The legalese: To state it accurately, a trust is a legal relationship in which one party holds property that was entrusted to him for the benefit of another. (Of course, it might not come as a surprise to you that there are better ways to explain things than using the legalese.)
The better explanation: A trust works like a bucket. Someone puts property into the bucket. That someone is often called the “trustor” or “grantor,” but many of our documents use the term “Trustmaker.” A second person (or institution) manages what’s in the bucket. In most documents, that manager is referred to as the “trustee.” The third person’s job is the one we all would like to have. This role is to receive some benefit from the property in the trust. This person is known as the “beneficiary.”
The tricky thing about trusts is that one person can play more than one role at the same time. Similarly, more than one person can play the same role. For example, a married couple can be the Trustmakers and also serve as the trustees. In most living trusts, the same person or persons serve all three roles. For example, a married couple can be the Trustmakers and also serve as the trustees. They put the property into the trust for their benefit and appoint themselves as managers.
Trusts Come in Different Models
Once we understand that the trust works like a bucket, we still need to understand the different types of trusts. Should your trust be revocable or irrevocable? Living or testamentary? Like cars, trusts come in different makes and models. Just as a father of six may select a minivan for his family rather than the two-seat sports car of his dreams, the Trustmaker must choose the model that suits his needs.
A Trusted Variety
First, you will need to choose between a revocable or irrevocable trust. This refers to the ability of the Trustmaker to undo the trust. A revocable trust can be undone, that is, revoked. An irrevocable trust cannot be undone, and generally, the Trustmaker cannot change the terms of the trust once it’s established.
Another choice is between living trusts and testamentary trusts. Living trusts, also known as intervivos trusts, are established during the lifetime of the Trustmaker. Testamentary trusts are established after the death of the Trustmaker. A testamentary trust is often created at the end of the probate process according to the instructions in the deceased person’s last will and testament. Having been described in the last testament it is called a testamentary trust.
Some Taxation Terms
Accountants will often ask whether a trust is simple or complex. This question isn’t asking how easy the trust is to understand or administer. It’s basically asking about distribution of the trust income. Simple trusts mandate payment of the trust’s income to the beneficiaries, while complex trusts do not mandate such payment.
Since we’re talking about taxation of trusts, we need to consider the term “grantor trust.” With this type of trust, the income the trust earns is taxed to the Trustmaker. Almost all revocable living trusts are grantor trusts, but some irrevocable trusts can be grantor trusts, as well, if the trust contains certain provisions.
If a trust is not a grantor trust, then the trust itself is considered a separate taxpayer, and is responsible for paying the taxes on its income. In other words, if it isn’t a grantor trust, the bucket must pay the taxes from the assets in the bucket.
The Most Common Combination
The most common type of trust used in estate planning is the revocable living trusts that are taxed as grantor trusts. These are trusts established during the Trustmaker’s lifetime, which he can undo if he so chooses. Irrevocable trusts are more commonly used when we are trying to help a family protect assets, especially in the realm of elder law.