At face value, the definition of a trust agreement is right there in the title – it's an agreement in which one person vests the ownership rights of certain assets to another person. That sounds simple enough but, of course, when you're speaking legalese, face value is often just the beginning of a definition. Whether you call it a trust document, trustee contract, trust arrangement, trust deed or trust instrument, this type of agreement has a whole lot of moving parts and a whole lot of potential for variation. Arm yourself with the basic terminology and a knowledge of the sections you'll commonly find in a trust agreement, and your dive down the trust rabbit hole will be a much smoother ride.
Trust Agreement Basics
As a formal agreement, a trust agreement usually takes the form of a contract. In this contract, a trustor confers the ownership rights of one or more assets to a trustee. The document typically details why this transfer is taking place, which is often for the purpose of conservation or protection of assets.
At its most basic, a trust agreement defines the purpose of establishing the trust, the terms that must be fulfilled to terminate the trust and the full details of the assets placed in the trust. It also spells out what powers and limitations the trustees hold and what sort of provisions may affect them, as well as any compensation the trustees may receive.
Read More: Requirements for a Irrevocable Family Trust Agreement
Breaking Down the Definitions
If you've got a trust agreement in your hands, there's a good chance you're staring down some fairly serious legal jargon. Before you can define a trust, it helps to define all of its parts. So let's take a look at some of the terms you'll most frequently come across in a trust arrangement:
- Trust: The legal definition of a trust is an entity created by a first party (the trustor) that enables a second party (the trustee) to manage the first party's assets for the benefit of a third party (the beneficiary).
- Trustor: This is the entity that establishes a trust. The trustor places his property or assets under the management and protection of a second party or multiple parties. A trustor is sometimes called a grantor, settlor, creator, donor, owner, initiator or trust maker.
- Trustee: The trustee is the second party in question – the person, persons, entity or entities who are tasked with managing or protecting the trustor's assets. Basically, the trustee carries out the trustor's wishes in regards to her assets. It is possible to act as your own trustee in most cases.
- Beneficiary: The key third party in the agreement, the beneficiary, is the party who ultimately receives the assets, profit, benefit or advantage from the trust. Like trustees, there may be multiple beneficiaries in a trust agreement. Beneficiaries can be people, businesses or charities.
- Assets: The assets are the items of value that the beneficiary will receive, under the care of the trustee. Assets often include money, real estate, stocks, business interests or insurance policies.
- Reporting Requirements: This term encompasses any information required from the trustee, including how often the information is needed and what format it must take.
- Vests: Used as a verb, this term simply means to confer or bestow. The trustor vests ownership rights to the trustee.
When to Use a Trust
Trust agreements aren't a catch-all solution to passing assets to beneficiaries. Like similar arrangements, such as wills, they have their own unique set of advantages and pitfalls. At their core, trust agreements offer three key benefits:
- Control of wealth
- Tax advantages
In the big picture, a trust agreement empowers trustors to exercise control of their wealth. Because of the agreement's flexible potential for precision, the trustor defines the terms of asset distribution with great specificity. This makes a trust arrangement particularly advantageous when the beneficiaries are not well-versed in wealth management or in cases where the trustor wants to protect the estate from creditors.
One of the major benefits of a trust agreement is that it often allows beneficiaries to receive assets more quickly when compared to, for instance, a will. Likewise, some trusts are not considered part of the trustor's taxable estate, which is a definite perk when April 15th rolls around. Because trusted assets often pass outside of probate, court fees are not usually an issue, either. When the courts aren't involved, that means you have more privacy, too, since probate proceedings are a matter of public record.
Trust Agreement Sections: The Basics
Right off the bat, a basic trust agreement identifies the name of the trust and establishes a declaration of trust. This identifies the trustor and the trustee, and recognizes the transfer of assets between them. Near the beginning of the contract, you're also likely to find definitions of the terminology used throughout the agreement.
Next, you might find details about amendments or revocations. These sections detail the powers the trustor has to change the terms of the trust agreement or to revoke it entirely, and lays out the limitations on those powers. Here, you'll also learn whether or not any other parties are able to exercise these powers on behalf of the trustor.
A payments section, as you might expect, dives in to the subject of how payments from the trust will be distributed. The trustee section – usually complete with a whole scroll of subsections – gets in to issues such as:
- Identifying the trustee.
- Defining the trustee's responsibilities.
- Defining the terms of the trustee's possible resignation.
- Outlining potential trustee compensation or the lack thereof.
- Listing any liabilities held by the trustee.
Near this section, you'll find other sections and subsections that describe the trustee's specified powers. These powers may include the ability to: sell trust property; manage trust real estate; sell or grant options in exchange for trust property; invest in trust property; add to the trust's assets; hire and compensate reasonable and necessary staff related to the trust; deposit trust funds in interest-bearing and noninterest-bearing accounts; continue the trustor's business operations; execute defined legal actions related to that business; draft new documents relevant to the existing trust; and diversify the trust's investments.
Trust Agreement Parts: Trustors and Beneficiaries
After communicating all sorts of info pertaining to the trustee, a trust agreement is then likely to delve into stipulations about the trustor, or grantor. These sections elaborate on what exactly should happen if the trustor becomes incapacitated or dies; they set out the exact details of how the trustee shall distribute the trust assets to the beneficiaries in these circumstances. This part, of course, includes who those beneficiaries are and lays out the terms of the property distribution, such as how joint beneficiaries are to share certain assets.
Here, you'll also find details about custodianships, which might come into play if any beneficiaries are minors; rights to certain tax exemptions; a severability of clauses disclaimer that notes that even if any terms of the trust are ruled unenforceable, the enforceable parts of the document remain valid.
Trust Agreement Parts: Digging Deeper
Often, a trust agreement refers the reader to various ancillary documents, such as Schedule A or Schedule B, that are attached to the main contract. These documents go into specific detail regarding certain terms of the trust, such as fully describing the characteristics of real estate or other assets being transferred to the trustee. Additionally, a solid trust agreement should include contingency plans that name a successor trustee and set out conditions in which a successor is needed and the methods for determining an alternate trustee.
To wrap the agreement up, the grantor certifies the trust agreement by signing and dating the contract. In a section that certifies the acknowledgment of a notary public, a notary public and witness add their signatures and official seals to formally execute the arrangement.
The DIY Route
Trust agreements are usually drafted by attorneys, and in most cases, this is the optimal choice. That said, it is entirely possible to go the DIY route with your trust agreement.
As an individual, chances are you'll be dealing with creating a living trust document. For about $30, you can buy a physical or digital book that includes instructions and all the necessary legal forms that make up a living trust agreement. At about twice the cost, living trust software automates the process. In either case, these tools include basic living trust documents and forms such as:
- Witness statements.
- Disclaimers and amendments.
- Property assignments (for shared property or to individuals).
- Revocation of the living trust.
- Wills for individuals and couples.
- Affidavits for successor trustees.
- Property worksheets.
- Beneficiary worksheets.
If you opt for using a lawyer, be prepared to pay about $1,200 to $2,000 for creating a basic living trust, as of 2019 rates provided by Nolo.
Common Types of Trusts
The language, requirements, sections and stipulations of trust agreements vary across different types of trusts. To help prepare you for the various types of trust contracts you may come across, here are just a few of the most common types:
- Living Trust: A living trust is created by the trustor while he is still alive.
- Testamentary Trust: This type of trust is established via a will, so it comes into effect or is created when the trustor is no longer living.
- Revocable Trust: A more flexible arrangement, a revocable trust can be modified – or even terminated – by the trustor after it's created. Usually, a revocable trust becomes irrevocable when the trustor dies.
- Irrevocable Trust: You can probably guess what this one is. That's right, an irrevocable trust can't be terminated or even modified by the trustor after it's created. This type of trust is often exempt from the taxable estate.
- Real Estate Trust: Real estate is one of the most common assets covered by a trust, so it's little wonder that real estate trusts are so numerous. For a real estate trust agreement to be valid, it must contain an exact and detailed description of the real estate at hand. Moreover, it needs the trustor's express and written consent.
- Marital Trust: This basic trust provides benefits to a surviving spouse from a deceased trustor. Also known as an A trust, it is part of a spouse's taxable estate.
- Bypass Trust: A bypass trust, as the name implies, bypasses the surviving spouse's estate. Because it seeks to take advantage of estate tax exemptions, it's also known as a credit shelter trust. Some call this a B trust.
- Generation-Skipping Trust: It's all in the name, here. A generation-skipping trust leapfrogs at least one generation of beneficiaries. Conveniently, this also helps it leapfrog estate taxes.
- Charitable Trusts: A charitable lead trust transfers the majority of a trustor's assets to charity and the remainder to the beneficiaries. A charitable remainder trust doles out an income stream to the beneficiaries, then gives the remainder to a charitable cause.
Basically, a trust agreement is a formal agreement by which a trustor vests the ownership rights of certain assets to a trustee.
As a freelance writer and small business owner with a decade of experience, Dan has contributed legal- and finance-oriented content to diverse sources including Chron, Fortune, Zacks.com, Motley Fool and MSN Money, among others.