Like HowStuffWorks on Facebook!

How Trusts Work


Putting Trusts into Perspective
Trusts can help wealthy families protect their significant assets for future generations, and average families can use them to avoid the stress of probate court after a grantor's death
Trusts can help wealthy families protect their significant assets for future generations, and average families can use them to avoid the stress of probate court after a grantor's death
Alexander Raths/iStock/Thinkstock

Trusts might be sold as a tax tool, but they're much more than that. Modern trusts are touted as a way to shield the assets of the super wealthy from estate taxes, but the U.S. federal estate tax has only been around since 1916 [source: Mider]. Trusts, on the other hand, have been around in some form for centuries. Some scholars say that ancient Romans first developed trust-like laws for transferring assets from one generation to another, and the trust as we know it today is said to have been developed in the Middle Ages [source: Langbein].

A trust is also a way to create a legacy that extends beyond one's lifetime. If you're substantially wealthy, a trust offers a way to keep your money working for future generations. Average families use them to transfer the ownership of a home or other assets without having to go through probate. They are used to make the most of what our loved ones leave behind.

Private trust funds should not to be confused with federal trust funds, which are set up to collect funds and pay for various federal programs, including bond dividends, Social Security, Medicare and government grants. Private trusts are set up by individuals through estate-planning attorneys. They are detailed documents containing instructions for how the assets and property should be handled in the future. Trusts do not have to be large, but they make the most sense for large estates, and some can be pretty substantial.

Trusts are typically set up to continue to create wealth for future generations. Investment portfolios, real estate or businesses placed into the trust may grow and prosper, even as the trusts make regular payments to beneficiaries. Over time, large family trusts have even turned into national trust companies. For example, Wilmington Trust (now part of M&T Bank Corp.) began as a multi-generational trust for Delaware's prestigious du Pont family [source: Mildenberg and Mider].

A trust is a legal entity, separate from you or your estate, which is why it allows you to remove those assets from the estate and any related estate tax consequences once you give up control of them. Beyond that, the tax benefits of a trust are minimal. A trust requires annual income tax filing, and higher tax brackets kick in at much lower rates within a trust. A trust with just $12,150 would have been in the maximum 39.6 percent income tax bracket in 2014 [source: TurboTax]. Income distributed from a trust is reported by the grantor, trustee or beneficiary, depending on the circumstances of the payment. Before setting up a trust, it helps to discuss the tax implications with a professional.

Trusts can also be created to distribute all assets in lump sums. Regardless of how the money and property leave the trust, once everything is distributed, the trust will come to an end. This is known as winding up or terminating the trust. A trust that is designed to last for several generations is known as a dynasty trust [source: Randolph].

Money in a trust may also be considered separate from the estate in a divorce proceeding, but if the trust is revocable, it's part of a couple's shared assets. Trusts can also be used in a similar way to prenuptial agreements, removing certain assets from shared marital ownership before the marriage takes place.


More to Explore