Family Trusts

You may have a vague idea of what a trust is, or at least what you think a trust is. You’ve thrown around the term “trust fund baby” more than a few times. You figure that trusts are something for rich people, not for ordinary folks.

It’s true that many affluent people establish trusts. But trusts aren’t just for rich people. In fact, a family trust may be an excellent way to ensure that your final wishes are carried out exactly as you would want. Family trusts protect your family’s privacy and provide potentially significant tax savings.

What Is a Family Trust?

The legal term for a family trust is a revocable living trust. The term revocable means that it can be changed by the person who creates the trust.  A family trust is a legally binding document that determines the administration and distribution of the estate of the person creating the trust.  They’re called family trusts because the beneficiaries are almost always blood relatives and extended family members, although many family trusts also include charitable organizations as beneficiaries.

Many families use family trusts as estate planning tools along with a will to largely replace a will. If you set up a family trust you become the grantor.  As the grantor, you serve as administrator of the family trust as long as you are alive and mentally competent.  Title and ownership of your assets are transferred from you to the trust, but you retain control over the use of your assets. If you include your house as part of a family trust, you can still live there. If you include your car, you can still drive it.

When you die, your designated trust administrator takes over the task of administering your trust. His or her main task is to distribute the contents of your trust to your beneficiaries according to your previously stated wishes. Your trust administrator   also would have power of attorney to take over the administration of the trust for your benefit if you become incapacitated through illness or injury.

A trust has separate legal status for tax purposes. That means that your trust must file its own tax returns. As the administrator, or your trust administrator you are responsible for paying taxes on any income generated by the trust.  Any material changes in your assets would require a modification of the trust.  Any new heirs that you wanted to include as beneficiaries would need to be added. 

What Are the Benefits of a Family Trust?

One major benefit of a family trust is that trusts do not go through probate. Unlike wills, trusts are considered private documents. You don’t have to submit your family trust to probate court or obtain court approval for your trust administrator.  As a result, your estate can often be distributed to your beneficiaries faster than with a will.

Establishing a family trust can also save money over probate. Attorneys’ fees and court costs associated with probate in some states can devour as much as 5 percent of the total value of the estate.  Even for a modest estate including a family home, furnishings, bank accounts and a car, 5 percent can represent a significant bite.

Many states have provisions that allow for expedited handling of small estates through probate.  A family trust removes the bulk of your assets from your estate. An attorney can also establish “pay on death” designations to individual beneficiaries for bank accounts, real estate and other assets that are not already included in the family trust to keep them out of your estate. Any remaining assets could be included in a “pour-over” will that would automatically transfer any remaining assets to the family trust when you die, and which would potentially qualify for expedited processing through probate.

How Can I Set Up a Family Trust?

The short answer: you can’t. Or at least you shouldn’t try, unless you’re a licensed attorney specializing in estate law. Although at least online program exists that allows you to create your own family trust, it’s really a bad idea to try the DIY approach where family trusts are concerned.  Trusts are legally more complicated than wills; there are also many potential pitfalls.  The phrase “penny wise and pound foolish” was never truer than when applied to estate planning.

The money you spend to hire a competent attorney would almost certainly be a bargain compared with the potential costs of a botched trust.  Even if your estate seems simple, an attorney can often catch potential pitfalls associated with family trusts. For instance, if you have minor children or children of any age with special needs, you will need a will in addition to a family trust. That’s because a trust can oversee the management of financial assets for their benefit, but cannot be used to appoint a guardian for their care.

If a tragedy occurred and you died from an accident, your survivors would likely be entitled to the proceeds from a settlement or a lawsuit. A family trust alone would not cover those assets. Without a pour-over will or some other means of inheritance in place, that settlement would be subject to the laws of intestate estates, which might produce the results you would want.

Hiring an attorney can also keep you on the right side of the IRS and state revenue departments.  It’s perfectly legitimate to establish a family trust to lawfully minimize your federal and state income tax obligations, and an attorney can help you establish a trust to accomplish that purpose. But if you go it alone, you may unwittingly establish what the IRS considers an abusive trust, or at least a trust that is legally defective.

Is a Family Trust for Me?

If you haven’t already settled on an estate plan, a family trust may be a viable option. A family trust can ensure that your final wishes are carried out.  A family trust can also maintain the privacy of the distribution of your assets. It’s worth your while to discuss a family trust along with other estate planning options with an attorney.