This first part of a primer on trusts set up by, and for, dentists can initiate financial planning that is bountiful.
William J. Davis, DDS, MS,
Joseph J. Massad, DDS, and
Gary J. Rathbun, CLU, ChFC
Normally, when dentists hear the word "trust," they immediately start to think about the wonderful trusting relationship they have developed between their staff and patients...
... This article will look at a different perspective of the word. Legal trusts or trust agreements are financial-planning strategies used for your future.
The questions you might ask about a trust are:
- How do I evaluate the validity of trusts?
- How will they work in my particular situation? The following will introduce you to the basics of trust agreements and what you should look for when evaluating a trust as a particular financial planning strategy when planning your financial future.
Let`s start off by refreshing our memory about some vocabulary. First of all, what is a trust? Technically, a trust is a legal relationship between a "trustee" and a "trustor" for the benefit of a third party known as the beneficiary. The trustee follows a set of instructions, terms, and conditions laid out in writing in a document called a "trust agreement."
Now, in English! Imagine a cookie jar. Let`s call this cookie jar a "trust." You can put virtually anything that you want into this "cookie jar." You can put cash, stock, bonds, mutual funds, real estate, and even life insurance into it. When you put any of these assets into the trust, it`s called "funding" the trust. The trust can receive different assets at different times. For instance, you can put some of your assets, say $100, into the trust during your lifetime and finish funding the trust at the time of your death. If you have life insurance, a pension plan, or an IRA, you can name the trust as the beneficiary.
The trust agreement spells out all of the aspects of the trust. The document will say how the assets should be managed, how they are to be invested, who will be the beneficiaries of the trust, what method is to be used in paying benefits out of the trust, and, finally, what will happen to the remaining principal and accumulated income of the trust.
A key aspect of any trust is the trustee. The trustee has the responsibility for investing, managing, and administrating the trust. This person or entity (such as a bank) holds the legal title to the assets in the trust. Even though trustees hold the legal title to assets, they can only use the property (and the income it produces) for the benefit of the beneficiaries.
The components of a trust
Trustee defined: Every trust needs someone or some entity to watch over the "cookie jar," to properly invest your assets, and, finally, to pay out the income and/or capital of those assets as you have directed. The person or entity you select to take charge of these responsibilities is called a trustee.
Remember, this important responsibility can last for just a couple of years or for as long as several generations. The person or entity can work alone or with other trustees. Depending on the size of the trust, you may consider naming backup trustees in the event that any of the original trustees are unable to fulfill their duties. Individuals and/or corporate trustees, such as a bank or trust company, can be named trustee. If more than one party is named as trustee, they are referred to as "co-trustees," and they make decisions collaboratively.
Beneficiary defined: All of the people for whom you have set up the trust are called the trust`s beneficiaries. The beneficiaries can include virtually anyone, including yourself. The beneficiary of the trust will receive income from trust assets and/or principal specified in the provisions of the trust document. A trust can be designed to provide benefits to one beneficiary first and then, sometime in the future, the benefits can be paid to someone else. The time of the future benefits can be triggered by time alone or by an event, such as death of the grantor or the primary beneficiary.
Income defined: Recently, the definition of income with regard to a trust has been changed. In the past, when a trust instructed the trustee to provide the beneficiary with income, the trustee was obligated to invest the assets of the trust in order to provide that income. Consequently, trustees usually invested in vehicles such as stocks, mutual funds, or bonds that provided income but very little growth.
Today, trust income is defined much more broadly. Trust income takes into consideration total growth of the trust`s assets. This gives the trustee much more freedom to construct an investment portfolio that will not only benefit the current beneficiary but also has the opportunity to grow the principal for future beneficiaries as well.
Types of trusts
There are almost as many different types of trusts as there are grantors who will create them. For the purposes of this basic discussion, we will look at a few different generic types of trusts. Let`s take a look at the distinction between living and testamentary trusts, as well as the distinction between revocable and irrevocable trusts.
Living trusts: Living trusts have several characteristics that have created its name. First, living trusts are established while you are alive, hence the name "living" trust. In technical terms, this is called "intervivos." This trust can be funded during your lifetime or can be established to receive assets when you die. Another characteristic of a living trust is that, during your lifetime, the provisions and funding of the trust can be changed. Therefore, this type of trust is a living document.
Testamentary trusts: This type of trust is established at the time of death through your will. The funding of the trust comes from assets you own at the time of your death and are transferred via your will to the trust. The actual document is not created until the time of your death, according to the instructions in your will. The timing of this process will make the creation of your will a little more complicated and will require specific details. It will require more frequent updates of your will due to the fact that your desires for the beneficiaries may change in your trust provisions. When you want to change the provisions of the trust, you will need to make the changes in your will.
A major problem with testamentary trusts is that if your will, for any reason, is successfully contested the trust inside your will and its provisions might never be carried out as you originally wished. Testamentary trusts will not assist in the reduction of income or estate taxes, since you still owned your personal assets at the time of your death.
Revocable trusts: Revocable trusts are exactly what they sound like, revocable. Let`s go back to our analogy of the cookie jar. Imagine that, with any form of an asset you put into the cookie jar, you can just reach right in at any time and take back all or part of what you put in. You can do this without any negative tax consequences. In addition, you can change, alter, or amend any of the provisions of this trust at any time up to your death.
Irrevocable trusts: In contrast to revocable trusts, you cannot change irrevocable trusts once they are established and funded. Once assets have been placed in this trust they cannot be removed, nor can you change, amend, or alter the provisions of the trust.
This article has discussed some of the basic concepts of trusts, trustees, and funding trusts. In our next article, we will look in more detail at some of the uses of these trusts. We`ll also examine why dentists should consider the use of trusts in present and future financial planning.