A trust is a legal structure that many people use for asset protection and estate planning. A trust splits legal and equitable ownership of the trust assets, which protects the assets from creditors during your lifetime. It also ensures that the assets get distributed according to your wishes after you die.
Learn how trusts get formed and why your trust needs to be funded.
Structure and Function of Trusts
Trusts have complex rights and duties, which can make them confusing for many people. All trusts involve three parties:
The grantor creates the trust and puts assets into it. The grantor also sets up the conditions for the distribution of those assets from the trust.
A grantor can create two types of trusts. A lifetime trust, or living trust, is created during the grantor’s lifetime. The grantor puts assets into the trust by changing ownership of the assets from the grantor’s name to the trust’s name.
For example, a grantor puts a house into a trust by assigning the deed to the house to the trust. After the assignment, the trust owns the house.
A testamentary trust gets created upon the grantor’s death. The grantor puts assets into the trust through a will. The will goes through probate and the assets designated for the trust get transferred by the will’s executor.
The beneficiary receives the assets or proceeds from the contents of the trust. The beneficiary and the grantor can be the same person. For example, in an asset protection trust, the grantor puts all of their assets into a trust and then receives an allowance as the beneficiary.
If the grantor ever gets sued, the grantor can only lose the assets outside the trust.
The trustee follows the instructions of the grantor to use or distribute to the beneficiary assets in the trust. The trustee owes the trust both a contractual and fiduciary duty to carry out the instructions. If the trustee violates the instructions, the grantor or the beneficiaries can sue them. The same person can act as trustee, grantor, and beneficiary.
Formation of a Trust
A trust is formed with a legal document, which serves to create a trust entity. This entity is similar to a partnership. According to the trust document, the grantor transfers ownership of the assets to the trust. This trust holds legal ownership of the assets.
There are two answers to the question, “Why does my trust need to be funded?” The first answer comes from New York State law. Lifetime trusts in New York must contain assets to remain valid. Once the assets get distributed, the trust disappears. Similarly, when the trust gets funded, it appears.
The second answer has to do with the purpose of the trust. A trust exists to hold, manage, and distribute property. Without property in the trust, the trustee has nothing to manage and distribute, and the beneficiary cannot receive anything.
How a Trust Operates
The grantor can set almost any condition on the management and distribution of the trust assets. This gives the grantor control over what the beneficiary has to do to get their distributions. For example, the grantor can limit the beneficiary’s access to trust distributions unless the beneficiary attends and graduates from college.
In this respect, trusts operate similarly to wills. But trusts can operate during the grantor’s lifetime instead of springing into existence upon death. More importantly, a lifetime trust does not go through probate. This saves time and money.