What is a Trust and How Does It Work?

Drafting a will lets you specify how your assets should be passed on after your death. If your estate is large, you might also set up a trust to manage those assets. A trust is not necessary for everyone, but it can offer certain advantages depending on your situation. Different types of trusts serve different purposes, and each has its own rules for how it works and how assets are handled. You may also want to work with a financial advisor to help plan your long-term goals and prepare for any trust you might need.

What Is a Trust?

When you write a will, you’re creating a legal document that spells out what you want to happen to your assets after you die. Meanwhile, you continue to own and control those assets while you’re still alive.

A trust is a little different. When you create a trust, you’re creating a legal entity that owns and manages your assets on behalf of your beneficiaries. There are three parties in a trust arrangement:

The grantor, who is the person making the trust
The trustee, who is the person responsible for managing the trust according to the grantor’s wishes
The beneficiaries, who enjoy some type of benefit from the trust

A trust that takes effect while you’re still alive is called a living trust or inter-vivos trust. Trusts can be revocable, meaning the terms of the trust can be changed during the grantor’s lifetime, or irrevocable, in which the trust terms are permanent. However, only certain types of trusts can be irrevocable.

How a Trust Works

The process for setting up a trust is generally more involved than making a will:

Create the trust document. First, you need to create a trust document. This is something that an estate planning attorney can help you with.
Appoint a trustee. In your trust, you will need to name a trustee who will oversee the trust for you. If you set up a revocable trust, you can act as your own trustee and name one or more successor trustees to follow you. However, if you are setting up an irrevocable trust, you have to name someone else to act as the trustee. Keep in mind that the trustee assumes a fiduciary role, which means they are required to act in the best interests of the trust’s beneficiaries.
Name your beneficiaries. You must also specify your beneficiaries when creating the trust document. For example, this could be your spouse, children, grandchildren or other relatives. Others may choose to set up a charitable trust, naming one or more charitable organizations as beneficiaries.
Fund your trust. The final step in creating a trust is funding it. Funding a trust means transferring assets to the trust and giving the trustee the authority to manage them. The kinds of assets you can use to fund a trust include real estate, investments, heirlooms, antiques, life insurance, business interests and cash accounts. Depending on the type of trust you establish, you may choose to fund the trust right away or transfer assets at a future date.

Types of Trusts

Many estate plans include living trusts.

All trusts can be either revocable or irrevocable but there are many different types of specialized trusts you can set up. Here’s a quick rundown of some of the most common trust options:

A/B trust: This type of trust combines a marital trust with a bypass trust to minimize estate taxes for surviving spouses.
Charitable trust: A charitable trust can be established specifically for the purpose of charitable giving. You can set up charitable trusts to divide your assets between selected charities and other beneficiaries, such as family members.
Testamentary trust: A testamentary trust is created by a will and only takes effect after you pass away. This type of trust allows for the transfer of assets when you die and not before.
Special needs trust: A special needs trust can be set up to manage assets for special needs beneficiaries, such as a child or another family member. This type of trust allows the beneficiary to remain eligible for government assistance programs to help pay for their care and living expenses.
Life insurance trust: A life insurance trust is a trust that’s designed specifically to hold the proceeds from a life insurance policy. This type of trust is irrevocable and the trustee is charged with managing the proceeds from the policy on behalf of your beneficiaries.

Trusts vs. Wills: Key Differences

Both wills and trusts are estate planning tools, but they work in very different ways. A will only takes effect after you pass away. It directs how your property should be distributed, but the process must go through probate, which is a court-supervised proceeding that can take months and generate legal fees. A trust, on the other hand, becomes effective as soon as it is created and funded. This allows assets held in the trust to transfer directly to beneficiaries without going through probate.

Privacy is another important difference. Once a will is filed with the court, it becomes a public record, meaning that anyone can access the details of your estate. A trust remains private, so the terms of asset transfers and the identity of beneficiaries are not disclosed outside the parties involved. For families who value discretion, this can be a significant advantage.

Trusts can also offer benefits that wills cannot. A revocable trust gives you flexibility during your lifetime since you can make changes or dissolve it entirely. An irrevocable trust, while permanent, provides protections against creditors and can reduce estate taxes because the assets are no longer considered part of your personal estate. By contrast, a will offers no protection from creditors and no tax advantages.

For many people, a will is sufficient if their estate is simple and straightforward. But as assets grow more complex, a trust can help reduce delays, avoid public disclosure, and provide tax or creditor protection that a will cannot achieve.

Benefits of a Trust

Establishing a trust has certain benefits that you don’t get from having a will alone. For example, creating an irrevocable trust would offer the dual benefits of creditor protection and minimizing estate taxes. Assets held in an irrevocable trust couldn’t be attached to satisfy a creditor lawsuit. Since they’re considered to be owned by the trust and not you, you could also use an irrevocable trust to minimize estate taxes for your heirs.

A revocable trust allows for flexibility in estate planning since you can change the terms of the trust or terminate it completely at any point during your lifetime. Both a revocable and irrevocable trust could also allow your beneficiaries to avoid the probate process. Probate can be a lengthy and expensive process but depending on how your trust is structured, you may be able to avoid it altogether.

Drawbacks of a Trust

A senior couple creating a trust as part of their estate plan.

There are a few drawbacks to keep in mind if you’re considering a trust for estate planning. For one thing, setting up the trust can be complicated and time-consuming. You may need an estate planning attorney’s help, which could mean paying several hundred or even several thousand dollars in fees.

Aside from that initial cost, there are ongoing expenses associated with a trust. For example, there’s the trustee’s fee to consider if you aren’t acting as your own trustee. If you have significant assets in a trust, the management fees can quickly add up.

Finally, a trust may not be necessary if you have a simpler financial situation. Drafting a last will and testament and purchasing life insurance, for example, may be enough to meet your needs.

Bottom Line

A trust is just one tool you might decide to include in your estate planning. Before setting up a trust, it’s important to consider the cost, the benefits and the tax implications. If you do decide to create a trust, check the laws and requirements in your state to make sure you’re following all the legal guidelines.

Tips for Estate Planning

Consider talking to a financial advisor about the benefits of trusts and whether it makes sense to create one. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
There are other legal documents you may need to include in your estate plan besides a trust. A will is one; a financial power of attorney is another. You may also want to draft an advance health care directive to outline your wishes for medical care when you’re not able to make decisions on your own.