What Is a Trust?

Bridget F. Wall is an advanced planning attorney at Northwestern Mutual.

The Scout motto “Be Prepared” is smart advice to follow if you’re camping in the wilderness.

But it’s hard to know exactly what that means when it comes to your money. Sure, you need enough life insurance to protect your family and a well-padded emergency fund for when a leaky roof strikes. But you should also think about a trust. Whether you have young kids or you plan to leave a legacy for your family, a trust may help. We’ll explain what a trust is, how it works, types of trusts, and how to set up a trust.

How does a trust work?

The concept of a trust is pretty straightforward. It’s a legal arrangement that you can set up to help ensure your assets are managed according to your wishes, especially after your death. With a trust, one person (the trustee) agrees to hold assets for another person (the beneficiary).

The trustee is responsible for managing the assets in accordance with the terms of the trust. The beneficiary has the right to receive all or part of the trust assets, as specified in the trust agreement. A trust can be a great way to help make sure your loved ones are taken care of in the future.

Trusts can be revocable or irrevocable. Irrevocable trusts cannot be changed by the grantor after they are executed, but revocable trusts can be changed or terminated by grantors while they’re alive.

You don’t necessarily have to be rich to start a trust. They vary significantly in size, from relatively modest amounts to substantial wealth. There’s no useful number to consider an average. Some trust funds are created to provide for specific needs, such as education or health care expenses, while others may be established to manage significant family wealth across multiple generations.

Trusts are not a “set it and forget it” concept. They usually require ongoing management, including funding the trust, appointing trustees, and updating the trust document as circumstances change.

Benefits of a trust

A common reason people set up a trust is to help ensure they have control over what happens to their money, property, investments and other assets after their death, similar to a last will and testament. But unlike a will, trusts typically don’t go through probate—which means they don’t become public record and don’t need to go through a court.

A trust can also set rules around the financial care of your minor children, as well as when and how they should receive their inheritance when they get older. For instance, if you want to pass your money to your kids but are worried that they don’t have the financial savvy to handle it, you can establish how often they receive the money and what they can spend it on.

Another reason people set up a trust relates to taxes. Transferring assets into certain types of trusts can help minimize estate taxes. The transfer reduces the taxable value of the estate, potentially lowering an estate tax bill. Trusts can also provide opportunities for gift tax planning, allowing you to transfer assets to beneficiaries under gift tax exemptions. Some trusts also offer income tax benefits, such as the ability to receive a stream of income while enjoying immediate tax deductions.

When it comes to inheriting money from a trust, the tax implications can vary depending on the specific circumstances and the type of trust. A trust beneficiary usually doesn’t have to pay income tax on the inheritance. Exceptions include income the trust earned, such as interest, dividends or rental income.

Parts of a trust

Grantor: A trust is set up by a grantor, typically the person who is putting the assets into the trust and who establishes the rules and guidelines for how the trust operates.

Trustee: The grantor appoints a trustee—which can be a person or an institution—to manage the assets for the person (or organization) who will get them. The grantor and trustee can be the same person if the trust is revocable. After the grantor dies, the trust becomes irrevocable, and a successor trustee would be appointed.

Beneficiary: The beneficiary is the person (or organization) who eventually gets the assets.

Property: Many investments and other assets can go into a trust, including cash, real estate, other types of property and business interests. You can also assign a trust as a beneficiary of a life insurance policy or a retirement account.

Types of trusts

There are many kinds of trusts you can set up, depending on what your goals are for your assets. But here are a few examples:

Living trust

This common type of trust helps pass your assets along to your heirs, but it can also help you manage your assets while you’re living. You can be your own trustee and then designate a successor trustee to take over in the event you become incapacitated or when you pass away.

A living trust can be revocable or irrevocable. Revocable means you can change or cancel any of the trust’s provisions. Irrevocable means that once you set up the terms of the trust, it can’t be changed (or at least not without a lot of headache). A trust can also change from revocable while the grantor is alive to irrevocable after the grantor passes away.

Special needs trust

You can set this up to provide for family members with special-needs. If you were to leave an inheritance directly to children or relatives with special needs, they could lose their eligibility for government benefits like Medicaid and Social Security. The trust can help ensure your loved ones have money to cover their care while protecting their access to those benefits.

Irrevocable life insurance trust

This trust holds payouts from life insurance policies, which can help ease potential estate tax issues when your death benefit passes directly to your family members. If you set up this type of trust, you would make payments to the trust, and then the trust would pay the life insurance premiums.

Generation-skipping trust

This enables you to skip a generation of heirs, so you can pass your assets along to your grandchildren rather than your children.

Charitable remainder trust

If philanthropy is important to you, you could put your assets into a charitable remainder trust. The trustee is typically the charity of your choice, which would manage the assets for you so that you or your beneficiaries receive income from the trust. After your death, or at the expiration of the non-charitable term of the trust, the charity would receive the remainder of the assets.

Testamentary trust

This is established through your last will and testament. Unlike other types of trusts that are created during the grantor’s lifetime, a testamentary trust goes into effect only upon your death. It allows the grantor to specify how their assets should be distributed and managed after their passing, ensuring that their wishes are carried out according to their instructions. Testamentary trusts are commonly used to provide for minor children or individuals with special needs or to control the distribution of assets over time.

What are the advantages of a trust over a will?

Many people have both a trust and a will. It’s likely that you’ll need a will even if you create a trust. And most people spend more time on maintaining a trust than they do a will.

Here are three advantages to keep in mind when you think about opening a trust:

1. Probate Avoidance: One potential advantage of a trust is that it can help avoid the probate process involved with a will. Probate can be time consuming and costly. Assets held in a trust can pass directly to beneficiaries, providing a more efficient transfer of assets.
2. Privacy: Trusts can offer a higher level of privacy compared to wills since the distribution of assets through a trust generally remains private. Wills become part of the public record during probate.
3. Asset Management and Control: Trusts can provide greater control and flexibility of asset management. Through a trust, you can specify how and when assets are distributed to beneficiaries, ensuring your wishes are carried out after your death. This can be particularly useful for individuals with complex family situations or concerns about how beneficiaries will handle their inheritances.

Is a trust right for you?

Trusts can be a great way to help retain control of your assets long after you’re gone, but the rules and tax implications surrounding them can get complicated. You’ll need an attorney to help you create one, but you should also consider tapping other types of estate planning and tax professionals to help you navigate the best way to set up a trust based on your goals for your money and your family. If you have questions about trusts, your Northwestern Mutual financial advisor is a great place to start.

Bridget has over four years of experience in estate and tax planning, with an emphasis on elder law and special-needs planning. Prior to joining Northwestern Mutual in 2021, she was a private-practice attorney at a Milwaukee-based firm, specializing in estate planning, elder law and special-needs planning. Bridget holds a bachelor’s degree in economics and political science from Marquette University and a Juris Doctor from Marquette University Law School.