What is a Trust and How Does It Work?

Drafting a will lets you specify how your assets should pass on after your death, especially if you have a large estate. A trust is not necessary for everyone, but it can offer certain advantages depending on your situation. Different types of trusts serve specific purposes, and each has its own rules for how it works and the handling of its assets.

Work with a financial advisor to prepare your trust so it aligns with your long-term goals.

What Is a Trust?

When you write a will, you create a legal document that spells out what you want to happen to your assets after you die. In the meantime, you continue to own and control those assets while you’re still alive.

A trust is a little different. When you create a trust, you’re creating a legal entity that owns and manages your assets on behalf of your beneficiaries. A trust that takes effect while you’re still alive is called a living trust, or inter-vivos trust.

There are three parties in a trust arrangement.

Grantor. The grantor is the person making the trust.
Trustee. The trustee is responsible for managing the trust according to the grantor’s wishes.
Beneficiaries. Beneficiaries are those who enjoy some type of benefit from the trust.

Types of Trusts

There are two main types of trusts.

Revocable. With a revocable trust, you can change the terms of the trust during the grantor’s lifetime.
Irrevocable. An irrevocable trust is one in which the terms are permanent.

However, only certain types of trusts can be irrevocable.

How a Trust Works

The process for setting up a trust is generally more involved than making a will.

Create the Trust Document

First, you must create a trust document.

You can create a trust using free online tools. You can also hire an estate planning attorney to oversee and advise on the process.

Appoint a Trustee

In your trust, you will need to name a trustee who will oversee the trust for you.

If you set up a revocable trust, you can act as your own trustee and name one or more successor trustees to follow you. However, if you are setting up an irrevocable trust, you have to name someone else to act as the trustee.

Keep in mind that the trustee assumes a fiduciary role. This means they legally must act in the best interests of the trust’s beneficiaries.

Name Your Beneficiaries

You must also specify your beneficiaries when creating the trust document. For example, this could be your spouse, children, grandchildren or other relatives.

Others may choose to set up a charitable trust. This names one or more charitable organizations as beneficiaries.

Fund Your Trust

The final step in creating a trust is funding it, which transfers assets into the trust and authorizes the trustee to manage them.

There are several types of assets that you can use to fund a trust.

Real estate
Business interests
Investments
Heirlooms
Antiques
Life insurance
Cash accounts

Depending on the type of trust you establish, you may choose to fund the trust immediately or transfer assets at a later date.

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Types of Trusts

Many estate plans include living trusts.

All trusts can be either revocable or irrevocable, but there are many different types of specialized trusts you can set up.

AB trust: An AB trust combines a marital trust with a bypass trust to minimize estate taxes for surviving spouses.
Charitable trust: A charitable trust can be established specifically for charitable giving. They divide your assets between selected charities and other beneficiaries, such as family members.
Testamentary trust: Your will creates a testamentary trust, which only takes effect after you pass away. This type of trust allows for the transfer of assets when you die, not before.
Special needs trust: A special needs trust manages assets for special needs beneficiaries, such as a child or another family member. This type of trust allows the beneficiary to remain eligible for government assistance programs to help pay for their care and living expenses.
Life insurance trust: A life insurance trust is a trust that holds the proceeds from a life insurance policy. This type of trust is irrevocable, and the trustee is responsible for managing the policy proceeds on behalf of your beneficiaries.

Trusts vs. Wills: Key Differences

Both wills and trusts are estate planning tools, but they work in very different ways.

Probate

A will only takes effect after you pass away. It directs how your property should be distributed but must first go through probate. This is a court-supervised proceeding that can take months and generate legal fees.

A trust, on the other hand, becomes effective as soon as you create and fund it. This allows assets held in the trust to transfer directly to beneficiaries while avoiding probate.

Privacy

Privacy is another important difference. Once a will is filed with the court, it becomes a public record, meaning that anyone can access the details of your estate.

A trust remains private, so it does not disclose the terms of asset transfers or the identities of beneficiaries to anyone not associated with it. For families who value discretion, this can be a significant advantage.

Asset Protection

Trusts can also offer benefits that wills cannot.

A revocable trust gives you flexibility during your lifetime since you can make changes or dissolve it entirely. An irrevocable trust, while permanent, provides protections against creditors and can reduce estate taxes because the assets are no longer considered part of your personal estate.

By contrast, a will offers no protection from creditors and no tax advantages.

For many people, a will is sufficient if their estate is simple and straightforward. But as assets grow more complex, a trust can help reduce delays, avoid public disclosure and provide tax or creditor protection that a will cannot achieve.

Benefits of a Trust

Establishing a trust has certain benefits that you don’t get from having a will alone.

Asset Protection

Creating an irrevocable trust would offer the dual benefits of creditor protection and lower estate taxes. A creditor cannot attach assets in an irrevocable trust to satisfy a lawsuit.

Since the trust owns them and not you, you can also use an irrevocable trust to minimize estate taxes for your heirs.

Flexibility

A revocable trust offers flexibility in estate planning, as you can change its terms or terminate it entirely at any time during your lifetime.

Both a revocable and irrevocable trust could also allow your beneficiaries to avoid the probate process. Probate can be a lengthy and expensive process, but depending on your trust’s structure, it may not be necessary.

Drawbacks of a Trust

There are a few disadvantages to keep in mind if you’re considering a trust for estate planning:

Complicated process. Setting up a trust can be confusing and time-consuming.
Expensive. You may need an estate planning attorney to help, which could mean paying several hundred or even several thousand dollars in fees.
Ongoing expenses. Aside from that initial cost, there are ongoing expenses associated with a trust. For example, there’s a trustee fee if you aren’t your own trustee, and management fees can quickly add up if you have significant assets in a trust.

Finally, a trust may not be required if you have a simpler financial situation. Drafting a last will and testament and purchasing life insurance, for example, may be enough to meet your needs.

When a Trust Makes Sense and When It Does Not

Whether a trust makes sense depends on the size of your estate, the types of assets you own and the goals you have for your heirs.

A trust may be worth considering if:

You have a large estate. Those who own substantial assets or have property in multiple states may need a trust.
You have dependents. A trust can be beneficial if you have children from a previous marriage or want to leave assets to a minor child or a beneficiary with special needs.
You want privacy. Trusts can appeal to people who want greater privacy, since assets held in a trust can generally avoid probate and the public disclosure that comes with it.
You want greater control. You have greater control over the distribution of trust assets. Rather than leaving an inheritance outright, a trust can direct the distribution of funds over time or at specific ages.
Your trust is for a specific reason. You may want a trust for a particular purpose, such as education, healthcare or ongoing support.

For some families, a trust can solve important estate planning challenges. For others, it may add complexity without providing significant benefits.

When a Trust May Not Be Necessary

On the other hand, a trust is not always necessary.

A will may be sufficient if your estate is relatively straightforward, you already have beneficiary designations and your primary goal is to transfer property to loved ones. Retirement accounts, life insurance policies and payable-on-death accounts generally pass directly to named beneficiaries regardless of a trust’s instructions.

The cost and administrative work involved should also be part of the decision. Creating a trust requires legal documents, and it must be properly funded by transferring assets into it. If that step never happens, the trust may provide little practical benefit.

For some families, a trust can save time, reduce legal costs and provide greater control over an inheritance. For others, a well-drafted will and updated beneficiary designations may accomplish the same goals with less complexity.

The right choice depends on your assets, family circumstances and long-term estate planning objectives.

Bottom Line

A senior couple creating a trust as part of their estate plan.

A trust is just one tool you may decide to include in your estate planning. Before setting up a trust, it’s important to consider the cost, benefits and tax implications. If you decide to create a trust, check your state’s laws and requirements to ensure you comply with all legal guidelines.

Tips for Estate Planning

Consider talking to a financial advisor about the benefits of trusts and whether it makes sense to create one. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
There are other legal documents you may need to include in your estate plan besides a trust. A will is one; a financial power of attorney is another. You may also want to draft an advance health care directive to outline your wishes for medical care when you’re not able to make decisions on your own.