As a financial advisor, one of my “unofficial duties” is acting as a sort of translator: Taking financial terms, jargon, or legalese that may be important but are hard to understand and explaining them in plain English. I really enjoy this part of my job, because it helps provide clarity…and the more clarity people have, the more confident they feel.
Helping people feel confident is one of the most important things any financial advisor can do.
One related group of financial terms that I am often asked about involve trusts.
Since trusts are widely used for a variety of estate planning purposes, I have prepared a simple primer of trust terms that should help with the translation.
First, a trust is simply a legal document that acts as a container to hold or own property, cash, securities, or other items of value.
There are three parties to a trust. The first is the maker of the trust, called the trustor or grantor, who establishes the trust. The second is the trustee who manages and carries out the terms of the trust. Finally, there is the beneficiary who receives the benefits of the trust, either in the form of income or outright distribution of assets.
Now, here is where many people sometimes get a little confused if they are setting up or dealing with a trust for the first time. You see, there are actually two forms of trusts: revocable and irrevocable. What’s the difference? A revocable trust can be changed by the grantor. For example, if the grantor ever wants to change which assets are inside a trust, or who the beneficiary is, a revocable trust enables them to do that.
An irrevocable trust, on the other hand, cannot be changed. Once established, it is fixed, with most details set in stone except under very specific circumstances. For this reason, most people only choose an irrevocable trust if they are trying to avoid triggering the estate tax or to protect assets from creditors, although there may be other reasons.
Two more types of trusts include a living trust and a testamentary trust. A living trust (also known as an inter vivos trust) is considered a revocable trust since it can be changed by the grantor. A trust created by a person’s will, known as a testamentary trust, is generally irrevocable. A living grantor may also establish an irrevocable trust by making an irrevocable decision to change title to property into the name of the trust. A typical example of such a trust would be an education trust fund set up by grandparents for a grandchild or a life insurance trust.
In a revocable trust, the grantor, the trustee, and the beneficiary may all be the same person. In most irrevocable trusts, each will be a different person.
When a grantor establishes a trust, it is funded by changing property titles to the name of the trust, which makes the property subject to the terms and control of the trust. For example, when a person establishes a living trust and changes the title of a home into the name of the trust, they have funded the trust with the retitled home. This asset now becomes part of the principal, or corpus, of the trust.
A grantor of a trust may reserve for themselves the power to manage the trust as a trustee. Alternatively, they may give those powers to another person. Commonly, a corporate trustee is named as the primary trustee, especially if the trust is expected to last many years. Banks with trust departments are most often named as a corporate trustee, since it is assumed the bank will be in existence for the life of the trust.
Trusts are often defined by their purpose. For example, a charitable remainder or charitable lead trust is used, as the name suggests, in charitable planning. Life insurance trusts allow the proceeds of a large amount of life insurance to pass, tax free, to beneficiaries. A Qualified Principal Residence Trust (QPRT) can be used to pass on a family or vacation home while allowing the grantor to live in the home.
As you can see, there are many terms related to trusts, and trusts themselves rarely make for light summer reading. But hopefully this makes the language of trusts easier to decipher in case you ever need to speak it in the future! As always, please let me know if you have questions, or if I can ever help you with anything related to trusts, estate planning…or finance in general.
Have a great week!