What Is a Family Trust? Guide and How to Set One Up

A family trust is a trust that benefits the children, grandchildren, siblings, spouse or other family members of the person establishing the trust (grantor). Family trusts are common in estate planning to ensure certain beneficiaries receive assets when the grantor dies. They can be revocable or irrevocable.

The main purpose of a family trust is to ensure that certain assets pass from one family member to another^[0]

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Family trusts can be revocable or irrevocable.

• A revocable trust allows the grantor (also known as the settlor) to make changes to the trust during his or her lifetime, such as adding funds, changing which assets are in the trust or changing beneficiaries.

• An irrevocable trust cannot be altered once it is created.

Family trusts, like most trusts, have three major players:

• The grantor or settlor, who creates the trust and transfers assets into it.

• The trustee (or trustees), who manage(s) the trust for the beneficiary. If the trust is revocable, the grantor can also be the trustee and appoint a successor trustee in case he or she becomes unable to handle trustee responsibilities in the future.

• The beneficiary (or beneficiaries), who will inherit assets or gain financially from the trust.

» MORE: Why to appraise your assets when you set up a family trust

The main difference between a family trust and a regular living trust is that in a family trust, all the beneficiaries are family members of the person who created the trust.

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Although some particulars vary depending on your state’s laws, setting up a family trust typically involves three steps:

1. Draft the family trust document. Your trust document will need to contain the names of your family beneficiaries and what each will inherit, as well as a list of the assets in the trust and the name(s) of your trustee(s).

2. Incorporate state rules. You can hire an estate planning attorney or use an online will maker to set up a trust. Whichever method you choose, be absolutely sure you’ve met all your state’s requirements and have the required signatures to create a valid family trust; even small errors or omissions could cause big headaches.

3. Fund the family trust. The grantor transfers assets — such as bank accounts, investment accounts and real estate — to the trust by retitling the assets in the name of the trust. Once transferred, these assets become the trust’s assets. Assets transferred to an irrevocable trust remove the assets from the grantor’s control in the eyes of the IRS, which could reduce estate taxes — although most estates aren’t large enough to be subject to estate tax. The federal estate tax ranges from rates of 18% to 40% and generally only applies to assets over $12.92 million in 2023 or $13.61 million in 2024.

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If you’re planning to create a family trust, you have a number of different trust types to choose from, such as:

• Special needs trust: A special needs trust enables a person with a disability or functional needs to receive financial support without negatively affecting means-tested government benefits they receive, such as Medicaid or Supplemental Security Income (SSI)^[0]

  Cornell Law School Legal Information Institute. Special needs trust. Accessed Jul 11, 2023.

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• Spendthrift trust: A spendthrift trust limits a beneficiary’s access to the trust assets according to specific terms the grantor sets. Spendthrift trusts help ensure that beneficiaries can’t squander their inheritance; they also protect trust assets from creditors^[0]

  Cornell Law School Legal Information Institute. Spendthrift trust. Accessed Jul 11, 2023.

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• Testamentary trust: A testamentary trust is a trust created by the terms of your will and only funded upon your death. Beneficiaries can only access the assets at a predetermined time. Testamentary trusts can be used to give a surviving spouse an income or provide children funds once they’ve reached a certain age.

• Bypass trust: A bypass trust transfers a spouse’s share of the estate to a trust at death. The surviving spouse may get income from and use the trust assets; however, the trust’s beneficiaries inherit the assets when the surviving spouse dies.

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Advantages of a family trust

Including a family trust in your estate plan offers many advantages.

Avoid probate: Unlike wills, trusts typically don’t have to go through probate, and your assets transfer to beneficiaries quickly and smoothly, without the time and expense that probate involves.

Avoid a conservatorship: If you choose a successor trustee or co-trustee to manage your trust, you might be able to avoid conservatorship if you become incapacitated.

Privacy: Because you avoid probate, which is public record, what your family inherits from you via a family trust remains private.

Less vulnerability to a court challenge: Because they avoid probate, trusts tend to be more difficult to contest than wills, and because trusts are private, fewer people will know about your estate.

Flexibility: A family trust lets you decide who gets what and when. You can also help ensure that family members with functional needs don’t lose access to government benefits because of their inheritance. Additionally, if your trust is revocable, you can add or remove assets or change your beneficiaries as you see fit.

Tax planning vehicle: Certain types of family trusts can help reduce estate taxes, though most estates fall below the threshold for estate taxes. However, income over $600 generated by trust assets may be taxable^[0]

Disadvantages of a family trust

Family trusts also have a few disadvantages to be aware of.

• Cost: Hiring an estate planning attorney to set up a family trust can be expensive. Additionally, you may have to pay court fees and compensation to your trustee.

• Paperwork and complexity: Creating a trust and transferring assets can require complex paperwork and recordkeeping.

• Higher tax rate: Trusts have their own tax brackets, and the threshold for the highest bracket is lower than for individuals. This means trusts might pay higher taxes on the income their assets generate.