A trust is created by a trust agreement to hold property for the benefit of the trust's designated beneficiaries. A settlor, the legal term for the person who creates a trust, transfers her property into the trust's name. Unlike property in a will, property in a trust is not subject to probate, which is one reason many people prefer trusts to a will.
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Revocable v. Irrevocable Trust
A revocable trust can be modified or revoked at any time during the lifetime of the settlor. The settlor can make changes to a revocable trust without consent from the trust beneficiaries. An irrevocable trust cannot be changed or revoked by the settlor during his lifetime. An irrevocable trust may be changed only with the consent of all the trust's beneficiaries. The settlor of an irrevocable trust gives up all the rights to the property put in the trust.
One reason to create an irrevocable trust is to satisfy a property settlement from a divorce. A judge may require property in a divorce settlement to be put in an irrevocable trust with the children as the beneficiaries. Another reason to put property in an irrevocable trust is to shelter the property from creditors. A common reason for creating an irrevocable trust is to avoid federal estate tax. Transferring a property into an irrevocable trust is like gifting the property, because the settlor no longer owns the property. At death, the settlor does not have to include the property in the irrevocable trust in his estate for federal estate tax purposes. The property transferred to the trust is still treated as a gift for federal gift tax purposes. Property that is appreciating in value can avoid some gift tax because the increase in value from the date the property is transferred to the trust to the date of the settlor's death is not subject to federal gift tax or estate tax.
Anyone can create an irrevocable trust if he has the mental capacity and the specific intention to do so. The capacity required to make a trust is the same capacity required to make a will, which requires a person to be at least 18 years old and of sound mind. Capacity includes knowledge of what objects are being put into a trust. Intention to create a trust means a person cannot create a trust if he only intends to set up a separate bank account. There must be specific intent to create an irrevocable trust.
An irrevocable trust must have a definite beneficiary. The trust property must be given to someone. The beneficiary can be anyone, including a relative or a charity, which makes the trust a charitable trust. The beneficiary of an irrevocable trust cannot be the settlor because the purpose of an irrevocable trust is to give up ownership of the property; if the settlor is the beneficiary, he has not cut ownership ties to the property. In addition, the settlor must appoint a trustee for the trust, and the trustee must have duties to perform. These duties relate to administration and management of the trust, such as filing tax returns or paying the trust's bills. Depending on the state, the settlor cannot obtain tax advantages of an irrevocable trust if he appoints himself as trustee.