A trust is a relationship in which a trustor transfers assets to a trustee who then manages and controls these assets for the benefit of the beneficiary. The trustee then manages and controls the property placed in the trust for the benefit of a third person, called a beneficiary. In managing the property, the trustee must comply with the terms of the trust and with other requirements established by state law.
Trusts are most commonly created under the terms of a will or in a separate written document known as a "trust agreement." A trust which does not become effective until the trustor has died is known as a "testamentary trust. A trust created while the trustor is alive is known as a "living trust." Trusts can also be either "revocable" or "irrevocable." Property placed in a revocable trust can be removed by the trustor at any time, at the trustor's discretion. However, placing property in an irrevocable trust is the same as making a gift - you are giving up ownership and control forever.
What are the uses of a trust? Trusts have several uses and they can be of much benefit when they are properly set up. One common use is to provide flexible control of assets for the benefit of minor children. This often avoids the necessity of having to have a guardian appointed to manage property inherited by minor children since they cannot legally handle their own financial affairs until they reach the age of 18. A "Miller Trust" is a special form of trust document to protect the qualification of person, who makes to much, but not enough to pay the full bill, for TennCare or Medicaid payment of nursing home.
Often parents want their children to be even older before they are given full use of their inheritance. It is not difficult to imagine the difficulty most 18-year olds would have with managing a large sum of money given to them in one lump sum. By establishing a trust, parents can select a trustee and specifically instruct them on how to use the assets for the benefit of the children. A trust may provide that a larger share of trust benefits may be directed toward the care of a disabled child with special needs. This kind of trust is most often included in a will and does not become effective until both parents have died. It is usually set up to provide for the support, care and education of the children until they have reached the age when the trust assets must be distributed outright.
In some instances a trust can serve as an alternative to a will. For example, an older person may create what is called a "living, revocable trust" by transferring most of his assets to the trust and then simply collect the income for the remainder of his lifetime. Such trusts are often revocable because trustors are reluctant to give up the right to change or even cancel the trust at any time. A major benefit of this type of trust is that, if the trustor becomes disabled, his assets are kept in the trust and managed by the trustee for his benefit which eliminates the need for a court appointed conservator. Upon the death of the trustor, the trustee distributes the assets to the ultimate beneficiaries as directed by the trust agreement.
Living trusts are often advertised as a much better alternative than having your estate subjected to probate. In Tennessee, however, the fear of probate should probably not be the deciding factor in your decision to create a living trust. A living trust does not eliminate the need for a will and probate unless every asset the trustor owned is transferred to the trustee prior to death.
For larger estates, a major disadvantage of living trusts is that all assets held in a living, revocable trust will be subject to federal and state death taxes. On the other hand, trusts can be used to reduce both estate and income taxes in many situations.
Like another person or entity which has income, a trust will have to pay income tax on any income earned, such as interest or rent on the property held in the trust. However, under certain conditions, the income tax becomes payable by the trust or by the beneficiaries of the trust, rather than by the person who created the trust. The savings occurs when the trust or the beneficiary has a lower tax rate than the trustor. Example: when supporting a retired, elderly parent, the parent will usually have a low income and thus a lower income tax rate. By placing an income-earning asset in an irrevocable trust which pays the income to the parent, the income will be taxed at the parent's lower rate. But look out for the asset rules of TennCare or Medicaid.
Often trusts can help avoid unnecessary death taxes, especially with married couples. A trust of this kind generally works as follows: the first spouse to pass away leaves a portion of their combined estate in a trust, giving the surviving spouse the income benefit of that trust for the rest of his or her life. The assets placed in the trust are not subject to tax because their value is less than the amount at which the government begins to assess the estate tax. When the surviving spouse dies, only that portion of the estate which was not placed in trust will be subject to estate tax. If everything is properly arranged, the couple's assets can pass to their children when the last parent dies with significantly less estate tax having been paid.
There are many other ways in which trusts can reduce estate taxes, dependent upon the particular circumstances. Many type of trusts and "trust-like" arrangements can be found. For instance, "trustee" bank accounts can be beneficial in appropriate circumstances. However, one should be careful about opening bank accounts "as trustee" without a formal trust agreement.
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