Estate planning is one of the most important steps in setting up your financial plan. By doing so, you’re able to preserve your assets and leave a lasting legacy for your family.

There are many approaches to estate planning; one of the most popular is a trust, which makes it easy to pass your assets down to the next generation. A trust can help you protect and secure your family’s wealth, not just for yourself and your children, but also for future generations.

How trust accounts work

When you hear the term “trust fund,” you may picture a privileged young person who has been handed a large sum of money from their wealthy family. And while that’s one example of what a trust can look like, trusts are a common estate planning tool for people of all incomes, including many middle-class families.

A trust is a financial arrangement where one party, known as the grantor, gives another party, known as the trustee, the right to hold and manage certain assets on their behalf. Many people use trusts as a part of their estate plan where, upon their death, a grantor’s assets go into a trust to be managed by a loved one who has been designated as the trustee.

Each trust also has a beneficiary, who is the person who will benefit from the trust. In many cases, the beneficiaries of a trust are the heirs of the grantor. However, someone could also set up a trust to benefit grandchildren, other family members, and even charitable causes.

Trusts have many benefits for wealthy and middle-class families alike, including the ability to avoid probate, which is a potentially costly and time-consuming legal process.

A trust is different from a will, which is what most people think of when it comes to estate planning. A will is a legal document that lays out your wishes for after you pass away, while a trust is a legal tool. Even if you have a trust, you will still need a will to direct how your affairs should be handled. Rather than thinking of it as an either-or situation, think of a will and a trust as two estate planning tools that can be used in tandem.

Why set up a trust?

A trust is a valuable tool that can help provide more control, privacy, tax savings, and more to your estate planning. They have some key benefits, some of which particularly benefit wealthy individuals planning their estates, while others are important for everyone.

Let’s talk about some of the reasons someone might decide to use a trust in estate planning.

Avoid probate

One of the most important reasons someone might choose to make a trust is to avoid their estate having to go through probate after they pass away.

Probate is a legal process that validates a will, appoints a personal representative or executor, and oversees the administration of an estate. Probate has several downsides. First, probate is a lengthy process and could last for upwards of a year, during which the assets in the estate may not be able to be distributed to heirs.

Probate can also be expensive. Not only are there court costs involved, but you may have to hire an estate attorney to help guide you through the process.

Another downside of probate is that it’s a public legal process. Anyone can see a listing of the assets and beneficiaries of an estate in probate. If you’d prefer for that information to remain private, as most people probably would, then you’ll want to use a trust instead.

Each state has different probate laws, so it’s important to find out how it works where you live. In some states, you may only need to go through probate if an estate is valued above a certain amount. In other states, probate may be required for all estates.

Research the laws in your state, and if you anticipate your estate having to go through probate, consider a trust instead.

Financial savings

Using a trust can result in financial savings in a few different ways. First, as mentioned, using a trust can help to avoid the probate process, which can be expensive. It may also help avoid legal disputes among beneficiaries, which could also result in costly legal fees.

Next, using a trust can help reduce estate taxes. Very large estates — those valued at more than $12.92 million in 2023 — are subject to federal estate taxes (state estate taxes may also apply).¹ But when you use certain types of trusts, the assets within belong to the trust rather than the decedent. As a result, estate taxes may not apply.

Finally, the probate process opens up the opportunity for creditors to make a claim against an estate. But as we mentioned, assets in a trust belong to the trust rather than the decedent. As a result, depending on the type of trust, trust assets may be protected from creditors.

Achieve a specific goal

One of the great things about a trust is you can use it for many different purposes. Yes, you can use it to set aside an inheritance for your children and grandchildren. But you can also use it for more specific goals, such as paying for someone’s education, establishing care for a loved one with special needs, or even supporting your favorite charitable cause.

Maintain control

Using a trust gives someone the opportunity to maintain more control over their estate, even after they’ve passed away. First of all, a grantor can set up exactly who they want their assets to go to. But more than that, someone can set certain criteria for when beneficiaries can receive their share of the trust assets.

For example, someone might set up a trust for their child or grandchild but stipulate that it must remain in the trust until that beneficiary reaches a certain age, such as 25. Additionally, a grantor may stipulate that someone can’t access all the trust assets at once but instead can receive a monthly or annual income.

A trust can provide peace of mind to someone leaving assets to someone who lacks financial responsibility. For example, suppose you’re setting up a trust to benefit your grandchild, who tends to use money irresponsibly. You would likely designate someone else as the trustee, so the grandchild doesn’t have direct access to the trust. You might also limit the amount the grandchild can take from the trust at any one time.

Read more: Why use a trust

Disadvantages of a trust

We’ve talked about some of the benefits of setting up a trust as a part of your estate planning, but we’d be remiss if we didn’t also discuss some of the downsides. Take these factors into account when deciding if a trust is the right estate planning tool for you.

• Cost of setting up and transferring assets: You will typically have to hire an estate planning attorney to help you set up your trust, and that could cost thousands of dollars. Many of the online services that create wills aren’t available for trust creation.
• Time investment and uncomfortable conversations: Setting up a trust can take time on your part. You’ll have to complete lots of paperwork and transfer your assets into the trust. You’ll also need to have conversations with loved ones related to the trust distribution, which could be uncomfortable or challenging.
• Limited tax benefits for most estates: A trust can have some major tax advantages for wealthy families, but the tax benefits for most estates are relatively limited, mostly because there are no estate taxes on most families anyway.

Read more: Estate planning primer: Trusts and estates

Alternatives to consider

If you’re unsure whether a trust is right for you, be sure to consider your other options. After all, there’s no one-size-fits-all approach to estate planning.

The first alternative to a trust is a will. In fact, everyone should have a will, even if they also have a trust. But for some people, the will by itself may be sufficient. A will may be enough for your financial plan if you have relatively simple finances and no significant assets to pass along. Keep in mind that any assets you do pass on may have to go through probate.

Another alternative to consider is joint ownership, which helps avoid probate just like a trust does. To accomplish this, you would simply make sure all of your assets — including your home, vehicle, and all financial accounts — are jointly owned with another individual.

Joint ownership could be a sufficient alternative to a trust for a married couple.

Different types of trust

There are several different types of trusts, each of which has different benefits and accomplishes a specific objective. The two primary types of trusts are revocable and irrevocable trusts, but there are also others to consider.²

Revocable trusts (living trusts)

A revocable trust, also known as a living trust, is one that a grantor creates and then maintains control over for their entire lifetime. The grantor can add and remove assets during their lifetime. They can also make changes to the trustee and beneficiaries. Ultimately, the assets within the trust are under the ownership of the grantor until they pass away or lose the capacity to manage their finances for some other reason.

A revocable trust doesn’t have some of the major benefits someone would want from a trust for estate planning. For example, it doesn’t reduce or eliminate estate taxes and doesn’t protect your assets from claims by creditors after you pass away. It doesn’t do these things because the grantor technically owns the assets in the trust.

However, a revocable trust has other key benefits, including ultimate flexibility for the grantor.

Irrevocable trusts

An irrevocable trust is largely the opposite of a revocable one. This type of trust can’t easily be changed once it’s been created. Additionally, once the grantor has moved assets into the trust, they can’t easily move them out again, as they no longer belong to them.

However, irrevocable trusts do have some major advantages in estate planning. Notably, they help shield assets from both estate taxes and creditors since those assets no longer belong to the grantor. For the same reason, the grantor of an irrevocable trust may qualify for certain income or asset-based government benefits because they’ve reduced their assets.

Other types of trusts

There are plenty of other types of trusts someone might use to ensure their assets are properly distributed after their death — or even during their lifetime. Those trusts include:^3,4

• Testamentary Trust: This type of trust is created through a will. Unlike revocable and irrevocable trusts, testamentary trusts don’t activate until the death of the grantor.
• Grantor Retained Annuity Trust (GRAT): A GRAT is a type of irrevocable trust that creates a source of income for a set period of time and helps wealthy families avoid estate taxes.
• Education Trust: Someone might create this type of trust to help a beneficiary pay for education expenses. It generally can’t be used for anything else.
• Spendthrift Trust: This type of trust limits the beneficiary's access to the assets within the trust. Instead, the trustee has full control of the trust assets.
• Charitable Trust: A charitable trust is one that someone creates to benefit one or more charitable organizations or causes. They also provide tax benefits for the grantor.
• Functional-Needs Trust: This type of trust may be used to benefit someone with special needs. This trust provides financial support without reducing a beneficiary’s eligibility for certain government benefits.
• Qualified Personal Residence Trust: Someone can use this type of trust to reduce their estate and gift taxes by moving their personal residence into the trust instead of maintaining legal ownership of it.
• Qualified Terminable Interest Property (QTIP) Trust: A QTIP trust can provide a source of income to a surviving spouse after the first has passed away but ultimately directs what happens to the assets after the second spouse dies.
• Generation-Skipping Trust: This type of trust is used to transfer assets to someone who is more than one generation removed from the grantor, such as a grandchild.

How to set up a trust

A trust is a legal arrangement that involves three parties: the grantor, the trustee, and the beneficiary. The grantor is the person who establishes a trust. The trustee is the person designated to manage the trust. Finally, the beneficiary (or beneficiaries) is the person who will ultimately benefit from the trust.

In most cases, the first step of creating a trust will be to hire an estate planning attorney to do most of the work on your behalf. While there are plenty of areas of your finances you can DIY, setting up a trust shouldn’t be one of them. Creating a trust is a complex process that requires precision and a knowledge of estate planning law.

Here’s how the process will work:

1. Choose the type of trust: Your estate planning attorney can help you choose the best type of trust for you based on your goals. Common types include revocable, irrevocable, and testamentary trusts.
2. Decide trust details: If you’re the person creating and funding the trust, you are the grantor. It’s also your responsibility to designate the trustee and the beneficiary(ies) and to decide how the assets will be distributed after your death.
3. Formalize the trust: On your behalf, your estate planning attorney will create a declaration of trust. The trust documents must comply with your state’s requirements and must be signed by you in the presence of a notary public.
4. Fund the trust: Once you’ve created your trust, you’ll retitle relevant assets in the name of the trust (unless you’re creating a testamentary trust).
5. Register the trust with the IRS: If you create an irrevocable trust, the trust will become its own entity for tax purposes. In that case, you’ll need to get a taxpayer identification for the trust.

Taxes & trust

We’ve already touched briefly on some of the tax benefits of certain types of trusts, but it may be helpful to do more of a deep dive.

First, a trust can be a complex financial tool. When you decide to create a trust, you’ll have additional paperwork to create. You may also have an additional tax return to file if the trust is a separate taxable entity (as irrevocable trusts are).

It’s critical that you maintain accurate records for your trust, either for yourself or for an accountant who handles your trust financials and taxes.

Now, let’s discuss several types of taxes relevant to the creation of a trust:

Estate taxes

The federal government charges an estate tax with rates ranging from 18% to 40%. This tax only applies to assets above $12.92 million in 2023. If you don’t have a trust or have a revocable trust and have an estate valued at more than $12.92, your estate will pay taxes on any amount that exceeds that value.

If you have an irrevocable trust, the assets within your trust won’t be subject to estate taxes. However, any assets not within the trust will count toward your exclusion of $12.92 million.

Finally, some states have their own estate taxes with thresholds considerably lower than the federal government’s. Be sure to research your state’s estate tax law when you’re creating your estate plan.

Gift taxes

Another tax that goes hand in hand with the estate tax is the gift tax. You may be subject to this tax if you make large financial gifts to another person. There’s an annual gift tax exclusion, meaning you won’t have to file a gift tax return for gifts of less than $17,000 to a single person.5

There’s also a lifetime gift tax exclusion, but it’s a shared exclusion with the estate tax exclusion. Therefore, if you use a portion of your $12.92 million estate tax exclusion by giving large financial gifts in your lifetime, your estate tax threshold after your death will be lower.6

This becomes important if you set up an irrevocable trust. When you deposit large assets into an irrevocable trust, you’re technically giving it away since you’ll no longer have ownership of it. As a result, those large gifts could reduce your available estate tax exclusion.

An estate planning attorney can help you strategically plan your gifting and trust transfers to avoid using more of your estate tax exclusion than is necessary.

Inheritance taxes

An estate tax is a tax on the estate itself, not the beneficiaries receiving it. However, some states impose an inheritance tax, which directly taxes people who have received a large inheritance. Consult an estate planning attorney about your state’s inheritance tax laws when creating your estate plan.

Income taxes

Assets within a trust can result in income, just like assets you personally own. Income earned in a trust could include interest, dividends, and capital gains.

If you have a revocable trust, you maintain ownership of all assets in the trust, and therefore, all income created is yours. You’ll claim it on your income tax return. However, an irrevocable trust is a separate taxable entity. You’ll need a tax identification number for your trust and will file a separate income tax return for any income earned in the trust. It’s the trust, not you, that will be responsible for income earned within the trust.

Choose trustees wisely

One of the most important decisions you’ll make when creating a trust is who will be the trustee or co-trustees. The trustee will be the person who will be the custodian of the assets within your trust and will be tasked with making important financial decisions. As a result, you want to make sure you’re choosing someone who will act as you would want in that situation.

Trustee options: Family members vs. third-party entities

When choosing a trustee, you can choose to designate either someone you know, such as a family member or friend, or you can choose a third-party entity, such as a bank, an attorney, or a professional fiduciary.

Each choice has some pros and cons. Choosing a third party can help eliminate conflict with loved ones, as well as emotional decision-making. However, the person making decisions may not know you or what you would want in a specific situation.

A third-party trustee may better understand the legal requirements and responsibility involved in being a trustee. However, many people still choose to designate family members.

Read more: Estate planning: How to choose your key people

Co-trustees: balancing family involvement and professional expertise

Rather than designating just one trustee, you can designate co-trustees. For example, you could designate a family member and a professional to serve as co-trustees. Then you get the benefit of having someone who understands the legal responsibilities and can make unbiased decisions, but still have someone involved who knows you and what you might want in a given situation.

You can also choose co-trustees who are both loved ones. You might do this if you want family to have to agree on certain decisions or if you have multiple loved ones and don’t want to have to choose between them. For example, if you have two adult children and are choosing a trustee, you may designate both as co-trustees so as to not leave someone out.

Whatever two parties you choose, it’s critical that they be able to communicate and set a clear delineation of responsibilities.

Preserving family dynamics and minimizing conflicts

Finances can be an emotional topic, especially when a loved one has passed away. When you choose a family member or another loved one as a trustee, you run the risk of emotional decisions being made, as well as there being conflicts in the family. Be sure to choose someone who can remain objective and separate their emotions from the important decisions that must be made.

Next steps

A trust is a powerful tool for estate and financial planning and for protecting your assets, not just in your lifetime, but after. Trusts come with plenty of benefits, including the ability to avoid probate and provide financial protection for your loved ones.