Why is this important to me?
Ordinary people, even those who aren’t millionaires or billionaires, may need trusts. At some point in your life, you may need to create a trust or be the beneficiary of a trust. If you’re in either of those positions, you’ll need to know about what trusts are, how they work, and how to create one. You’ll typically need a lawyer to create a trust.
By Lucy Carmel
Trust fund babies aren’t just born to millionaires and billionaires. They’re also sons and daughters of everyday people with a solid financial plan. A trust enables ordinary people with ordinary money to be prudent with their property.
People too often assume that their modest assets wouldn’t warrant the need for a trust. “But if you buy enough life insurance to provide for your spouse and kids, you’ve created an estate,” says Bill Hesch, CPA, Esq., and President of William E. Hesch, CPAs, LLC of Cincinnati, Ohio. “The trust would be used to hold the life insurance.”
Whether your assets consist of a home, life insurance or other investments, leaving money to your loved ones outright can cause unintended consequences. Earmarking specified amounts for specified individuals at specified times is a more secure option.
Reasons for regular people to set up trusts
“A big reason to set up a trust is to control who gets what and when,” says Hesch. “A trust is a vehicle that controls how much gets distributed and at what time.”
If your spouse or children are spendthrifts, a sudden life insurance windfall could be detrimental to their long-term financial health. You wouldn’t want them to receive $1 million at once. Even $250,000 could be squandered quickly.
“You don’t want college-age kids to ‘win the lottery.’ It could be a curse,” says Hesch. “People tend to spend most of the money the year they receive it.”
A trust can phase out distributions to moderate misuses of money and motivate heirs to pursue an education and a career as if they didn’t have funds coming their way.
Another concern is not only how much and how quickly heirs could spend money, but where they’d spend it. For children with drug and alcohol problems, for example, you want to be sure you’re not feeding an addiction.
With divorce rates as high as they are, families can also rely on trusts to keep funds in the family in the event of a separation.
A parent may want to guarantee that a spouse wouldn’t control money intended for children of a previous marriage. And many grandparents want to ensure that in the event of their child’s death, their money would go to grandkids, not daughters and sons-in-laws.
“Avoiding probate is another reason why you may choose to have a trust,” says Cathy Pareto, MBA, CFP, and President of Cathy Pareto and Associates, a Miami, Fla.-based financial planning firm. “A trust offers privacy advantages if the state where you live requires filing an inventory of assets and more.”
For the uninitiated, probate is the legal process of administering your estate.
Probate takes place in the county where you reside. “There are a lot of busybodies around. And people like to have a sense of privacy,” adds Hesch.
With a living trust, there’s minimal work to do in the probate court, and financial documents are kept confidential. You can avoid having to disclose all of your assets to potential nosy neighbors.
Not all trusts are created equal
Both Pareto and Hesch recommend setting up a living trust in many cases and advise using caution with testamentary, or “after death,” trusts.
“The testamentary trust does nothing to avoid probate,” says Pareto.
“A testamentary trust typically only benefits the attorneys, in my opinion,” adds Hesch, explaining that attorneys are required to oversee the trust in probate court. Trustees would be required to appear in court every two years, listing “every dime of income and expenses” they have. “It’s an administrative situation that’s time-consuming and costly.”
A living trust would be created during your lifetime. According to Pareto, the owner, or grantor, generally retains the power to change or revoke the trust. When the grantor passes away, the trust becomes irrevocable, which means that the trust cannot be changed, and the designated trustee must follow the rules set forth in the trust concerning the distribution of property and the payment of taxes and expenses.