You've heard the term "trust," but what does it mean, exactly? Trusts are a form of owning property, created by law, where one party, the trustee, holds legal title to property for the benefit of one or more people, called beneficiaries. There are different trust types, used for different purposes. Trusts can be simple or complex, and can have an important role in managing your finances and in your estate plan.

Basic Trust Terms and Functions

Trust Creation and Basic Roles

Trusts are created when a property owner, called the "grantor," "creator" or "trustor," transfers ownership to another party, called the "trustee." The trustee then holds legal title or ownership, and follows the trust document's terms in dealing with the property. The trust and trustee operate for the benefit of one or more beneficiaries.

Sometimes the same person or entity holds more than one role. For example, a grantor could be also be trustee or one of the beneficiaries, but not the only one. There are limits, however, depending on the type of trust and other laws, such as tax laws.

Trust Types and Features

There are several trust types and features, each serving a specific need or function. An estate planning attorney can help you decide what your needs are and draft the right trust for you.

Trusts can be "revocable" or "irrevocable." In a revocable trust, as the grantor, you can change trust terms or end the trust if you like at any time. If you choose an irrevocable trust form, it's permanent; trust terms aren't subject to change, and you can't end it voluntarily.

Trusts are also classified based on time of creation. A "living trust" is created during the grantor's life, while a "testamentary" trust is set up in the grantor's will.

Trust Creation and Operation

A trust is created by writing the trust document, containing the trust's terms and identifying the grantor, trustee and beneficiaries. Assets placed in the trust, the corpus, are transferred to the trustee's ownership. Completing formal steps includes signing ownership papers, such as real property deeds and bank or investment account papers.

The formal steps in creating a trust must be followed, even if you're the grantor and trustee, or co-trustee with your spouse. If required procedures aren't followed, your trust won't be valid and operate as you planned.

Testamentary trusts, set out in your will, require probate of your will. Depending on the law in your state, further court action may follow, such as accounting to the probate court by the trustee periodically. These measures aren't required for living trusts. Even so, many people select a testamentary trust type, in part because no present transfer of property is needed.

There are pros and cons to each trust type and feature, so planning with your attorney is the best way to make sure your trust documents serve your needs.

Choosing Your Trustee

Often people look at and choose trusts to make sure their affairs and beneficiaries are taken care of when they are unable to act. Terms of a living trust taking action if you're incapacitated or a testamentary trust providing for your affairs after death are good examples. Selection of your trustee or trustees, and their successors is a critical decision in trust planning.

Your trustee choices include individuals or institutions; bank or trust companies are examples. However, institutional trustees often add cost and formality to your trust scheme, and may not be needed, but are always impartial. Many people look to trusted family members and friends to serve as trustees. The personal connection to you and your beneficiaries is often an advantage in running your trust.

When choosing the trustee type and the particular trustee, first consider these factors: your personal needs, beneficiary needs, trust complexity and trustee abilities and qualifications. If you ask a relative or friend to serve, think ahead to how he will deal with conflict and his ability to carry out trust terms and your plan; often a close contact is the best candidate for these reasons. Also give a candidate the freedom to say no.

Give the same considerations to successor trustees you nominate in your trust. You don't know the future, and your named trustee may be unable or unwilling to serve later on.

Keeping Community Property in Mind

Address the effect of community property laws when planning your trust. If community property is used to set up your trust, for example, language acknowledging the property type and it's reversion to community property upon revocation of a living trust may be needed. Tax and divorce law issues may come up if it isn't clear how the property is classified.

Questions for Your Attorney

  • Does placing property such as my house into a living trust affect my mortgage or insurance policies?
  • When should I use an irrevocable trust?
  • Can a court alter the terms of my testamentary trust, or could someone challenge the terms or validity of my trust if I'm incapacitated or dead?