Many are surprised to learn the definition of a "family trust" does not describe a specific type of trust. For example, many people ask "is a family trust revocable or irrevocable?" The answer is the term describes any trust that is formed to benefit ones own family, whether revocable or irrevocable.
Example uses of a family trust are a parent wanting to help their child, a grandparent for the benefit of a grandchild, or an aunt to benefit a niece or nephew.
Most family trusts in Colorado are meant to accomplish some or all of the following goals:
- Avoid Colorado Probate: Family trusts can avoid probate in it's entirety.
- Reduce Estate Taxes: Lower taxes through trusts.
- Anonymously Own Assets: Protect you and your family's privacy.
- Asset Protection: Keep Assets Away from Creditors
- Control Your Assets: Responsibly distribute assets to a child or grandchild only when specific conditions are met.
Ultimately, part of drafting a trust is ensuring large amounts of money are not given, all at once, to a family member unable to handle the responsibility that goes along with it. Learn more about the various Colorado trusts here.
Trust Terminology
While there are many types of family trusts, every trust, including family trusts have something in common and that is they all have three roles. Those roles are the Grantor, the Trustee, and the Beneficiary. Each of these roles can be filled by one or more people or companies.
- The Grantor is the person who creates and puts assets into the trust. In a family trust, the Grantor is generally the parents or grandparents.
- The Trustee is the company or person who oversees the day-to-day functions of the trust. The Trustee ensures the trust is administered according to the Grantor's wishes.
- The beneficiary is the person who gets the benefit of the trust assets. The Beneficiary in a family trust will be a family member, but a beneficiary can be an unrelated person, or charity.
Family Trust and Succession Planning
Family trusts can be an effective means of succession planning because they allow for a responsible trustee to manage the finances, assets, investments, and income for multiple beneficiaries. Because the family trust is independent of the grantor and beneficiaries, a lack of responsibility on the part of one beneficiary will not harm other beneficiaries. A family trust can also protect a family member from the effects of their own bad decisions. For example, a trust may be set up so that the trustee cannot be forced to give assets to a beneficiary's creditor or ex-spouse, even if the family member tells the trustee to make a payment to them. In another example, a trustee may only be able to distribute money to a family member if the money will be used to fulfill specific need of the beneficiary such as health, or education. In the end, family trusts allow the grantor to provide a benefit to loved ones without having to fear that assets will be wasted.
Family Trust Advantages & Disadvantages
Many parents and grandparents think that a family trust is important when there is a fear that a child or grandchild will not be able to handle the responsibility of managing inherited wealth. When a child or grandchild receives a lump sum payment through a will, the generous parent or grandparent loses all control over how that inheritance can and will be spent. A young adult who receive a big inheritance might be tempted to buy a fancy car or travel the world instead of using the inheritance to pay for college. But with a family trust, the trustee maintains control over the trust assets and how they will be distributed to a child or grandchild. The trustee could make a payment directly to a college or only give the child income if they are attending college. In this way, the family trust can help the child or grandchild make good decisions, just like the parent or grandparent helped them make good decisions when they were alive.
Consider the Tax Consequences of a Family Trust
A grantor can establish a family trust in a variety of ways that will each have very different tax consequence. For instance, a family trust can be established so that the taxes on the trust will be paid by the beneficiary, the trustee, or the grantor. Deciding how to set up a trust when it comes to taxes can have significant consequences. For instance, it may not be a good idea to make an irresponsible beneficiary responsible for paying taxes on money they get from the trust, because not paying the taxes could lead to penalties and interest. However, making the trust responsible for paying taxes can lead to paying much more in taxes because of the way trusts are taxed. It is important to work with qualified and experienced attorneys and accountants when setting up and funding a family trust so that no one is surprised on tax day.
Types of Colorado Trusts
A family trust is not actually a type of trust, it just describes the goal of the trust. Therefore, many types of trusts can be family trusts. Any of the trusts described below can be set up as family trusts.
- Inter Vivos Trust: Created while the grantor is alive and can be revocable or irrevocable.
- Testamentary Trust: Created in the grantor’s will and must be an irrevocable trust.
- Revocable Trust: Created anytime prior to death. Allows the grantor to change or revoke the trust at any time. Upon the death of the grantor, it becomes irrevocable.
- Irrevocable Trust: Created at anytime including at the time of death. The grantor may not change or revoke the trust, but the trustee may have the power to do so.
Setting up a Family Trust
Setting up a family trust is a two-step process:
Trust Creation and Execution
A trust document is prepared that lists the beneficiaries and trustees, and instructions the trustee on how the trust should be managed.
Assets Transfer:
Grantor transfers assets to the trust by opening bank and investment accounts in the trust's name and depositing cash and other assets into the accounts; transferring real estate by quit claim deed into the name of the trust; and identifying the trust's ownership of personal property like coins or art. A trust will be ineffective unless an asset is transferred to the trust when it is formed. Other assets may be transferred into the trust over time.
Irrevocable Family Trusts
A trust provision that is likely to be included in every family trust is called a spendthrift provision. A spendthrift is a person who spends money in an extravagant irresponsible way. A spendthrift provision protects the beneficiary from their own bad decisions and keeps the trust assets out of the reach of creditors and other who may try to take trust assets. The spendthrift provision results in a restriction on the beneficiary's ability to transfer future payments of income or assets to any third party, including a creditor. This is accomplished by giving the trustee complete discretion to make, or note make, distributions to a beneficiary. While spendthrift provisions can provide strong protections to trust assets, certain creditors like those who supply the beneficiary with necessities, may be able force the trustee to pay the beneficiary's debt. In addition, the trustee may be forced to pay the beneficiary's alimony and or child support obligations.
Should You Set Up a Family Trust?
Deciding if a family trust is right for you can be a difficult decision. Plus, there are many types of trusts (e.g. charitable remainder trusts,personal property trusts) to consider. If you decide a family trust is right for you, you will need the assistance of a qualified and experienced attorney to guide you through the process. To schedule a consultation with our experienced Colorado estate planning attorneys, please use the contact link on our website.
