Would you prefer your assets not become a matter of public record after you die? Do you have minor children or children with special needs? Are you concerned one of your kids will spend his or her inheritance too quickly?
According to Mark McLennon, vice president of Investment Advisory Services at Northwestern Mutual Wealth Management Company, these are some common reasons people set up family trusts.
Trusts are legal entities through which individuals can control distribution of their assets during their lives and after their deaths. They are often managed by a trustee, a person or company that manages the trust for the benefit of the heirs.
If you’re wondering whether a family trust is a good choice, it’s important to understand the common reasons for establishing one in the first place, the different kinds of trusts available and whether the benefits of a trust will outweigh the drawbacks in your situation. Here’s three things that you need to know:
1. Reasons to Set Up a Trust
People set up trusts for many reasons, but one common motivating factor is that they want to be able to control what happens to their assets when they die.
For example, if a parent is concerned about providing for a minor child or fearful that an adult child won’t handle a large lump-sum inheritance responsibly, a trust can arrange for annual disbursements of funds or give the child his or her inheritance in stages.
Similarly, just as a living parent would provide help to a child with special needs, a trust can provide regular assistance—through the help of a trustee—upon the parent’s death. If done properly, such a trust can allow someone with special needs to keep access to government benefits.
Trusts also avoid the costly process of going to probate court, where a judge approves wills and allows heirs to start receiving money and assets from the estate. Michael Bremmer, 43, CEO of TelecomQuotes.com, recently set up a trust for this reason.
“I was shocked to find out my wife did not automatically take over ownership of my assets when I died,” he said. “Without a trust she would have to spend thousands on probate.”
Depending on where you live, if you have a small estate or live in a state where marital assets are seen as jointly owned, you might be able to avoid probate. If not, the expenses can add up because of attorney costs and court costs, which in some states are a percentage of the estate.
Some people also want to avoid probate for privacy’s sake. When your assets are in a trust, they won’t become a matter of public record after your death, said McLennon.
Trusts can also be set up to protect your beneficiaries—the heirs of the trust—from creditors or ex-spouses, facilitate charitable giving, manage inheritance taxes and make administering your financial affairs easier.
2. Common Types of Trusts
The easiest type of trust to create is a revocable living trust. With a revocable trust, you transfer assets to the trust but still maintain ownership of them during your lifetime and can cancel or change any trust provisions.
When the grantor—the person who set up the trust—becomes disabled or dies, the trust provisions kick in automatically, McLennon said. The trust will then become irrevocable. At that point, the trustee takes over the management of distributing assets or interest in whatever manner the trust documents specify.
Another option is an irrevocable trust. With this type of trust, assets are transferred outside your estate during your lifetime—often to take advantage of gift tax provisions and reduce inheritance taxes. McLennon stresses the importance of working with an experienced lawyer who can create the trust with as much flexibility as possible, since irrevocable trusts generally can’t be amended.
Other trusts can help families preserve wealth over generations. For example, a generation-skipping trust allows grandparents to give assets directly to grandchildren. This helps a family avoid being taxed twice: once when the children inherit the assets and again when the grandchildren do. These trusts often still allow children to redeem interest income earned from assets in the trust even though the assets belong to the grandchildren.
Such generational trusts can “help the family in perpetuity,” said McLennon. “Over the years, the family continues to benefit from the income, but the trust passes without estate taxes.”
3. Is a Trust Right for You?
It’s important to weigh the disadvantages of having a trust against the benefits.
One disadvantage is the upfront cost of setting up a trust. LegalZoom estimates that an average trust costs between $1,000 and $2,500 to create. These costs include attorney fees and the expense of retitling assets.
For a revocable trust, since you act as your own trustee, there will be no further costs beyond the upfront legal and retitling fees. Even if you decide to hire a trustee while you are still alive, “the cost of paying for a trustee is often not much more than you would be paying for an investment manager,” said McLennon. After you die, trust income can pay for the trustee.
If you’re establishing a trust for minor children, your estate can pay to set up the trust after your death (if you have a life insurance policy, your insurance should cover these costs).
Another big drawback of irrevocable trusts is their inflexibility. It’s difficult to change them after you set them up, although McLennon said some states will now let you transfer assets between trusts.
Before you decide to set up a trust of any sort, consult with a specialized lawyer and accountant.
Written by Amanda Reaume. Originally published as part of Northwestern MutualVoice on Forbes.com.