Some people think of a trust as an estate planning tool reserved for only the very wealthy. But for those who would like to control how they receive their inheritance, a trust may be a great solution. There are two broad categories of trusts: an inter vivos trust, or living trust, operates during your lifetime (though may continue after your death); a testamentary trust — the one we will focus on here — is established under a will and comes into effect at death.
Basics of a trust
A testamentary trust is an estate planning tool established by the testator (the person who has made a will) to provide for their heirs. The trust can include any assets — typically investments, cash, life insurance proceeds, or real estate. You appoint a trustee — which can be one or more individuals, a trust company, or both — to manage the funds. The beneficiaries enjoy the benefits of the property according to the terms of the trust as established by the testator. Most testamentary trusts are spousal trusts or family trusts, though there are other specialized types.
Assets transferred to a qualifying spousal trust are entitled to the same rollover treatment available when transferred directly to the spouse. Assets are received by the trust at cost, instead of at fair market value — maximizing income on capital. No tax is paid on capital gains until your spouse’s death, or when assets are sold.
A spousal trust allows the testator to control how the assets are used for various situations. For example:
- If you have children from a previous marriage, your current spouse can receive income from a spousal trust and possibly capital during his or her lifetime, with the remaining assets going to your children.
- If you are concerned whether your spouse has the financial expertise to properly manage your assets, the trustee can manage funds to support your spouse’s lifestyle during his or her lifetime, then distribute the remaining assets to your other beneficiaries.
- If your spouse suffers from an illness or disability, a spousal trust can ensure that he or she continues to receive proper care, financially, after your death.
Family trusts are established for children, grandchildren, or other relatives. Though they offer tax advantages, family trusts are primarily established to provide direction over the use of the inheritance. For example:
- If your child or other beneficiary is not able to properly manage the assets, a trustee will do so on his or her behalf.
- If your grandchildren or other beneficiaries are minors, the trust can transfer assets once they reach a specified age.
- If you have a family member with a physical or intellectual disability, the trustee can ensure your loved one is properly looked after for life.
- You may specify that a grandchild can access capital just for education costs.
- You may allow beneficiaries to receive only income in their younger years, then gain access to capital at a certain age or specific amounts at different ages.
- If you want to safeguard the inheritance for your adult children, assets in a trust may be protected from potential creditors or an ex-spouse.
A trust is a flexible instrument with many applications. For instance, if you have a vacation property that the family is not ready to manage, a cottage trust has the trustee take care of maintenance and finances, so your children can enjoy the property, then plan for ownership later. Also, if you want to leave a legacy to a charity, you can use the trust to support beneficiaries during their lifetime, with the remaining capital donated to the charity upon their death.