Trusts can be an important vehicle for estate planning because they help protect a person's estate and ensure that a beneficiary's needs are adequately met during his or her lifetime. One of the key elements of a trust is that it creates a distinction between the income of the trust and the principal of the trust. Trusts can be created in many different ways, with various types of provisions, so the specific trust administration will depend on those provisions.
In general, trusts will stipulate that the income of the trust should be distributed to a particular person during his or her lifetime. In contrast, the principal will be distributed to a different person at a later time, or to the person receiving the income from the trust, but at a different time or in a particular situation. For example, trusts frequently provide that the income is to be distributed to a surviving spouse, with the principal distributed to children after that spouse's death. However, this is only one potential possibility. There can be many different types of distributions.
A fiduciary is the person who generally handles the trust administration. It is important for the fiduciary to be very aware of the potential effects of any action he or she takes in administering the trust. For example, some fiduciaries may seek to invest trust assets. Investment of trust assets can be complicated, however, and if the fiduciary has limited financial experience, he or she should generally seek advice from an experienced financial professional in order to ensure that the investments comply with the terms of the trust and the prudent investor rule.
Important decisions that must be made by the fiduciary with regard to investments include deciding which assets should be sold to make gifts or to cover taxes or expenses, deciding how to invest, and minimizing taxation relating to income and capital gains. As part of the trust administration, the fiduciary also has the responsibility to file an annual tax return for the trust and provide to beneficiaries a Schedule K-1. A Schedule K-1 is a specific tax statement needed by the beneficiary if the beneficiary may be taxed on the income received from the trust.
Source: American Bar Association, "Guidelines for Individual Executors & Trustees," last accessed May 12, 2015