinds of giving and plenty of nonprofits that do not qualify for the tax benefits you’re looking for, but don’t worry! There is a multitude of ways for you to show your generosity and contribute to a charity that can minimize your estate taxes, bypass capital gains taxes, and receive current tax deductions. Of course, planned giving is not the only kind of giving. Unplanned giving is no less a means of showing your generosity and supporting those organizations whose mission and activities you believe in.