Trusts can be a sobering and overwhelming topic. I know that was the case for me when I started considering how my assets would be handled after I’m gone. Because it’s not a matter of if…it’s a matter of when.
Why should you think about a trust? It can be vital to continuing the amazing legacy you’ve started. And I often get this question from readers and colleagues alike: “What are the benefits of a trust?” So whether you’re just beginning to think about trusts or have already started your research, I wanted to answer the most common questions I hear about this important part of the financial planning process.
So sit back and relax. It’s time you arm yourself with enough information to determine if acquiring a trust is right for you and your family.
Common Questions About Trusts
Keep in mind that the questions I’ll answer today don’t represent an exhaustive list. However, there is enough ground covered to get the conversations going with your financial team and within your communities to spark your next actionable steps. Let’s answer some questions!
Q: What is a trust, and how does it work?
A trust is a legal arrangement where assets are held by a trustee for the benefit of beneficiaries. It’s like a protective container for your assets, managed according to your instructions by a trusted individual or entity, the trustee. The beauty of trusts lies in their ability to bypass probate, maintain privacy, and provide precise control over asset distribution.
Q: How is a trust different from a will?
A will is a simple legal document that provides instructions on how to distribute property to beneficiaries after death. Whereas a trust is a complex legal contract that allows you to transfer your property to an account to be managed by another person.
Because a will is an after-the-fact legal document, it has to be closely monitored by the judicial system to make sure the instructions are carried out—this is called probate. While probate is not required for all assets, it is very common that wills trigger probate. The process of probate itself can be lengthy and cost inheritors money.
Trusts are not subject to probate because they are managed by a trusted entity, and the estate has given permission for the trustee to distribute the assets according to the trust’s terms without the need for probate. This hastens the distribution process while avoiding costly fees.
Q: What are the different types of trusts?
Because they are complex, trusts come in many types that serve specific purposes, each type with a lot of options. Let’s look at some of the most common types.
Revocable vs. Irrevocable Trusts
With revocable trusts, one major benefit is that changes to details can be made at any time. It’s also excluded from probate court and is non-public. However, this type of trust is subject to taxes.
For irrevocable trusts, changes cannot be made once it’s created and are typically not subject to taxes. Like revocable trusts, they are excluded from probate court and are non-public. While not being subject to taxes is an obvious benefit, what are the benefits of being “non-public”? I’m glad you asked! With probate or public trusts, your assets will go into the public record. High-net-worth individuals are more vulnerable to lawsuits and claims. With private trusts, assets and property remain anonymous and protected.
Trusts Designed for Specific Financial Goals
Martial Trusts: This trust is for the benefit of your partner. A major advantage is that this trust can reduce or eliminate estate taxes through the unlimited marital deduction. You can also provide a surviving spouse financial stability by preplanning distributions designed to pay for health, education, household, or any number of targeted, purposeful payments.
Charitable Trusts: More formally known as a charitable remainder trust, this type allows you to give back to the causes that mean the most to you. You can transfer any sort of asset into this trust. For example, you could transfer an investment property and give instructions of its rental or sale upon your passing for the benefit of a specific charity.
When setting up a charitable trust you could reduce your tax burden, so make sure you talk to a CPA if you’re planning one. And there won’t be capital gains on the eventual sale of the property.
You could also set up the trust in such a way that allows the targeted charity to sell the asset without tax liability, place the remainder back into the trust, and create a possible income stream for the donor’s benefit. This means that this is a flexible trust—not everything has to go to the charity. Because these trusts are so flexible and beneficial, they require more planning.
Spendthrift Trusts: These trusts limit the beneficiary’s access to the assets. Set one up when protecting your assets from a potentially unreliable beneficiary, safeguarding your estate without completely withholding the beneficiary’s inheritance.
How does this work? Assets will be distributed in a timely and quantifiable manner according to your wishes. For example, that could mean distributing an inheritance at intervals to only to cover living expenses. And, if it is a concern, the beneficiary’s creditors will not be able to reach the assets of the trust.
Business Trusts: These legal entities hold an individual’s ownership or stake in a business, meaning the trust “owns” their portion of the business. For entrepreneurs looking to shield themselves from taxes or liabilities, this could be a useful option.
It’s also helpful for succession planning, especially if you know how you want to transition ownership and managerial responsibilities. And because trusts aren’t subject to the same public disclosure requirements, they offer privacy beyond what LLCs are capable of.
Special Needs Trusts: Known as SNTs, these trusts are also sometimes called supplemental needs trusts. They are designed to provide for the future of a beneficiary with special needs while protecting their eligibility for government benefits and programs. Common needs that government programs don’t pay for that can be supplemented by an SNT include education, transportation, and housing.
Education Trusts: Speaking of education, an education trust provides estate-tax reduction though qualified and tax-exempt transfers to the beneficiaries’s educational institution. These funds could also go toward establishing or financing educational institutions.
Besides the tax benefits of education trusts, a trustee will ensure there is no risk of a beneficiary obtaining and spending assets you’ve assigned for education on something else.
Life Insurance Trusts: This one is fairly straightforward. A life insurance trust allows the trustee to disburse payments from a life insurance policy in a manner that aligns with your instructions. Rather than receive the policy monies in a lump sum and without strings attached, this trust distributes funds based on the trust’s terms.
In addition to control over how the funds are spent/distributed, this type of trust avoids the wait and fees of probate, can prevent estate taxes, and protects assets from creditors.
Grantor-Retained Annuity Trusts: GRATs, as they are known, help families move wealth to their heirs while using little, if any, of their lifetime federal gift and estate-tax exclusion. When assets are placed in this type of trust, their value essentially “freezes,” shifting the appreciation to the distribution of the assets to the beneficiary. When the beneficiary receives the trust’s funds, the growth of the assets would pass to heirs free of gift and estate taxes.
This type of trust contains an annuity payment to the grantor during the term of the trust. So talk with your CPA and lawyer to find out the IRS implications of this annuity payment and how a GRAT can be structured.
Q: Who should consider setting up a trust?
Physicians and entrepreneurs, given their diverse income streams and asset portfolios, find trusts particularly valuable for asset protection and seamless wealth transfer.
Trusts are also beneficial if you have substantial assets, complex family dynamics, or specific wishes regarding asset management and inheritance.
Q: What are the benefits of trusts?
Although we’ve been answering this question throughout, let’s summarize what we’ve learned. Benefits of trusts vary. One major benefit is they provide a faster payout to beneficiaries. Nobody will need to go through probate (nor will they incur the fees).
But trusts also give you more control over how your legacy continues by specifically designating who receives what, how, and when. If you want, you can even dictate what the money is spent on.
Trusts are also a way to avoid conflict among beneficiaries, as they cannot be contested in court like a standard will. The privacy of a trust also prevents conflict arising from lawsuits and claims. Lastly, trusts help your heirs save money. Assets will be protected from creditors and they can reduce estate, gift, or income taxes.
Q: How can physicians and entrepreneurs use trusts in their financial planning?
Speak with your financial team—especially your lawyer, financial advisor, and CPA—to align your trust with your financial goals. Integrating trusts into your financial strategy can yield significant advantages to building enduring wealth. You can safeguard personal and business assets, minimize taxes, and ensure a smooth transition of wealth to future generations.
Q: How do you set up a trust?
Meet with your financial team, review the types of trusts with them, and discuss which type aligns most with your financial strategies and goals. From there, determine what heirs to identify as beneficiaries, what assets or properties could be included, and what charities to consider including.
You’ll also need to name a trustee, either a corporate entity or a trusted friend or relative. When you’re ready and you have the go-ahead from your financial team, you can move assets into your trust.
Trust in Your Legacy
If you have a partner, kids, or a home, it’s important to take a preemptive and proactive approach to your asset protection and legacy. What’s more, financial knowledge is financial power.
Estate planning is one of those big topics, and working through it is worth your time and effort. In our community here at Passive Income MD, we want to help people create multiple streams of income and grow wealth, but we also want you to be able to protect it and pass it on. That’s where a trust comes in. I hope this was helpful in some way and that you’ll soon take actionable steps toward creating and passing on enduring wealth. Thanks for letting Passive Income MD be part of that journey!
Peter Kim, MD is the founder of Passive Income MD, the creator of Passive Real Estate Academy, and offers weekly education through his Monday podcast, the Passive Income MD Podcast. Join our community at the Passive Income Doc Facebook Group.