How to Secure Debt with Trust Assets

When you hear the term "trust," you may think of an account set up by a wealthy parent or grandparent that can’t be accessed without a trustee's consent. However, this is only partly the case. A trust is a financial tool that is important in estate planning because it allows assets to be controlled even after the death of the person who created the trust. Although you can’t freely access trust funds until you actually inherit the trust, there may be a way that you can use the trust assets as loan collateral.

Check the Trust's Rules

Before you consider borrowing from a trust or using trust assets as collateral, you should first check the rules of the trust agreement to see if lending is allowed. In the case of a living trust, also known as a revocable trust, you are free to do as you wish with the funds if you are the trustee. For an irrevocable trust that’s managed by a third-party trustee, you will have to talk to the trustee to find out what type of loans and distributions are allowed.

Consult With the Trustee

If a trust agreement allows loans, then the trustee has the final say when it comes to borrowing from the trust or using it as loan security. If the trustee agrees, it may be possible to secure a loan from a trust with a lower interest rate than a comparable loan offered by a commercial bank. The trust may benefit from such a loan if the interest rate is higher than the trust’s investment vehicle, which may be a money market fund or bank CD. Using cash from a trust to secure a loan that will be repaid doesn’t deplete the trust in the same way that a distribution does.

Considerations for the Trustee

The trustee is responsible for the health of the trust, so the trustee must determine if the beneficiary of the trust will be able to repay the loan before agreeing to let trust assets be used for a loan. If the trustee doesn’t complete due diligence, and the beneficiary cannot repay the loan, the IRS may treat it as a trust distribution and require the beneficiary to pay income tax on the loan amount. The trustee should be careful to document any loans made from the trust with a promissory note and other documentation that will help show the IRS that a loan was made rather than a distribution.

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