What Is a Family Trust?

When someone is looking into their family’s financial future, odds are they’re looking into a lot of estate planning options. A family trust might be one of them. But what is a family trust? How do they work? How is one created?

This guide walks through all the essentials of family trusts, including what they are, the different types of family trusts, and how a person can get started creating one.

What are family trusts?

A family trust is a common type of tool used in estate planning. While every trust is a little different, they generally function the same way. The trust becomes a separate legal entity that holds assets “in trust” until the appointed time — for example, when the parents pass, or the child reaches a certain age.

Each family trust has three important parties: the grantor, the trustee, and the beneficiary (or beneficiaries). The grantor is the person creating the estate, and the trustee is the individual appointed to manage the estate. Sometimes the grantor and the trustee are the same person, and other times they’re different people. Regardless, the grantor sets terms for the trustee to follow, all so the beneficiaries receive their share of the estate smoothly and efficiently.

Revocable vs. Irrevocable Trusts

There are two primary categories of trusts: revocable and irrevocable trusts. Revocable trusts are ones that can change if the grantor wants them to, including who the beneficiaries are, which assets are included, and more. Typically, they’re living trusts. 

In contrast, in an irrevocable family trust, the terms and conditions of the trust can’t be changed as soon as the trust is executed. It’s a permanent trust. Either type of trust can be a viable option for a family trust, so it’s recommended to talk with a financial planner or estate lawyer to discuss which is right.

Benefits of a Family Trust

There are several benefits of forming a family trust. First, a trust allows someone to fully control the terms and conditions of how the estate is administered. More importantly, putting assets into a trust can help someone’s family members avoid probate court. Probate can be an expensive, drawn-out process, especially if the trust has substantial assets, so avoiding it can greatly reduce stress for any heirs.

If someone has a large estate, certain types of trusts can help them avoid or reduce estate taxes when the trust assets are passed to the beneficiaries. For some families, this can create significant tax savings. It’s even possible to use a trust in conjunction with other planning tools, like a family LLC for estate planning. It’s highly recommended to consult with an estate planner or lawyer before jumping into any investment vehicle.

Types of Family Trusts

There is a wide variety of trust options that investors can create for their families, even beyond revocable and irrevocable trusts. Any of the options below could work, but again, it’s recommended that investors talk with an estate planning attorney for customized guidance.

Living Trust vs. Testamentary Trust

A living trust is a trust someone sets up during their lifetime, and most family trusts begin as living trusts. That way, the trust property can change and be reallocated as needed. Depending on the investor’s wishes, a living trust can be revocable or irrevocable. It’s even possible to set up an original trustee, successor trustees, and more, all depending on the estate’s needs.

Some families prefer to set up a testamentary trust, sometimes called an after-death trust. These trusts are irrevocable, and they’re essentially created by the wishes set out by an individual’s will and testament.

Special Needs Trust

Some families with dependents who need medical care or have other special needs dependents utilize a special needs trust to help provide for their loved one’s financial security. By using a trust, some families can ensure that their dependent will still be eligible for government-provided disability benefits like Medicare or the Supplemental Security Income program, while still getting some income from the trust.

Life Insurance Trust

Many people have already set up life insurance policies to protect their loved ones, but not everyone realizes that it’s possible to set up a trust to hold a life insurance policy. Some families choose to set up their insurance policy within a trust for relief from estate taxes when the policy is paid out. While this isn’t the right approach for every family, it can be a valuable tool.

Spendthrift Trust

Spendthrift trusts are especially common for families with young children (or dependents that need growth in their financial responsibility). A spendthrift trust sets out very specific terms for how and when the money can be released and used by the beneficiaries.

Charitable Trust

If someone wants part of their financial legacy to go toward charitable causes, they might consider setting up a charitable trust. This type of trust allows a person to separately allocate funds and assets toward the charitable organizations of their choice.  

This is, of course, not an exhaustive list of trust types. Even more choices can include marital trusts, generation-skipping trusts, and many more. Before jumping into an investment vehicle, it’s highly recommended to consult with a financial planner to learn more.

How to Set Up a Family Trust

Technically, someone can set up a family trust on their own. But it’s highly recommended to enlist the help of an estate planning attorney. Every state has slightly different terms for what constitutes a legal, viable trust. For example, some states have different legal requirements for trusts, such as notarizing them. Hiring a lawyer can help individuals ensure their trust complies with all state requirements.

That said, the basic process for setting up a family trust is largely the same. First, a person decides what trust to create and drafts a trust agreement document for it. Within that trust document, they’ll designate who the trustee is, who the beneficiaries are, and themself (and perhaps their partner, if applicable) as the trust grantor.

Finally, the grantor needs to transfer their desired assets into the trust, such as real estate properties, some of their bank account balance, and more. Done correctly, this process can protect some assets from creditors. Since this legal process technically involves a transfer of property ownership into a “business entity,” it’s a little complicated. That’s why it’s highly recommended to work with an attorney or financial planner to avoid any potential issues.

Try ZenBusiness

Managing finances can feel overwhelming, but no one has to do everything alone. ZenBusiness can’t help investors create a trust, but they can help with other needs. ZenBusiness can assist anyone who wants to start an LLC or who needs a registered agent for their family business. They’ll also provide support to stay compliant year-round.

Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.

FAQs

What is the point of a family trust?

Many families choose to create a family trust to provide financial benefits for their families long-term and to keep their assets protected and out of probate court when they pass away. Many trusts can also help significantly reduce a family’s burden for estate and gift taxes.

What is the downside of family trusts?

The biggest drawback to family trusts is that they can be a bit complicated to set up and manage. Often, these investors need to enlist an estate planning lawyer’s help to set up an effective trust.

What is the difference between a family trust and a regular trust?

Practically speaking, a family trust and a regular trust don’t function any differently. They’re the same legal structure. A family trust is just a regular trust that’s being used to meet the needs of family members (and potentially future generations) as opposed to other beneficiaries.

Can someone utilize a family trust if they have a family business?

Estate planning is extremely important for every family, but especially for those that have a family business wrapped in their estate planning. Using tools like a family trust can help families create a comprehensive estate plan, detailing the exact ways their money is passed on to the next generation as smoothly as possible.

Are the tax shelter benefits of a family trust really worth it?

Currently, the tax rate for estate and gift taxes maxes out at 40%, but usually only if the estate is larger than $15 million. If an estate doesn’t exceed the taxable threshold, forming a trust won’t give any estate tax savings.