Making sense of Trusts

Recently I had another Financial Advisor come to my office and ask why someone would set up a trust. The Financial Advisor thought that a client would be diving into a very complex world that perhaps they would be better served in another product. Trusts are not just for the rich and are not necessarily complex.  For most people, trusts are just misunderstood.In fact, Trusts can be a very easy way to deal with estate planning situations whether it is a business or a family situation. Trusts can meet just about any objective or need.

The parts of a trust

To have a legitimate trust you need to have something to put into the trust like property or money. Also, there must be a Settlor (person who establishes the trust), a trustee (the person who manages trust) and of course beneficiaries. The beneficiaries are the main reason for creating a trust.

Two types of trusts

The first type of trust is called an Inter-vivos Trust. Inter-vivos is a living trust which is set up while the client is alive. It becomes active or in force once all the documents are signed and the trust is funded. One way common use for an inter-vivos trust is for income splitting. Parents who are in the highest tax brackets could set up an inter-vivos trust with their children as beneficiaries. The income from the trust can be paid to the children who are naturally in a lower tax bracket.

Living trusts are often used to deal with businesses as well.  Owners of successful and growing businesses can do an “estate freeze” where the current values of the shares of the business are frozen and the future growth will be attributed to new shares issued by the business. The new shares can put into a family trust with the spouse and/or children of the business owner as the owners of the new shares.

The second type of trust is a Testamentary Trust. Testamentary trusts are set up upon the death of testator. The trust is actually established in the will first and then comes into effect upon the death of that person. Testamentary trusts are far more common and are used for family issues. Let’s look at one example of a family that has a child with a disability. The parents will look after the child while they are alive but when they pass away a testamentary trust can be set up to make sure their disabled child is looked after for the remainder of that child’s life.  Another common use for Testamentary Trusts revolve around second marriages where one spouse, who owns the home solely (perhaps it is a home that was purchased while he/she was between marriages), passes away and sets up a trust so the spouse of that second marriage can live in the home until their death and then the home passes to the kids of parent who set up the testamentary trust.

Taxation of trusts

The two trusts are also taxed differently. Inter-vivos trusts are taxed at the highest marginal tax rate where as Testamentary trusts are taxed at the same graduated rates that individuals are taxed at. This can mean some tax advantages to setting up a Testamentary trust. Probably the most obvious is that there is no disposition until death. A living trust has a disposition at the time of setting it up.

Related article:  Marginal tax vs Average Tax

Remember trusts are not for the wealthy or the business owner. There are many reasons that trusts are a plausible tool for financial planning for all. Talk to your Financial Advisor on how a trust may help your specific situation.

Written by Scott Wallace

Scott Wallace has been in the Insurance and Investment industry for the past 19 years. His role is to take what is important to his clients and help them make those dreams a reality. Scott is a CFP, CLU and a Qualifying and Lifetime Member of the Million Dollar Round Table.

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