As families accumulate significant assets, a basic will may not address every issue involved in transferring and managing wealth. A will generally takes effect at death and directs the distribution of assets that pass through the probate process. A properly structured trust can provide additional instructions for how selected assets are managed, invested, and distributed during a person's lifetime and after death.

A trust fund is not a specific type of trust. Rather, it generally refers to assets placed into a legal trust arrangement for the benefit of one or more beneficiaries. Depending on its terms, a trust can address estate administration, privacy, control over distributions, support for beneficiaries, charitable objectives, and certain tax or asset-protection considerations.

The appropriate structure depends on the family's assets, beneficiaries, state law, tax situation, and long-term objectives.

Revocable and Irrevocable Trusts

Two broad categories frequently appear in estate planning: revocable trusts and irrevocable trusts.

Revocable Living Trusts

A revocable living trust generally allows the person who created the trust, known as the grantor or settlor, to retain substantial control during their lifetime.

The grantor can often:

  • Amend the trust
  • Revoke the trust
  • Change beneficiaries
  • Change distribution instructions
  • Serve as trustee
  • Continue using trust property for personal purposes

A revocable living trust is frequently used as part of a probate-avoidance strategy. Assets properly transferred to the trust may generally be administered by a successor trustee after the grantor's death without going through probate for those assets.

However, a revocable trust does not automatically eliminate probate for every asset. Property that was never transferred to the trust, assets governed by beneficiary designations, and certain other property may be handled separately.

A revocable trust also generally does not provide the grantor with meaningful protection from their own creditors because the grantor retains control and beneficial enjoyment of the assets.

Irrevocable Trusts

An irrevocable trust generally involves greater restrictions on the grantor's ability to change or reclaim trust property.

Depending on its terms and applicable law, transferring assets to an irrevocable trust can change:

  • Ownership
  • Tax treatment
  • Beneficiary rights
  • Control over investments
  • Distribution authority
  • Exposure to certain creditor claims

Some irrevocable trusts are specifically designed for estate-tax planning or asset protection.

However, simply labeling a trust “irrevocable” does not guarantee protection from creditors or eliminate estate taxes. The effectiveness of a structure depends on the trust's provisions, timing of the transfer, applicable state law, and the grantor's retained rights and interests.

Transfers made after a creditor claim arises, or transfers intended to defraud creditors, can create separate legal problems.

Trusts for Generational Wealth Planning

Different trust structures can address different family objectives.

Dynasty Trusts

A dynasty trust is designed to hold assets for multiple generations.

Depending on jurisdiction and structure, a dynasty trust may allow assets to remain in trust for children, grandchildren, and later descendants rather than being distributed outright to each generation.

Estate and generation-skipping transfer tax planning can be important when designing these structures.

The federal generation-skipping transfer tax system imposes specific rules and exemptions, while state laws can impose additional requirements or limitations.

A dynasty trust therefore requires careful coordination of the trust terms, funding strategy, tax allocations, and governing law.

Special Needs Trusts

A Special Needs Trust (SNT) can provide resources for a beneficiary with a disability while potentially preserving eligibility for certain means-tested government programs.

The treatment depends on the type of special needs trust and the rules governing the particular public benefit.

For example, a properly structured trust may allow assets to be used for supplemental expenses without simply transferring those assets directly to the beneficiary.

Because Medicaid and Supplemental Security Income have specific eligibility rules, special-needs planning should be coordinated with an attorney familiar with the applicable benefits programs.

Spendthrift Trusts

A spendthrift provision can restrict a beneficiary's ability to voluntarily transfer certain trust interests and may provide protection from some creditor claims under applicable state law.

The protection is not unlimited.

State statutes can contain exceptions for particular types of claims, and the protection available to a beneficiary can depend on the trust's structure and whether the beneficiary also has control over the trust.

Trustee Responsibilities

The trustee is responsible for administering the trust according to its governing document and applicable law.

The trustee may be an individual, family member, professional fiduciary, bank, or trust company.

Duty of Loyalty

Trustees generally must act in accordance with their fiduciary obligations and avoid improper self-dealing and conflicts of interest.

Trust assets should be managed for the benefit of the beneficiaries rather than for the trustee's personal financial interests.

Duty of Prudence

Investment decisions generally must be made with appropriate care and attention to the trust's objectives, terms, and applicable fiduciary investment standards.

A trustee may need to consider:

  • Investment risk
  • Diversification
  • Liquidity
  • Income requirements
  • Time horizon
  • Distribution obligations
  • Tax consequences

The trust document may also establish specific investment restrictions or powers.

Duty of Impartiality

When a trust has multiple beneficiaries, the trustee may need to balance competing interests.

For example, a trust could provide income to a surviving spouse while preserving principal for children from a previous relationship.

The trustee must follow the trust's terms while observing applicable fiduciary duties concerning different classes of beneficiaries.

Record-Keeping and Reporting

Trust administration generally requires detailed records of:

  • Income
  • Expenses
  • Investments
  • Distributions
  • Tax payments
  • Professional fees
  • Trust assets

Certain trusts may also have federal income-tax filing obligations, including Form 1041, U.S. Income Tax Return for Estates and Trusts.

Not every trust is taxed in the same manner, however. Revocable grantor trusts, irrevocable grantor trusts, and nongrantor trusts can have substantially different tax treatment.

Trust Taxation and Estate Planning

Trust taxation is one of the areas where generic estate-planning advice can become misleading.

A revocable living trust is generally treated as a grantor trust for federal income-tax purposes while the grantor retains the relevant powers. The income is generally reported by the grantor rather than treated as a separate income-taxpayer arrangement.

An irrevocable trust may also be classified as a grantor trust depending on the powers retained by the grantor. Other irrevocable trusts may be separate taxpayers and may file Form 1041.

Estate-tax consequences are similarly dependent on the structure.

Transferring property into an irrevocable trust does not automatically remove the property from the grantor's taxable estate. The specific terms and retained interests matter.

Funding the Trust

Creating a trust document is only part of the process.

The trust generally needs to be funded with the assets that the trust is intended to control.

Depending on the asset, this can involve:

  • Retitling bank accounts
  • Transferring brokerage accounts
  • Recording real-estate deeds
  • Assigning certain business interests
  • Reviewing life-insurance ownership
  • Coordinating beneficiary designations

Retirement accounts require particular care. Simply retitling an IRA or qualified retirement account into a trust is generally not the same process as transferring ordinary investment assets.

Instead, beneficiary designations and applicable retirement-account rules must be reviewed as part of the estate plan.

Step-by-Step Trust Planning Process

1. Identify the Objective

Determine what the trust is intended to accomplish.

Possible objectives include:

  • Probate avoidance
  • Controlled distributions
  • Incapacity planning
  • Special-needs planning
  • Estate-tax planning
  • Multigenerational wealth transfer
  • Charitable giving
  • Asset protection

A trust structure should follow the objective rather than the other way around.

2. Inventory Your Assets

Create a complete list of:

  • Bank accounts
  • Brokerage accounts
  • Real estate
  • Business interests
  • Retirement accounts
  • Life insurance
  • Personal property
  • Existing trusts

The ownership and beneficiary designation of each asset should be reviewed.

3. Work With an Estate-Planning Attorney

Trust law is heavily dependent on state law.

An estate-planning attorney can evaluate the proposed structure, prepare the trust document, coordinate related wills and powers of attorney, and identify assets requiring separate treatment.

Complex situations may also require coordination with a CPA, tax attorney, financial adviser, or professional trustee.

4. Fund and Maintain the Trust

After signing the trust documents, complete the necessary transfers and beneficiary updates.

The plan should then be reviewed periodically after major events such as marriage, divorce, births, deaths, relocation, business sales, major asset purchases, or significant changes in financial circumstances.

The Bottom Line

A trust can provide a structured framework for managing and transferring family assets, but there is no universal trust structure that accomplishes every estate-planning objective.

Revocable living trusts can provide lifetime management and may help avoid probate for assets properly transferred to the trust. Irrevocable trusts can serve more specialized estate, tax, or asset-protection purposes, but they generally involve greater restrictions and require careful legal design.

Specialized structures such as dynasty trusts, special needs trusts, and spendthrift trusts can address particular family circumstances, while trustee fiduciary duties help govern how trust assets are administered.

The most important step is matching the trust structure to the family's actual objectives, assets, beneficiaries, and applicable law. Proper funding and ongoing administration are just as important as drafting the original document.

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