Most people are familiar with the concept of a ‘trust’, but they can be shrouded in mystique. What exactly is a trust, and how do they work?
Put simply, a trust is a legal agreement between three separate parties. They are:
- Settlor: this is the person who creates the initial trust agreement. They’re also commonly called the trustor or grantor.
- Trustee: this is the person or business entity that is responsible for the management of the property and titles in the name of the trust.
- Beneficiary (or beneficiaries): the people or business entities that are entitled to receive the benefits of the property that is titled under the name of the trust.
The settlor transfers the ownership of assets to the trust and trustee. The trustee then manages them on behalf of the beneficiaries.
What is a living trust?
This is a trust created and working within the Settlor’s lifetime. You may hear it referred to as an ‘inter vivos’ trust.
Other kinds of trusts don’t go into effect until the Settlor has passed away. These are known as ‘testamentary’ trusts. It’s usually formed by the executor of the dead person’s estate where his will named the trust as a beneficiary.
What is a revocable living trust?
With revocable living trusts, the trustee, Settlor and beneficiary are usually one and the same. The trust agreement can also cite other beneficiaries – people who would benefit after the death of the Settlor. These kinds of trusts are generally used to plan for mental disability and to avoid probate of the trust’s assets before the Settlor’s death.
What is an irrevocable living trust?
In most cases, if a Settlor creates an irrevocable trust, he can’t act as trustee. These kinds of trusts are usually used to move assets out of the Settlor’s ownership to the next generation, so they can use them. This reduces the value of the estate owned by the Settlor for estate tax purposes.
Once property has been transferred into an irrevocable trust, it cannot then be taken back. While the Settlor can change or dissolve a revocable living trust, an irrevocable trust is forever.
Other trust types
Every living trust must be either revocable or irrevocable, but they can be adjusted within these parameters to suit specific uses and purposes. For example:
- An irrevocable life insurance trust (ILIT) holds a policy of insurance on the life of the Settlor. As the policy is owned by the trust, its proceeds aren’t usually included in the gross valuation of the dead person’s estate for tax purposes.
- A special needs trust is generally set up to provide for the disabled beneficiary in a way that won’t compromise any entitlement to disability benefits.
- A ‘spendthrift’ trust allows the trustee discretion in terms of how and when distributions are made. These are used when the beneficiary isn’t considered financially responsible, or to safeguard an inheritance should the beneficiary divorce.
This is not a finite list and trusts can be formed to suit other specific purposes.
