Trusts - What is a Trust and How does it Work?

Trusts can be a great way to shelter money for your heirs, and also a great way to help provide for those that need it. A trust is a legal entity that earns income, pays taxes, and then distributes the earnings. There are trustees, that handle the trust and makes any investment decisions needed. The trustee pays taxes and distributes the income.

With a trust, you can give the trustee authority to do different things. For instance you can give your trustee the authority to match up and meet the needs of your heirs. So you can imagine the peace of mind that it can bring. Since there can be funds that cover things like college or or buying property, you can see how one will benefit one person at a given point in their life and while another item may be better suited for another.

Trusts can be set up as an accumulation trust, or as a regular distribution trust. An accumulation trust retains and then reinvests the income that it earns for future distribution.

Who Benefits from a Trust?

You can establish a trust for anyone really. The idea is that this will be a source of income for them. Often we see trusts for a person's parents, or their spouse, and of course children and even close friends. There are different time frames too for how long a trust fund can last. Some might choose a trust to last for a parent's lifetime. Another may last until a child turns 25, and another might last until a grandchild finishes high school or college.

So how long does a trust fund last? It depends on if the fund is revocable or irrevocable, first of all. If it is irrevocable then you cannot make any changes once the trust is set up. When you have a revocable trust, you can opt to make modifications over time if need be. So what other difference are there between revocable and irrevocable trusts?

Irrevocable Trusts

Irrevocable Trusts don't allow for any changes, and you also don't have any control over the assets. You cannot benefit from the assets of an irrevocable trust and gifts are limited to 10,000 dollars annually. You can sometimes avoid estate taxes, it just depends so do more research for your particular situation and trust.

Revocable Trusts

You can modify a revocable trust for your lifetime, and you control the assets and pay for the taxes. You can transfer the assets in and out. There are no annual limits to the transfers. They will be taxed as part of your estate, whereas with the irrevocable that isn't always the case.