A trust is an estate planning tool used by people to protect their assets during their lifetime, and to dictate how those assets are to be disbursed upon their death. A family trust, also known as a “by-pass trust,” is a trust created by a married couple with a large estate for the purpose of avoiding federal estate taxes when the first spouse dies. The couple, known together as the “Trustors,” usually place ownership of assets whose value meets, but does not exceed, the federal estate tax exemption, into the family trust, the couple’s remaining assets transferring to the surviving spouse. To explore this concept, consider the following family trust definition.
Definition of Family Trust
- A trust created by a married couple, which is structured to avoid federal estate taxes when the first spouse dies. (also: by-pass trust)
1175-1225 Middle English < Old Norse traust
What is a Family Trust
A trust provides a method of managing the assets of belonging to an individual or couple while they live, as well as to specify how the assets are to be distributed when they pass away. Many people find that a trust is a superior alternative to simply leaving a will, as the trust is not subject to probate, as is a will, and it is kept private, rather than becoming a matter of public record. The purpose of a family trust is for the surviving spouse to avoid paying estate taxes when the first spouse dies.
When this occurs, an amount of the couple’s assets up to the amount of the federal estate tax exemption, which in 2015 is $5.43 million per spouse. The surviving spouse maintains control over, and use of, all assets over the exemption amount until his or her death, at which time all assets are automatically moved into the trust, and become subject to estate taxes.
Setting Up a Family Trust
The laws governing the creation of trusts vary by state, making it important for a couple thinking about setting up a family trust to be sure it conforms. While many people hire an attorney to help them create their family trust, it is possible to undertake this endeavor without one. To set up a family trust, the couple should:
- List Assets – write a lit of all the couple’s assets that will be included in the trust. This may include such items as the couple’s home, personal property, cash, bank accounts, stocks, bonds, and other investment accounts, business interests, and other assets.
- State Goals – whatever goals the couple has for the trust, such as the tax benefits sought, should be written down.
- Choose a Trustee – while a couple may choose to act as Trustee of their own trust, a successor trustee must be chosen to manage the trust after their deaths, or in the event of incapacity. The individual or entity appointed as trustee should be trustworthy and of good character. Many couples choose a trusted family member as Trustee, though some name a legal or financial professional instead.
- List Beneficiaries – the couple must specify who will receive the proceeds of the trust after both spouses pass away.
- Specify Trust Distribution – while the Trustee will handle the details of distributing the trust’s assets when the time comes, the creators of the trust must specify exactly where the assets are to go. For example, how much each named beneficiary will receive, and when.
- Select a Name – choosing a name for the trust, such as “The Jones Family Living Trust,” helps avoid confusion between multiple trusts.
- Hire an Attorney – if desired, hiring an estate planning attorney to draft the trust, once the important details have been decided, helps ensure the trust meets the legal requirements.
- Proofread – carefully proofread the trust draft, making note of any errors, and make sure they are fixed before the final printing.
- Sign the Trust – both spouses must sign and date the trust, usually before witnesses or a notary public. If the signatures do not conform to state law, the trust may be deemed invalid.
- Keep in a Safe Place – the signed original trust should be kept in a place safe from the environment, fire, and theft. A copy of the trust should be given to any named trustees, and if an attorney is used, he will generally keep a copy as well.
Reasons for Creating a Family Trust
Trust funds are not just for the wealthy, as many people once believed, but can be used by people in all economic groups to manage property and protect assets. A family trust helps ensure a couple’s heirs and beneficiaries receive their property and financial assets after they pass away, while avoiding a potentially lengthy probate process. A properly structured family trust offers certain tax advantages to the couple, or to their heirs. Avoiding the probate process also saves money by eliminating legal fees.
What is a Revocable Family Trust
A revocable family trust allows the Trustors to make changes to the trust, or to revoke or terminate the trust if they choose to do so during their lifetime. Once the first spouse dies, however, the trust becomes an irrevocable family trust that cannot be changed or terminated by the surviving spouse. At this time, the surviving spouse still has access to the assets, as specified in the trust, until his or her death. Once both spouses have passed, the Trustee will distribute the assets according to the instructions in the trust.
What is an Irrevocable Family Trust
An irrevocable family trust is one that, once created and funded, cannot be altered, changed, or revoked by either Trustor. Once ownership of assets is transferred into the trust, they can never be taken out of the trust, nor can the terms of the trust be changed. Because of the strictness of the irrevocable family trust, they are used only in special circumstances, usually for tax purposes. It is highly recommended that anyone considering an irrevocable family trust consult an experienced estate planning attorney first.
A discretionary trust gives the named Trustee a great deal of authority in deciding how to distribute the assets to the beneficiaries. While the Trustors provide some guidelines regarding the asset distribution, they are general in nature. This is a common type of trust because of its flexibility. It is often the least costly type of trust to create.
An incentive trust gives the Trustee some flexibility in making trust distributions, though the Trustors dictate certain behaviors or milestones the beneficiaries must reach or show before receiving trust assets. In other words, the beneficiaries are given incentives to act a certain way, or to achieve certain goals, in order to receive trust funds. Common trust incentives include:
- Education – achievement of a certain grade point average, or obtaining a college degree
- Behavior – getting married, having a baby, or moving to a specific location
- Employment – successfully working in the family business, gaining employment in a specific field, starting a successful business, or attaining a certain income level
- Avoiding Negative Behavior – drug or alcohol use, gambling, or criminal activity
Disadvantages of a Family Trust
Creating and funding a family trust can be complicated and time consuming, and may entail the payment of substantial legal fees. If the family trust is mismanaged after it has been created and funded, there may be large financial losses, and even legal consequences.
Family Trust Forms
Generally speaking, it may be difficult to find generic family trust forms. This is because the creation of a trust is a complex matter, and most attorneys create their own boilerplate templates, then do a substantial amount of personalization to meet each client’s needs. Some people find it useful to use family trust forms provided by their attorney or other professional as a guideline to determining and writing down specifics before their actual family trust is put together.
Family Trusts and Tax Issues
Whenever assets are transferred to an heir or beneficiary after a person’s death, there are tax consequences. On the other hand, when assets over a certain value are placed into certain types of trust, there may be gift tax consequences. Manipulating when and how much taxes will become due is one of the primary reasons for creating a trust. Tax issues are different depending on whether a trust is revocable or irrevocable, as well as whether the trust is made by an individual or a couple. Because of the complexity of tax issues with regard to trusts, it is recommended that a wealth management professional or experienced estate planning attorney be consulted.
Living Trust vs. Will
Both a living trust and a will are written documents created for an individual or couple to specify how they want their assets dealt with upon their death. While a will specifies who receives what, the law requires that it go through a probate process before anyone gets anything. The probate process is a legal process by which a judge determines whether the will is valid before authorizing the named executor to distribute the assets according to the will’s instructions. If there are any questions as to the validity of the will, or if any heirs contest its provisions, the probate process can take months, or even years.
When a living trust is created, actual ownership of the creator’s assets is transferred to the trust, meaning that the trust itself owns the property. Because of this, there is no requirement for those assets to go through the probate process, allowing the Trustee to distribute them immediately on the Trustor’s death, or according to the Trustor’s instructions. Another important difference between the two is that, once a will has been entered into probate court, it becomes a matter of public record. A trust is private, never being made available to prying eyes.
One example of this in action occurred when pop superstar Michael Jackson passed away. The press and many nosy individuals flocked to the probate courthouse to see to whom Jackson had left his considerable fortune. They learned nothing, however, as Jackson’s will simply left all he had to his trust, which has remained a private document.
Related Legal Terms and Issues
- Asset – Anything owned or controlled by a person or company that is expected to have value.
- Beneficiary – A person named in a will or trust as the intended recipient of assets or property.
- Executor – A person appointed to administer a person’s estate, according to his will.
- Heir – A person who, by right of inheritance, inherits the assets of a deceased person.
- Probate Court – The section of the judicial system that deals with matters relating to wills, trusts, estates, guardianships, and conservatorships.
- Trustee – A person given control of property according to a trust.
- Trustor – A person that creates a trust.