Wealth Management: How to Set up a Trust

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What exactly is a trust, and how do you go about setting one up? This article walks you through the answers.

Many people establish trusts as part of their estate planning process. Doing so can provide management assistance for the beneficiaries, including yourself if the need arises, help you save on estate taxes, potentially avoid probate, increase privacy, provide for special needs of loved ones in the manner you desire, and preserve your assets for generations to come. But what exactly is a trust, and how do you go about setting one up? This article walks you through the answers.

A Simple Explanation

Cadence Bank Executive Vice President and Managing Executive of the Asset Management and Trust division Patrick Pacheco explains trusts in an easy-to-understand way:

“A trust is simply a tool to give an individual or entity ownership of an asset to hold and manage for the benefit of someone else,” Pacheco says. "The person giving the asset is referred to as the grantor, the holder of the asset is the trustee, the person receiving the asset is the beneficiary and the relationship is a trust.”

“Or, suppose I give you a dollar and ask you to hold and manage it for my son’s benefit,” he continues. “If you accept the dollar on that condition, we’ve just created a trust relationship, with myself as the grantor, you as the trustee and my son as the beneficiary.”

Types of Personal Trusts

There are many different kinds of personal trusts, but they all fall into one of two categories:

  • Inter vivos or lifetime trusts. These are created during the grantor’s lifetime in order to transfer property to beneficiaries, which typically include family members and charities. These trusts can be further categorized as revocable and irrevocable. Revocable trusts, also referred to as revocable management trusts or living trusts, can be changed or revoked during the grantor’s lifetime and are generally for the primary benefit of the grantor during that time. Irrevocable trusts, on the other hand, generally can’t be changed or revoked absent some legal authority and the beneficiary’s consent.
  • Testamentary trusts. These don’t become effective until after the grantor dies. Typically, they are part of the grantor’s last will and testament or arise under the terms of their revocable management trust after the grantor’s death.

Common Personal Trusts

Within these two broad categories are a wide range of different types of personal trusts. The most common personal trusts are:

GST Exempt or Non-Exempt Gift Trusts. This trust is designed to receive gifts of liquid and/or illiquid assets by taking advantage of the grantor’s lifetime gift tax credit so that future appreciation of the gifted assets occurs outside the grantor’s estate. These trusts can also take advantage of the grantor’s generation skipping tax exemption (GST Exempt Gift Trust), but are not required to do so (non-Exempt Gift Trust).

Irrevocable Life Insurance Trust (ILIT): This trust is a gift trust that holds life insurance on the grantor’s life as its primary asset. This allows for substantial appreciation of the trust via receipt of the death benefit on the grantor’s life and removes the proceeds of life insurance from the grantor’s estate. But aren’t life insurance proceeds tax-free? Yes, they are income tax free; however, the death benefit is included in the grantor’s estate for estate tax purposes.

Marital and Bypass Trusts: These trusts are common testamentary trusts found in wills designed to ensure optimum use of the unlimited estate tax marital deduction and the credit against estate tax or applicable exclusion amount. These trusts can also provide protection for future creditors or spouses, ensure assets pass to those the first-to-die spouse desires on the death of the survivor, and provide management assistance for the surviving spouse.

Charitable remainder trust (CRT). This trust may be useful if you have a highly appreciated asset and want to provide for both yourself or your family heirs and a charitable organization. Since you can secure a partial income tax charitable deduction and sell the appreciated asset capital gains tax free inside the CRT. Appreciated assets are placed in the trust while you’re alive, and you or family members (e.g. children) receive distributions first, often from the proceeds of the assets sale. Once the non-charitable interests have terminated (after 20 years or less or upon the death of a beneficiary), any remaining assets are distributed to your designated charity.

Intentionally defective grantor trust (IDGT) and Grantor Retained Annuity Trusts (GRAT). These trusts are primarily used for estate tax reduction purposes by transferring the appreciation of assets to beneficiaries while the grantor retains the principal value plus a small additional amount in the form of interest or a small return of appreciation. Assets, including business ownership interests, are transferred to the IDGT or GRAT while you’re alive, thus removing them (assuming certain conditions are met) from your taxable estate. Also, income generated from the assets is taxed to you, not your family heirs, so assets grow free from the burden of income taxes.

Set Trust Objectives

To determine whether you need a trust and, if so, which type of trust you should establish, Pacheco says you should start by deciding exactly what you want to accomplish with your trust.

“For example, do you want to manage and protect assets for your child or children?” he says. “Ensure that assets are passed on to your spouse or a charity after you die? Save on gift and estate taxes? Or protect assets from creditors? These are all legitimate reasons for establishing a trust. That being said, make sure there is a reason as well as a trust structure that can provide a solution you find suitable.”

Pacheco recommends meeting with your team of advisers to discuss and help frame these questions before sitting down with a trust and estate lawyer to begin the actual drafting process. This team usually consists of your banker, wealth manager, CPA and the estate attorney—all of which bring a different perspective to the table

“Also, I strongly recommend using a board-certified trust and estate planning attorney to draft your trust and other estate planning documents,” says Pacheco. “There are just so many intricacies involved in setting up trusts that you want to work with an attorney who specializes in this area in order to provide the best potential for success.”

Choosing a Trustee

One of the most important decisions to make when setting up a personal trust is who will be the trustee. There are two main options: designating an individual trustee, such as a close friend or family member, or a corporate trustee, such as a bank or trust company. In some circumstances, you can name an individual and a corporate trustee as co-trustees.

Pacheco urges clients not to base this decision on cost alone. “While there’s a cost to designating a corporate trustee, it’s often far less than expected, especially if the trust is large and complex and/or professional money management will be required even with an individual trustee,” he says. “Also, friends and family members may not have the knowledge or time necessary to handle the complexities involved in being a trustee.”

The duties of a trustee typically include managing trust assets prudently and making distributions to beneficiaries according to the grantor’s wishes as expressed in the trust. “Using a corporate trustee may cost as little as 15 to 20 basis points over the cost associated with an individual trustee who utilizes a professional money manager. This is a small price to pay for professional money management, along with professional and experienced trustee services,” says Pacheco.

On the flip side, if a trust is relatively simple and the money management duties are minimal, a friend or family member may be able to handle the trustee duties just fine as long as they remember they are legally enforceable duties and act accordingly.

Get in touch

For more information on how to set up a personal trust, contact Cadence Bank with your questions about setting up a personal trust.

This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.

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