The 5 main uses of trusts in estate planning

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Trusts are highly flexible instruments for estate planning. Because they are so adaptable, trusts may acquire any number of names that are shorthand for what they try to accomplish or how they work. This can be very confusing, especially for people outside of estate planning.

Here is a simple breakdown of their primary uses. Before we do this, we should explain the essence of a trust. When trusts were first used in the 13th century in England, the legal innovation consisted of separating legal ownership (legal title) on one hand, from the right to use and enjoy the property on the other hand. In short, one person, the trustee, was holding the property in trust for another, the beneficiary. The following should clarify why this separation into legal title in the trustee and equitable interest* in the beneficiary is so valuable.

1. Provides for management of assets

Assume you want to make a gift to your children. However, you have little confidence that your children, still in their 20s, will be able to manage your investment portfolio. Placing the gift into a trust will allow you, as a trustee, to manage the assets for your children’s benefit.

Now assume the situation where the husband has always managed the household finances but passes away and leaves a widow behind. She has neither the experience nor the inclination to manage the finances or, because of illness or forgetfulness, she can no longer do so. The widow could put the inherited assets into a trust and name a family member as trustee and herself as beneficiary. Providing for the management of assets if the owner is either too young or too old is, in addition to probate avoidance, the main purpose of revocable living trusts.

2. Splitting assets up regarding who gets what and when (split interests)

Example: Alice has a sizable investment portfolio which she puts into a trust. She instructs the trustee to pay the dividends and other income to her sister Bonnie while Bonnie is alive. Furthermore, Alice has instructed the trustee that the portfolio income should be distributed to her (Alice’s) children in equal parts upon Bonnie’s passing. At the death of the last of Alice’s children, the trustee has been instructed to distribute the entire trust property to Alice’s grandchildren.

3. Postponing dividing up a gift for a class of beneficiaries

A class of beneficiaries could be your children or grandchildren. It may not make sense to decide what portion of your assets each class member should receive. Think about education. One child or grandchild may attend medical school, the other a 2-year college. The parents of one of your grandchildren may be affluent, the others not. With a trust, but not a will, you can defer the decision regarding the ultimate distribution. You would instruct the trustee to decide how much and when to distribute funds to class members according to their needs and circumstances.  Such a trust is known as a pot trust; see an earlier post here.

4. Shelter assets

A trust can have distribution provisions that make it impossible for a beneficiary to squander their money (see spendthrift trust). A trustee can be empowered to make distributions at her complete discretion or limit distribution to what is needed for health, education, and support.

In a like manner, if the trustee has complete discretion in distributing assets to the beneficiary, and, if the trust instrument prohibits direct distribution to the beneficiary’s creditors, assets are protected, and are generally, but not always, out of the reach of creditors.

5. Probate avoidance

Probate administration by the court can be a lengthy and cumbersome process. A trust takes assets out of the probate property, and the assets get distributed without court administration. In contrast to probate, which is public, trusts are private. The assets pass according to the terms of the trust that are not known to the public.

In conclusion, these are the major uses of trusts., But, it has been said that the purposes of trusts are as unlimited as the imagination of the lawyers who draft them. We have written about some more esoteric ones here.

*Equitable interest, as opposed to legal title, is the ownership interest that derives from the fact that one is a beneficiary. It is sometimes also called a beneficial interest. This is a concept that is more fully explained here.

Further reading:

Trusts – A general overview

Trusts – Who invented them and why? – “Uses” and abuses.

Comparison of California Wills, Revocable and Irrevocable Trusts

Avoiding Probate in California – In trusts we trust?

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