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What is a trust? Types and their uses

A trust is a provision of the law in which one party — the trustee — has legal ownership of any form of property that has been transferred to him, her or "it" (e.g., a bank) by the person creating the trust. The trust creator is called the grantor (or settlor).

Assets of all forms can be transferred to a trust, and these assets are then invested and/or managed for the benefit of one or more beneficiaries, whom the grantor names in the trust document. Sometimes, the grantor also wears the hats of trustee and beneficiary.

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Think of a trust as an empty vessel into which the grantor "pours" property. Like an executor, a trustee has the highest of legal obligations — a fiduciary duty — to manage the property, and see that it is used only in a manner, and for the purposes established by the grantor in the trust document.

Types of trusts

Trusts can be "living" — established during the grantor's lifetime, or testamentary — established in a will.

Most living trusts are revocable — subject to termination or modification at any time by the grantor for any reason. As for testamentary trusts, of course, a deceased grantor is unable to change the terms of a trust created under his or her will, so these trusts are always irrevocable. (Before death, however, the grantor is certainly free to change the will.)

In order to function at all, a trust must have assets formally transferred to the trustee. Even when husband and wife serve as their own trustees, for example, real estate deeds and financial accounts must be re-titled in order to be owned by the trust. For a living trust, legal title is transferred, during life, to: "John and Jane Smith, Co-Trustees of the Smith Family Trust."

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Who uses trusts?

Trusts are perhaps most commonly used by people with minor or young adult children. These folks naturally want their kids to benefit from the money and property they've accumulated in life.

But if the parents die prematurely, they realize that guardianship ends at the age of legal adulthood — usually 18 — and they don't want significant funds to be directly available to these young people until they have matured a bit. Of course, while the parents are alive, they can keep whatever strings attached to their money they feel are appropriate.

A trust can do the same thing in case of the parents' premature death. In the common case of a married couple with children, upon the death of the first spouse, usually, the survivor stays in control as sole trustee. But it is also important to have an alternate trustee already in place when the second parent dies.

The value of a trust

The trust document might authorize the trustee to pay educational expenses after high school, help with the down payment on a starter home, or virtually anything else the grantor(s) — i.e., the parent(s) — spells out in the trust. In a nutshell, the trust document can give the trustee the guidance and authority to do that which the parents would do if they were alive to do it.

(Graphic: Hannah Smart/Cashay)
(Graphic: Hannah Smart/Cashay)

Who should be a trustee?

Obviously, the trustee should be a person (or bank) with good judgment and discretion. Your lawyer can draft a trust document with almost any kind of conditions to guide, dictate or limit the use of trust funds, but you alone are responsible for finding a party willing and competent to wear the hat of trustee.

There are two very different aspects to any trustee's job — managing the assets wisely from an investment point of view, and applying the funds as called for by the trust. The choice of trustee therefore deserves more thought than it often gets.

Dive Deeper: Estate Planning: Everything you need to know

This content was created in partnership with the Financial Fitness Group, a FINRA-backed e-learning platform focused on improving personal financial literacy in the U.S.

Read more information and tips in our Estate planning section

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