Sometimes it is good to review basics. I often write about how trusts can be used in estate planning. And for good reason: Planning is all about the future. Estate planning says what you want to happen to your family and your farm with its related assets. Trusts are incredibly flexible tools for holding, controlling, protecting and directing assets into the future. In my mind, they are the Swiss army knife of estate planning.

To understand trusts, let’s first distinguish them from business organizations like limited liability companies, partnerships and corporations. Business organizations are essentially an artificial “person” created under the law. We sometimes call them an entity. An entity can own property. But the entity itself is also something that is owned, such as by its members, partners or shareholders.

So when you think of your LLC, you can ask, “What does it own?” But you can also ask, “Who owns the LLC itself?”

A trust is a different animal altogether. We don’t speak in terms of who owns the trust, like you would ask, “Who owns the LLC?” No one owns the trust. A better way to think about trusts is, “Who are the parties to the trust?” There are three parties to any trust:

1. Creator. I like to call this the trustmaker. This party has something of value (assets) that they want held for someone’s benefit and according to some stipulations. They establish the terms of the trust — the stipulations according to which they want the assets held — and contribute the assets.

2. Trustee. The trustmaker transfers the assets to the trustee on the condition that the trustee will hold the assets according to the stipulations of the trust. At this point, a trust really looks like a contract. One party, the trustmaker, says, “These are the terms by which I want these assets managed; will you do it?” The second party accepts those terms or must decline to be the trustee. In a very real sense, the trustmaker “entrusts” the property to the care of the trustee.

3. Beneficiary. Every trust is for the benefit of someone. We call this third party the “beneficiary.” The trustmaker wanted to provide financial benefits of some sort to this person but wanted the assets to be managed by the trustee.

So you might come back to, “Who owns a trust?” No one owns the trust. The correct question is, “Who owns the assets in the trust?” This is the fun part. A trust separates the beneficial ownership from the legal ownership. The beneficiary has the beneficial ownership, but the trustee has legal ownership.

Meet Gordy, Sue and Junior

Let’s apply these concepts. Grandpa Gordy wants to give away $100,000 to help grandson Junior through college. Gordy could simply pay Junior’s bills along the way during his four-year college experience, but given his age and declining health, he wants to get this money out of his hands now and be done with it. However, Gordy does not trust Junior to use the money solely for the intended purposes. So Gordy isn’t willing to simply give the $100,000 to Junior today. Instead, Gordy asks his daughter Sue to hold on to the funds and disburse them for Junior.

Gordy as trustmaker is entrusting Sue as trustee with assets for the benefit of Junior, beneficiary. The terms of the trust can vary widely.

Gordy might write out very specific details for what is and is not permitted. Maybe he says yes to paying tuition, a shared dorm room on campus, a basic college meal plan and $25 spending money per week. But no money for a car, new clothing, alcohol or dates! If Sue agrees to be trustee according to those trust terms, she is legally permitted to disburse money only for these purposes.

Alternatively, Gordy might leave the terms of the trust broad, relying on Sue’s judgment about what is appropriate for college expenses of Junior. In that case, Sue might pay for the exact same things listed above, or she might be more or less generous with the $100,000 entrusted to her.

Either way, Sue must not use the $100,000 for her own benefit. She must manage the funds strictly to benefit Junior. So, who owns the $100,000? Sue owns the legal title to the money, but Junior owns the benefits of the money.

In my next article, we will apply these basic principles to typical estate planning trusts.