What is a trust and should you have one?

If you go down the internet rabbit hole of trusts, you will undoubtedly mystify yourself.

Trusts aren’t only tough to understand for the average person, they’re also confusing for lawyers and accountants. It takes years to understand the complexities of trusts and probate litigation, so don’t feel overwhelmed if you just started researching trusts and you feel like you’re being slammed by a tidal wave of information.

In essence, a trust is a relationship between two people to handle funds or assets or property in a certain way.

Here’s a very simple example: My friend Bill and I pull in to the Dunkin Donuts parking lot. Bill gives me $5 and says “buy me a medium latte.” I run in and buy him his latte while he waits in the car. Then I bring him back his latte.

In this hypothetical Bill and I have a relationship where I amtrusted to handle his $5 in accordance with his wishes. In law a trust relationship like this is called a “fiduciary” relationship. The assets entrusted to me, or put into the trust fund was the $5 bill.

Now imagine that I have a house, a life insurance policy, a savings and checking account, mutual funds, and a pension. I can put these into “trust” and have them doled out in accordance with my wishes, similar to how a will operates except that trusts come with unique benefits (and unique drawbacks.)

When I die (or while I’m still alive) I can have my trust dole out $1,000 a month to my oldest son, and reasonable living expenses to my wife, and $25 every christmas to my granddaughter, etc. I would need a friend like Bill to be the “trustee” and make sure that my assets are doled out in accordance with the terms of the trust.

Ever hear of a “trust fund baby”? or a “Trustifarian”? These are nick names for people whose parents have set up trust funds that dole out money to them for their living expenses. That is the simplest example and usage of a trust… Comma, but, they can get extremely more complex.

What are the benefits of a trust?

A trust is something you can use while you’re alive or when you die to help distribute your assets. If you’re considering using a trust for when you die, it’s important to understand what happens to our assets when we die. This is called “Probate.”

Common benefits of trusts are as follows:

• Avoid probate
• Protect privacy
• Avoid creditors
• Become eligible for medicaid
• Avoid estate taxes

I’ll go into each benefit in more detail below because not all “benefits” are as simple as they seem.

Avoid probate

A lot of people are afraid of probate. Probate is what happens when you die and (spoiler alert) there is literally no way to avoid it.

Everyone who dies has to have their estate, or assets, go through the probate court system. Even if you don’t own a single penny, your estate must be “probated.” Even if you have all your assets in trusts.

Your assets will be reviewed will be reviewed by the probate court and then distributed to your heirs. This could take anywhere from 6-months to a year. Now, if all of your assets are in trusts then they don’t have to go through probate. Legally you don’t own them, the trust does. For that reason they can go directly to the beneficiaries.

So in some regard, a trust does avoid probate. However, trusts aren’t the only way to avoid probate. Think about the assets you have… Mutual funds? A house? A bank account?

Mutual funds and *some* bank accounts can avoid probate by designating beneficiaries. Why spend $5,000 on a trust for your mutual funds if you could just contact Vanguard or Fidelity and designate your beneficiaries. Their distributions will be payable upon death, which is why beneficiary designations are called “POD” or Payable On Death designations.

Likewise, some banks you can also designate beneficiaries.

As far as your house goes, you can jointly own it with a spouse or a loved one or someone you trust and it will also pass outside of probate.

The takeaway here is that jointly owned property and bank accounts or accounts with payable on death beneficiaries avoid probate just like a trust does. So why spend $5,000 on a trust when you can some of your assets can avoid probate for free!

Protect privacy

A lot of people want trusts because they “protect privacy.” While it is true that when you die your personal information will be entered into public record, along with your will, it is not as scary as it sounds.

We all know people who die. Have you ever heard of someone filing a records request with the probate court to retrieve documents for deceased friends and family? It’s bizarre and uncommon, most people don’t even know that you’re able to retrieve those records or how to do it… It is so incredibly uncommon and odd that it’s really nothing to worry about.

Also, none of your most important information like your social security number is shared either. Besides your will, other things that are already public record like addresses, and names are shared. But that’s all public record anyway.

The bottom line is, if you’re really concerned about privacy, a trust might be worth it. But practically speaking no layperson snoops around the probate court requesting records. It’s uncommon and bizarre behavior that rarely occurs.

Avoid creditors

While it is true that some types of trusts avoid creditors, hopefully you will not have this problem. There are practical complexities with credit shelter trusts that are beyond the scope of this blog.

Become eligible for medicaid

With the exorbitant costs of healthcare spiralling out of control, a lot of elderly people plan to get on to free Medicaid programs to avoid the costs of end of life care. The problem is that you need less than $2,000 in your bank account to be eligible. AND, if you die owning a house while owing Medicaid money, they will take your house as repayment.

In order to avoid this, Medicaid has a 5-year look back period meaning that you have to be “broke” for 5 years before you qualify. Putting your house and assets into a trust will make “broke” because technically you don’t own the assets anymore, the trust does. However, Medicaid only recognizes “irrevocable” trusts for this, meaning once you put the assets in trust you can’t take them back.

A different way to achieve this goal is by either giving your house to a loved one, then having your loved one give you a “life estate” or “life use” in the property. More on that in another blog.

The bottom line is, there are other ways to become eligible for medicaid than having a trust.

Avoid estate taxes

Here’s the big banana.

When you die and leave your heirs money, some states will tax the amount that you leave.

In Massachussetts the tax is on any assets over $1million. A lot of people don’t realize that they’re actually worth $1million or more. For example, if you have a $400k house, plus $200k in the bank and a $400k life insurance policy, BOOM, you’re worth over $1million. That means your estate will be taxed.

Putting some of your assets in trust will avoid the taxes because they are not “owned” by you.

In Connecticut the estate tax is on anything over $9.1million, meaning that unless you’re worth over $9.1million you won’t get taxed.

So unless you’re a multi millionare, there’s no good reason to get a trust to avoid taxes.

Now, some trust mills will say “you need a trust just in case Connecticut ever lowers the estate tax rate!!” – If Connecticut changes the estate tax rate it would be all over the news and your lawyer would likely inform you. New laws aren’t passed overnight. There is no good reason to get a tax avoidance trust on the off-chance that Connecticut changes their estate tax laws too quickly to make any adjustments in your estate plan. It just wouldn’t happen.