How can you reduce estate tax, leave money for dependents, and control the uses and terms for your property after your death? The answer is a trust. It allows you to set terms for how and when the property can be used and who can use it.
What Is a Trust?
A trust is a legal vehicle for an asset to be given to beneficiaries under certain terms. The reason why you are able to set terms and why it is more tax-efficient is because it does not transfer ownership to the beneficiary. The beneficiary receives all the income benefits of the asset under the terms that you set.
Who Is Involved in a Trust?
There are a number of parties involved in a trust:
- The settlor – the person who creates the trust
- The beneficiary – the person who receives the income from the trust
- The trustee – the person who manages the trust
Why Should I Create a Trust?
One of the most common uses of a trust is to set money aside for minors that will be released to them once they reach a certain age, for higher schooling, or to purchase a house. This ensures the money is properly managed and held for them, rather than relying on other family members to do the right thing. If the trustee is good at their job, the money in the trust may also grow by the time it is released.
Another common reason for creating a trust is for the family home. If you own a house that you live in with your partner, you may put the house in a trust. This way, you can stipulate that your partner continues to live in the property until they pass away, and then it will be released to the beneficiaries. By putting the house in a trust, you can ensure that your partner is not kicked out of their home. And that upon their death, the house will be released to the beneficiaries. Your partner will not be able to sell the property or will it to someone else as your estate owns the property.
A third common reason is to create an income source or maintenance fund for a dependent. Whether you have named a family member as a guardian or have chosen a suitable assisted living facility, by providing the money required to care for the dependent, you can have peace of mind. This ensures there is money to cover day to day living expenses as well as any medical care that may be necessary.
Other reasons you may decide to create a trust include:
- To leave money to young people
- To protect heirlooms and family assets
- To support family members who are bad with money
- To reduce inheritance tax
- To leave an asset to more than one beneficiary
- To pass on an asset to someone who cannot legally inherit your property due to age or residency status.
- To leave money to charity
- To control the use of an asset or money
Types of Trusts
There are different types of trusts that are built for very specific situations. They have different tax structures and legal requirements.
- Bare Trusts – For minor beneficiaries. The assets are held in trust and managed by the trustee until they are old enough to inherit them. That age is 16 in Scotland and 18 in the UK. Once the beneficiary reaches that age, the assets are turned over in full.
- Interest in Possession Trusts – The income from the assets will pass to beneficiaries, but not the asset itself. This allows you to pass income along to generations of your family. Your partner may be the beneficiary until their death, when children may be the beneficiary.
- Discretionary Trusts – These trusts are perfect for family members who are financially irresponsible or as an emergency fund for multiple beneficiaries. The trustee will make decisions on how the capital and income for the fund are used. You can leave the trustee guidance on how funds should be allocated and when. You can even leave conditions for how the money should be used by the beneficiaries.
- Accumulation Trusts – This trust type allows the income from the assets to accumulate and be added to the trust’s capital. They can be managed by the trustee like a discretionary trust or taken care of until a certain circumstance or event.
- Mixed Trusts – A mixed trust allows the different functions to be applied to the trust. Each function portion will be taxed as that type of trust would be.
- Settlor-Interested Trust – This kind of trust is one you set up for you or your spouse. It gives you an income source that could be set up for certain circumstances like a discretionary trust. It might also be set up like an accumulation trust or an interest in possession trust.
- Non-Resident Trust – This trust is specifically for non-resident beneficiaries. The tax rules can be complex, but it allows you to look after loved ones who would not otherwise be able to inherit anything.
So which type of trust is best for my needs? Well, you should outline who you want to be a beneficiary and how you want to support them. Then, you should discuss your trusts with an attorney or someone who can help you figure out the tax implications of the different types of trust.
Who Should I Choose To Be the Trustee of A Trust
You need to pick someone you trust to be the trustee. Depending on the type of trust you set up, they may need to make important decisions that will affect the trust and the beneficiaries.
The trustee will also have a number of legal and tax responsibilities while managing the trust. Many people have attorneys as a trustee, so that is something you should consider too.