This article originally appeared on Parent Portfolio and has been republished with permission.
Do you have assets that you want to pass down to your children or grandchildren? Although you mention them in your Will, it still has to be verified in court. Having a family trust avoids this judicial process and is one less worry for your children.
Without a family trust, your children will have to pay attorney fees and other administrative expenses from their inheritance.
Elvis Presley's estate was worth over $10 billion. Sadly, the heirs lost more than 70% of his estate due to probate!
What Is a Family Trust?
A family trust is a legal agreement where a person transfers their assets to a third party who holds and manages the designated recipients' assets when the grantor passes away.
The legal term for this arrangement is called a trust agreement document. The person who transfers their assets is called the grantor. Additionally, the described third party is the trustee, and the designated recipient is called the beneficiary.
For example, parents want to transfer their homeownership of a townhouse to their children if they unexpectedly pass away. They create a trust agreement that assigns the grandparents as the ones in charge of the property until the children become adults.
In this scenario, the parents are the grantor, the grandparents are the trustees, and the children are the beneficiaries.
Technically, the trustee doesn't have to be a relative but can be someone else, such as a company or any legal entity.
What Is Probate?
Probate is a legal process validating a deceased person's last and testament. An executor will manage the estate and verify the involved parties fulfill the will's intentions.
For example, the executor will liquidate stocks and pay any debt due to creditors, administrative fees, taxes, etc. Afterward, the executor will allocate any remaining assets to the heirs or benefactors.
Benefits of a Family Trust
A family trust can protect assets from creditors, claims, and other administrative fees. So, if the grantor had debt due to credit cards, the trust assets are hidden from creditors.
Avoid Estate Tax
Trusts provide tax advantages preventing the IRS from fully taxing the assets held in a trust.
According to the Internal Revenue Service (IRS), the federal estate tax is a tax on any property transferred upon your death. These properties include assets, such as cash, real estate, insurance, annuities, and business interests.
When a will goes through the probate process, the information becomes public information and available for anyone to find.
Qualify for Medicaid
Adding assets to a family trust lowers one's countable assets allowing them to be eligible for Medicaid. According to Commonwealth.com, a person needs to contribute to the trust five years before applying for Medicaid.
Living Trust vs. Testamentary Trust?
A living trust is an agreement created while the grantor is still alive. This kind of trust allows a grantor to pass legal ownership upon their death and yet control the assets while still alive.
On the other hand, a testamentary trust is an assignment of one's assets formed from their last will (and testament) after they pass away. However, a testamentary trust does not avoid probate because it needs to be confirmed by the judicial system.
The main reason people choose between a living trust and testamentary trust is cost. Setting up a living trust comes with a higher upfront cost.
For example, my husband and I hired an estate planning lawyer to create a family trust. Our lawyer would send us documents for our review. Any work she had to do, such as respond to an email or correct any typo, was an extra cost.
However, heirs could lose more money on the back end with a testamentary trust due to probate. Thus, the cost of setting up a family trust can be minimal compared to the money saved!
Revocable Trust vs. Irrevocable Trust
A revocable family trust is where the grantor can change the terms of the trust or cancel it entirely. A revoked trust returns all the assets to the grantor. However, after the grantor passes away, the trust becomes irrevocable.
In contrast, an irrevocable family trust is a trust that a grantor can not change or revoke. The grantor can not remove any assets held in the trust. The benefit of this kind of trust is that it avoids estate taxes. Instead, the trust will pay the gift taxes, which are relatively lower than estate taxes!
Our family trust is a revocable one. When our children act naughty, my husband and I joke that we're removing them from the trust.
Who Should Have a Family Trust?
Anyone whose financial goal is to build and transfer generational wealth should have a family trust as part of their estate plan. The primary benefit of a family trust is avoiding probate and all the costs associated with it. My husband and I created an estate plan once we had our first child.
However, people shouldn't underestimate how much they own. Having any kind of property that helps improve someone's life is always worth protecting.
Regardless, if your asset is a small sum in a company 401k or a vehicle, having a family trust is necessary to maximize your assets' value that you pass down to your heirs.
Even if you don't have a child, the beneficiary can be any family member. You might have a niece or nephew who you can help support!
How to Set up a Family Trust
Hire an Estate Planning Attorney
There may be an estate planning tool online. However, I recommend scheduling a meeting with an estate planning attorney. Let them worry about all the legal jargon involved, such as qualified terminable interest property.
You want to be sure all your bases are covered. Hence, it's better to leave it up to a professional.
Network with your business associates or co-workers to receive a recommendation. The right financial advisor will recommend an attorney that can help you protect your wealth.
Determine Your Trustees and Beneficiaries
Although the lawyer will be taking care of preparing all the legal documents, especially the trust agreement, there are a few things you need to address:
Who are you going to assign as the trustee to own and manage your assets?
And, who are you to elect as your beneficiaries to benefit from the assets?
Are there any special conditions that you want to add?
For example, the beneficiaries of our family trust are our children. We assigned one of the grandparents as the trustee to manage the estate upon my husband and I's death.
Furthermore, we had the trustee (i.e., a grandparent) responsible for managing the estate until the children become legal adults.
Make Family Trust a Beneficiary
Once you have our trust created, the next step is to update all your assets and assign the trust as the beneficiary.
For example, retirement accounts require a beneficiary. Most people designate their surviving spouse or children as a beneficiary. In this case, the beneficiary should be the name of the trust.
Some of our assets that we assign the family trust as the beneficiary are our 401k, life insurance policy, annuity, mutual funds, and investment properties.
A family trust is an excellent way for asset protection after you pass away. A trust allows the beneficiaries to avoid the costs associated with probate and keep the grantor's net worth private.
The trust document gives another party the right to manage the assets in an estate.
Regardless of what kind of property you own, if you can help someone after you pass away, I recommend you do it. Seek advice from an experienced estate planning lawyer to help you keep your wealth.
I'm not trying to create a "trust fund baby" with my kids. Thus, I make it a point for the kids to understand personal finance and its monetary value.