For years, trusts have acted as a powerful financial platform which provides individuals with the ability to safely store assets over time. Both revocable and irrevocable trusts provide numerous benefits for the grantors of these accounts. Although many of the fine details regarding these two forms of trust differ significantly, their primary function remains the same: to safeguard a given set of assets which, following the death of the grantor, pass on to the named beneficiary.
Although we commonly think of trust beneficiaries as single individuals, it is also possible to name an organization, such as a charity, as the beneficiary of a revocable trust. The process of naming the charity as the beneficiary is virtually no different than the one used to name an individual.
Naming a charity beneficiary in a revocable trust is a common practice today. Not only does this help transfer money to excellent organizations with admirable causes, but it also allows the grantor to include a charitable set-aside deduction on their tax returns.
The Basics of Trusts
As mentioned previously, there are two primary forms of trusts in use today: revocable and irrevocable trusts. Whether you are planning on naming an individual as a beneficiary or a charity, you can do so using either trust. For many individuals, understanding the core foundation and critical differences between a revocable trust and an irrevocable trust is the first step to fully evaluating the best possible financial planning opportunities.
On a fundamental level, the successful operation of a trust requires a grantor (also referred to as a truster), or the individual placing the assets inside of the trust, a trustee, who supervises the operation of the trust, and a beneficiary, an individual or organization who receives the assets inside of the trust upon the death of the grantor. Although in certain circumstances the grantor of the trust can also be the trustee, this is typically discouraged.
The primary function of a trust is simple: by placing assets inside of a trust and naming a beneficiary, the assets themselves can quickly be transferred out of the trust following the death of the grantor without first requiring a probate process. This can be particularly beneficial if the assets inside of the trust are in any way "time-sensitive," such as shares of stock or similar items.
Key Components of a Revocable Trust
A revocable trust is arguably the easiest form of trust to established due in large part to the fact that it requires very few regulatory statutes to be met. The grantor of the revocable trust can choose to place any type of asset they would like inside of the trust while still retaining ownership of the item in question. Because of this, the grantor can decide at any point to remove items from the trust, add items to the trust or tweak the list of beneficiaries. Due to the fact that the grantor retains full control of the items in the trust, he or she is still responsible for paying taxes on these items in the event that they are sold for a profit at any time.
For example, if a grantor has placed shares of Company X inside of the trust and later decides to sell them at a higher price, they will be responsible for paying either long- or short-term capital gains on the transaction based on how long the shares were in their possession.
When the grantor of a revocable trust dies, the items inside of the trust are essentially "locked in" and the trust itself transforms into an irrevocable trust. At this point, sole control of the trust is granted to the trustee, whose job then becomes to oversee the distribution of assets to named beneficiaries in as efficient and timely a manner possible.
The trustee is legally bound to act in the best interests of the trust rather than themselves or a third-party. With that in mind, it is possible for a beneficiary to file a lawsuit against the trustee in the event that they suspect that personal agendas are taking priority over the welfare of the trust itself.
The trustee essentially remains the guardian of the trust until all of the assets inside of it are fully distributed to the beneficiaries. At this point, the trust is closed by the trustee and his/her duties are effectively over. Once the trust has been dissolved, the trustee has no legal oversight over any assets that may have once been included in the trust itself. If the beneficiaries have not yet received all that is owed to them, the trust remains active.
Irrevocable Trust Basics
Unlike a revocable trust, asset ownership becomes somewhat more complicated when an irrevocable trust is involved. When a grantor creates an irrevocable trust, they must accept that any items placed inside of the trust are no longer their property but, instead, the full property of the trust itself. There are certain advantages and disadvantages to this process.
By relinquishing ownership of assets, the grantor of the trust is no longer required to pay tax on any asset they have placed inside of the irrevocable trust. That being said, they also are given no say when it comes to how the assets in the trust are managed. With that in mind, it can be argued that an irrevocable trust transfers significantly more power to the trustee compared to a revocable trust.
With regards to taxation, it is important to mention that an irrevocable trust becomes its own taxable entity once it begins to harbor assets. Because of this, the trustee must ensure that a tax return is filed for the irrevocable trust on an annual basis. Failure to do so could result in a variety of legal and financial penalties.
Given the fact that a revocable trust becomes an irrevocable trust following the death of the grantor, the information included previously regarding the distribution of trust assets remains the same regardless of whether or not a trust actually began as an irrevocable trust. Once the original grantor of the trust has passed away, all actions related to the distribution of assets from the trust must adhere to the guidelines incorporated into irrevocable trusts.
Naming an Organization as Beneficiary
If you named a charity as the beneficiary of your trust, you will be required to follow slightly different procedures than if you were to name both a charity and an individual as the beneficiary of the trust. When a trust involves not only two separate beneficiaries but also two distinct types of beneficiaries, it is commonly referred to as a split-interest trust. At this point, the trust must then be classified as either a charitable lead trust or a charitable remainder trust.
Defining a Charitable Lead Trust
If the grantor of the trust would like for the assets of the trust to be distributed to charities during his or her lifetime, then they are effectively creating a charitable lead trust. As part of this process, the named charity or charities will receive recurring payments from the trust over the lifetime of the grantor, and any additional named beneficiaries will receive the remaining sum once the charitable distributions are completed.
The specific timeline for charitable payments can be determined by one of two parameters: A.) the death of the grantor or B.) the defined time interval included in the trust documentation. In either situation, a point will come when the payments to charity will end and the remaining beneficiaries will receive distributions from the trust until all assets are removed.
For the grantor, a charitable lead trust is particularly beneficial due to the fact that these distributions all qualify as tax deductions. Because of this, it may be in the best interest of the grantor to space these distributions out over an extended period of time to maximize the lifespan of these deductions.
Defining a Charitable Remainder Trust
Unlike a charitable lead trust, a charitable remainder trust prioritizes distributions to individual beneficiaries over charitable organizations. Any individual named as a beneficiary in the trust – which could also include the grantor – must receive the specific sum of distributions promised to them over the dictated lifespan of disbursements before the charitable organization is eligible to receive funds.
As with a charitable lead trust, the distributions to individual beneficiaries will end either with the death of the grantor or according to a defined timeline within the trust documentation. Even though the order of priority has been reversed with a charitable lead trust, the grantor is still eligible to receive a charitable deduction on their tax return for any year in which money was disbursed to a charitable organization. With both charitable lead trusts and charitable remainder trusts, the grantor is given an attractive incentive to donate part of their assets to worthy causes.
The Importance of the Trustee
Because of the immense responsibilities placed on the trustee following the death of the grantor, it is imperative that this individual is well qualified in virtually all aspects of trust oversight. The absolute control and authority vested in the trustee mean that this individual can choose to act in whatever manner they so please regarding trust assets as long as their position can be defended as being in the best interest of the trust. Even the best interests can result in financial loss, however.
The grantor should devote considerable attention to their potential picks for the position of trustee prior to appointing an individual. Once the documents for these trusts have been organized, it can be difficult to replace these individuals in the event that the grantor changes their mind. In fact, a grantor loses virtually all agency in an irrevocable trust once it has been established.
Moving Ahead With Trusts
In the event that you have decided to establish a trust, you will likely be presented with a variety of considerations which will inform not only your decision as to which type of trust you would like to create, but also as to whether or not you would like to include a charity as a beneficiary. In many situations, consulting with a financial adviser and/or tax expert can help you determine specifically what the best realization of your interests will be.
Even the best of intentions can result in a variety of tax and logistical complications if not planned correctly, which is why it is imperative that the organization of your trust is administered to by experts in the field.
Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community. Ryan's work has been featured on PocketSense, Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.