[MUSIC PLAYING]

Laura K. Zeigler:

What is a trust? Wealth frequently gets passed from one generation to another through something called a trust. But what exactly is a trust, and what makes it so valuable? A trust is perhaps best understood by imagining the three parties involved—the grantor, the beneficiary, and the trustee.

A grantor—sometimes called a donor or a settlor—decides to transfer property to a person or organization for a specific purpose. The property could be real estate, an investment portfolio, or shares in a company, among other things. The grantor in our example—Liz, a former Fortune 500 executive—decides that she wants to transfer a portion of her investment portfolio to her eight-year-old daughter, Meghan, using a trust. Meghan, because she will be receiving the benefits of this trust, is what we call the beneficiary. Let's say Liz wants to use an irrevocable trust, one where she has to decide the rules for the trust at the very beginning, such as when Meghan receives the money, for what reasons, and in what amounts. Once Liz puts her assets in this type of trust and sets the rules, she no longer has control over the assets.

So after thinking it over for a while and consulting with an attorney who specializes in trusts, Liz decides that these assets should be used to cover certain expenses that might arise for Meghan in the future. Liz specifies what these particular instances are in the terms of the trust. Now remember, Meghan is only eight years old. Liz needs somebody to manage the investments with Meghan's future in mind, and she needs somebody to make sure that the rules she's laid out for in this trust are enforced and respected and that Meghan gets the money as she should at the right time, in the right amount, and for the right reasons.

Well, this brings us to the third party in the trust triangle—the trustee. A trustee carries out the grantor's wishes for the trust, and it can be a person or a trust company. Let's say that time passes and Meghan is now 23 and she knows she has this trust and wants to ask for a distribution to pay for some expense. Maybe it's medical school or a car.

She would then go to the trustee and ask for a distribution. At which point, the trustee would review the terms of the trust and determine whether or not this expense is allowed. And in some cases, the answer may well be yes. In other cases, it might be no.

All of this prompts an interesting question: why pass wealth using a trust instead of just giving it to someone directly? Well, there are four key benefits of transferring wealth using a trust. The first is it allows you to specify the who, the when, and the why. If a grantor wants to pass their wealth only to a particular charity, to pay for a home for a family member in the future, or maybe just go to a person or organization with no strings attached whatsoever, they can do all of these things through a trust.

Trusts give that flexibility. Plus, as we saw in the case of Liz and Meghan, it allows the grantor to transfer assets to somebody years from now because of their age or other circumstances. The second reason for passing wealth through a trust is professional management. With trusts, a grantor can select someone or an organization to manage the investments to make sure that the rules of the trust are enforced and respected and to oversee distributions to the beneficiaries.

The third reason is it may help limit taxes. Though it varies according to the terms of each trust, in some cases, a trust allows grantors to pass wealth on to someone while limiting the amount that gets eaten up by taxes. The fourth benefit is, in some cases, it may help protect assets. So in Meghan's case, if she goes on to become a very successful doctor someday and faces a lawsuit, most likely whoever is suing her wouldn't be able to go after the assets in the trust.

For all of these reasons, a trust remains a smart and popular way to transfer wealth.

[MUSIC PLAYING]