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Trusts: Definition, Function & Examples

Instructor: Michelle Reichartz

Michelle has lead multiple training initiatives and has a master's degree in Business Administration.

Many people have heard of a trust fund but are unaware of how they work. Anyone can establish a trust. In this lesson we will review exactly what a trust is, how they are used, and laws that surround trust.

Planning for the Future

You are a successful blogger who has recently had your first child, a daughter named Rosy. Until now, you thought having a checking account and a 401(k) was enough. However, now that you're a parent, you want to make sure there is plenty of money available to Rosy in the future.

How can you ensure her future is secure? What will happen if something happens to you? The last thing you want is to be unprepared. One way to prepare is with a trust.

What Is a Trust?

A trust is an arrangement that allows a third party, known as a trustee, to hold assets on behalf of beneficiaries. A trustee is the individual that is given control over the assets left in the trust; this person's primary role is to act in the best interest of the beneficiary. A grantor is the individual who sets up the trust and provides the assets to be used in the trust. A beneficiary is the person who legally receives the assets left in the trust as the grantor specified when creating the trust.

Although the trustee has control over the trust, the beneficiaries are the ones who actually get to receive the trust's assets. A trust can specify exactly how the assets are to be used and when the assets can be passed to the beneficiary. Due to the unique nature of trusts, they can avoid probate altogether and can reduce your court expenses or taxes. Probate is the legal process of verifying a will is reviewed to ensure it is authentic. There are primarily two types of trusts: living trusts and testamentary trusts.

Living Trust

A living trust provides assets for the beneficiary's use over their lifetime. In this arrangement, the trustee is in charge of transferring the assets throughout the beneficiary's lifetime.

Living trusts are typically setup as a revocable trust. With this arrangement, the trust can be dissolved at any time, as long as the grantor is alive. Irrevocable trusts, on the other hand, cannot be changed or dissolved at any time. However, the trust would still be subject to estate taxes with either a revocable or irrevocable setup.

In the example above with Rosy, the living trust could have been created as a revocable trust prior to her birth to benefit yourself. Then, when she was born, it could have been changed at the time of her birth to show Rosy as a beneficiary. With each new child that is born, you could update the living trust to add each new child as an additional beneficiary.

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