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Taking Care of Mom and Dad: Trusts for Family or Charities

If your parents have enough money and are serious about giving it to family or to charities, they should think about setting up trusts that will do this. They don't need to be billionaires to use trusts; most can be set up with only a few thousand dollars.

The use of a trust says more about your parents' seriousness about giving than the extent of their wealth. Giving a few hundred dollars each to many charities is not as tax effective as setting up several thousand dollars to earn money over a long period for a few groups.

A trust is a legal contract by which one party -- the trustee -- is given legal ownership of some property to be managed or invested for the benefit of someone else. Trusts are private contracts or agreements, but are recognized by the laws and courts as independent legal entities -- like people or corporations.

The property in the trust is known as the trust principal or corpus. The person for whom it's being managed or invested is the beneficiary (there can be more than one beneficiary to a trust). Finally, the person making the trust is called the grantor (or settlor or trustor in different locations).

Generally, one person can play up to two of the three key roles in a trust. The grantor can also be the trustee; the grantor can also be the beneficiary. In most cases, though, one person can't be all three.

Like any contract, a trust can be structured too rigidly and with unreasonable conditions -- or it may be written too loosely. Both extremes can encourage unwise decisions among the people they're intended to benefit.

Most married people leave their property to their spouses when they die. But, for larger estates, it may be better to leave property in a credit shelter trust for the surviving (also called second in some contracts) spouse's benefit.

This trust shelters the first spouse's assets -- and credit -- up to $1 million. The income from it still goes to the surviving spouse for life; even the principal can be tapped for purposes of health, education and support. But the assets aren't subject to estate tax when the surviving spouse dies. Without this type of trust, the tax hammer would fall on the children with the death of the second spouse.

Single people have fewer options, but can also reduce estate taxes by setting up charitable trusts (in which a charity owns the principal but the beneficiaries collect interest as long as they live) or making annual gifts.

In many cases, a trust can remain empty (or unfunded in trust jargon) for quite a while after its creation. In some states, however, nominal funding (e.g., $100 in a bank account) is required. This is a good idea anyway. It shows that the trust is more than a piece of paper.

Although an empty trust can exist, in order to function, a trust must have assets formally transferred to the trustee, with this title used in the documents of ownership. Financial institutions will require authorization, in the form of the trust document, before they will accept instructions from a trustee.

Trusts can be living (established during the grantor's lifetime) or testamentary (established in a will). Separately, trusts can either be revocable or irrevocable. Living trusts are usually revocable, which means the grantor can change structure or terms. If a trust is irrevocable, the grantor can never change or terminate it -- or withdraw assets, even in an emergency. An irrevocable trust is an independent entity under the law.

Testamentary trusts remain more common than living trusts because most people are hesitant about transferring major assets while they're still alive.

Lifetime property transfers into living trusts inevitably involve frank discussions about death...and lots of paper work. And many people are uncomfortable talking about death, let alone executing a contract about it. But relying on testamentary trusts to transfer assets only delays the work until somebody else (usually a lawyer or accountant) has to do it.

The main problem with trusts is that they are sometimes badly drawn. If they leave important people or facts out -- or if they include language that contradicts itself -- trouble will follow. The existence and structure of trusts also may complicate family relationships.

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