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Selecting a Trust to Suit Your Needs

Wills and trusts are often confused, or at best seen as an either/or proposition.

“A lot of people think you use one or the other, but nothing could be further from the truth,” says Jim Madden, a Schwab wealth strategist in Phoenix. “Everyone should have a will, whereas the suitability of a trust depends on your individual circumstances.”

Trusts differ from wills in three key ways:

  • A will goes through probate, in which a court reviews the document and ensures its validity; trusts bypass this process.
  • A will takes effect only upon death, while a trust can take effect before death, after death or in case of incapacitation.
  • And finally, trusts come in all shapes and sizes, depending on your needs and those of your heirs.

“Wills can be flexible, too, but many trust types are designed for specific goals, such as charitable giving or providing for an heir with a disability,” says Rob Williams, vice president of financial planning at the Schwab Center for Financial Research.

Where to start

If, in consultation with an estate-planning professional, you decide a trust is right for you, “the first step may be to create a revocable living trust,” says Tucker Smith, a Schwab wealth strategist in Denver. A revocable trust can be changed at any time and for any reason during the grantor’s, or creator’s, lifetime. “You’re not giving up any control. It’s just a different way to hold your assets,” Tucker says.

A revocable trust becomes irrevocable when the grantor passes or becomes incapacitated—meaning it can no longer be changed or revoked, depending on how the trust is structured.

This type of trust is often only a beginning, however. “Think of a revocable living trust as an umbrella under which you can add any number of provisions or supplemental trusts tailored to your specific goals,” Tucker says.

Here are six common varieties of trusts individuals and families could consider when tailoring their legacy.

For blended families

If you’ve remarried but want to ensure your children from a prior relationship are cared for, a Qualified Terminable Interest Property (QTIP) trust can help. QTIPs provide for the living expenses of the surviving spouse as long as he or she lives. When that person dies, the QTIP distributes the remainder of the estate to the children of the original relationship. Often these trusts will include provisions that prevent the estate from being excessively drawn down during the surviving stepparent’s lifetime.

For heirs with a disability

An inheritance can reduce or eliminate the government benefits to which dependents with disabilities may otherwise be entitled. A special-needs trust can help avoid this pitfall by agreeing to pay only those qualified education, equipment, insurance and medical expenses not covered by federal or state benefits. “If government benefits are paying for housing but the house needs a wheelchair ramp, the trust can cover that,” Tucker says. “The trustee pays such expenses directly, so that no money from the trust flows directly to the dependent.”

For the prodigal heir

Leaving a lump sum isn’t always wise, especially if a loved one lacks financial know-how, or struggles with alcohol, drug or gambling dependencies. This is where spendthrift trusts come in. These provisions appoint a trustee to distribute the assets of a trust on an ongoing basis, rather than giving direct access to heirs themselves.

An independent entity, such as Charles Schwab Trust Company (see “Trust us,” below), often administers a spendthrift trust so that family conflicts can be avoided. “A good trustee can help educate heirs about budgeting and financial planning,” Tucker says.

More to the point, the trustee typically distributes a preset amount based on a budget and may pay creditors and service providers directly. “For example, I have a client whose son is an artist,” Tucker says. “He’s immensely talented; he’s just extremely right-brained and not especially astute at managing money.”

What’s more, because the beneficiary doesn’t control the trust, her or his creditors may not be able to claim a right to its assets.

For the philanthropically minded

Charitable trusts fall into two basic camps, depending on when you want the donations to go to the charity or charities of your choice. One is a charitable lead trust, which provides a predetermined income to a charity for a set number of years, after which the remaining sum passes to your heirs.

A charitable remainder trust does the opposite: It provides a fixed payment to the donor while living, with the remainder going to a charity upon her or his death.

Jim Madden says the latter is more common among his clients. He recounts how one client bought an apartment building many years ago but later decided he no longer wanted to manage the property. Selling the building outright would have incurred taxes on the sizable capital gains, so instead he transferred it to a charitable remainder trust. “He’ll still receive the income from it for as long as he lives—along with a tax deduction for gifting it to the trust—without having to sell the building and pay capital gains,” Jim says. “When he passes, however, the remaining trust assets will go to charity.”

It’s important to keep in mind that charitable trusts are irrevocable. “Once you transfer your assets, you no longer own them,” Jim says, “so be sure to think through all your options before making a final decision.”

For those concerned about litigation

Attorneys, medical professionals and others may be especially susceptible to lawsuits. That’s why some turn to asset-protection trusts, which name the grantor as the beneficiary, often with a corporate entity like Schwab serving as trustee. By law, these trusts can be established only if you’re not aware of a lawsuit or possible lawsuit, but when employed in advance they can shield assets from litigation. Many states—including California, New York and Texas—prohibit asset-protection trusts, in which case individuals often turn to a corporate trustee in a state in which they are permitted.

For those wishing to maximize life insurance payouts

The IRS considers life insurance benefits as part of an estate, so families with significant assets who also own or are considering purchasing a life insurance policy might benefit from an irrevocable life insurance trust, or ILIT.

“If your revocable living trust owns your life insurance policy, the death benefit would be included in the value of your estate,” Jim says. If, on the other hand, an ILIT owns your life insurance policy, it is considered separate from the main estate and therefore not subject to estate taxes.1

A helping hand

A basic understanding of the options out there is the first step to establishing a lasting legacy—but is no substitute for consulting with the proper professionals.

“Schwab financial consultants have access to a network of estate-planning specialists who can help clients think through their options before enlisting an attorney to draft any trust documents,” Tucker says.

1To be considered separate from the gross estate, existing policies must be gifted to an ILIT and the insured must live at least three years beyond the gift date.

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Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

Charles Schwab & Co., Inc. (“Schwab”) is affiliated with Charles Schwab Trust Company (“CSTC”), the corporate trustee for Schwab Personal Trust Services. Schwab introduces clients to CSTC but does not evaluate whether their services are appropriate for each client or recommend their services to any particular client. Schwab does not provide legal or tax advice. Always consult with your legal counsel and tax advisors about your particular circumstances.

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