Table of Contents
SERIES 65 | FINANCIAL REGULATION COURSES
A trust is a legal arrangement in which one party — the grantor, also called the settlor or trustor — transfers legal title to assets to a second party — the trustee — who holds and manages those assets for the benefit of one or more third parties — the beneficiaries — according to the terms and conditions specified in the trust document, which governs the trustee's duties, powers, and obligations throughout the trust's existence.
The trust is one of the most flexible and widely used structures in estate planning, asset protection, tax planning, and investment management — enabling the separation of legal ownership from beneficial enjoyment of assets in ways that can achieve a remarkable range of financial, tax, and personal objectives that would be impossible through outright ownership alone.
The trust structure creates a fiduciary relationship in which the trustee owes the highest legal duty of care, loyalty, and impartiality to the beneficiaries — managing the trust assets not for the trustee's own benefit but exclusively for the purposes defined in the trust document and the applicable law.
Investment advisers who serve clients with trust accounts or who advise trustees on investment policy must understand the foundational trust framework, the distinctions among the major trust types, the fiduciary obligations of trustees under the Uniform Prudent Investor Act, and the tax treatment of trust income under IRC Subchapter J — all of which are directly tested on the Series 65 examination in the context of client account types, estate planning, and the legal framework governing investment management.
Every trust relationship involves three essential parties whose roles and relationships to each other define the legal and economic structure of the arrangement.
The grantor — also called the settlor, trustor, or creator — is the person who establishes the trust by executing the trust document and transferring assets into the trust. The grantor defines the trust's purpose, identifies the trustee and beneficiaries, specifies the terms under which the trust will be administered, and determines the conditions under which distributions will be made. The grantor's authority over the trust after its creation depends fundamentally on whether the trust is revocable or irrevocable — in a revocable trust the grantor retains the power to amend, modify, or terminate the trust during their lifetime, while in an irrevocable trust the grantor permanently relinquishes control over the transferred assets and generally cannot modify the trust's terms after its creation.
The trustee is the individual or institution — most commonly a bank trust department, a trust company, or a professional fiduciary — who holds legal title to the trust assets and bears the fiduciary responsibility for managing those assets according to the trust document's terms and applicable law. The trustee's role is not ownership in any economically beneficial sense — the trustee holds title as a legal mechanism for management and control rather than for personal benefit. The trustee owes the beneficiaries a comprehensive set of fiduciary duties including the duty of loyalty — to act solely in the beneficiaries' interests without self-dealing — the duty of prudence — to invest and manage the trust assets as a prudent investor would — the duty of impartiality — to balance the competing interests of current income beneficiaries and remainder beneficiaries — and the duty of full disclosure — to keep beneficiaries informed about the trust's administration and financial condition.
The beneficiary is the person or entity for whose benefit the trust assets are held and managed. Trusts frequently have two categories of beneficiaries with different temporal interests — current beneficiaries who are entitled to receive income or other distributions during the trust's administration period, and remainder beneficiaries who receive the trust's remaining assets when the trust terminates at a specified event such as the death of the grantor or the attainment of a specified age by the current beneficiary. The trust document specifies the trustee's obligations to each category — including mandatory income distributions, discretionary principal distributions, and the conditions under which the trustee may or must make payments.
The most fundamental classification of any trust is whether it is revocable or irrevocable — a distinction with profound implications for the grantor's control over the assets, the trust's tax treatment, and its effectiveness for asset protection and estate planning purposes.
A revocable trust — most commonly established as a revocable living trust or inter vivos trust — is one that the grantor retains the power to amend, modify, or revoke entirely during their lifetime. Because the grantor can reclaim the assets at any time by revoking the trust, the assets are treated as still belonging to the grantor for virtually all legal and tax purposes during the grantor's lifetime. The Internal Revenue Code under IRC Sections 671 through 677 treats the grantor as the owner of a revocable trust's assets — all income, gains, deductions, and credits of the trust are reported directly on the grantor's personal income tax return as if the trust did not exist as a separate entity. The revocable trust does not file its own income tax return and does not require a separate employer identification number during the grantor's lifetime — the grantor's own Social Security number serves as the trust's tax identification number.
The primary benefits of a revocable living trust are probate avoidance and continuity of management. Assets held in a revocable trust at the grantor's death transfer directly to the named successor beneficiaries without passing through probate — the court-supervised estate administration process that applies to assets held in the grantor's individual name. This avoidance of probate provides privacy — trust distributions are not part of the public record as probate proceedings are — and efficiency — trust distributions can be made within days or weeks of the grantor's death rather than the months or years that complex probate proceedings can require. If the grantor becomes incapacitated during their lifetime the named successor trustee — designated in the trust document — can assume management of the trust assets immediately without requiring a court-appointed conservatorship, providing continuity of financial management during incapacity.
An irrevocable trust is one in which the grantor permanently relinquishes control over the transferred assets — after the trust is created and funded the grantor generally cannot modify its terms, reclaim the assets, or change the beneficiaries without the consent of the beneficiaries and potentially court approval. This permanent relinquishment of control is the essential characteristic from which all of the irrevocable trust's distinctive tax and asset protection benefits flow.
Because the grantor no longer owns or controls the assets in an irrevocable trust, those assets are generally excluded from the grantor's taxable estate for federal estate tax purposes — a powerful estate planning benefit for high-net-worth individuals whose estates exceed the federal estate tax exemption. Assets transferred to an irrevocable trust may also be protected from the grantor's creditors — because the grantor no longer legally owns the assets, creditors of the grantor generally cannot reach them — subject to applicable fraudulent transfer laws that prevent transfers made with the intent to defraud existing creditors. The irrevocable trust is treated as a separate taxable entity — it must obtain its own employer identification number, file its own fiduciary income tax return on Form 1041, and pay its own income taxes on any income it does not distribute to beneficiaries under the compressed trust income tax rate schedule in IRC Subchapter J.
Trusts are also classified by when they are created relative to the grantor's lifetime — as either inter vivos trusts created during the grantor's lifetime or testamentary trusts that come into existence only upon the grantor's death.
A living trust — formally called an inter vivos trust from the Latin meaning between the living — is established and funded during the grantor's lifetime. It becomes operational immediately upon execution and funding — the grantor transfers assets into the trust and the trustee assumes management responsibilities during the grantor's life. Living trusts may be either revocable or irrevocable as discussed above. The revocable living trust is the most widely used estate planning vehicle for middle and upper-income individuals — providing probate avoidance, incapacity planning, and privacy at relatively low cost compared to complex irrevocable trust arrangements.
A testamentary trust is created through a grantor's last will and testament and comes into existence only upon the grantor's death — when the will is probated and the assets designated for the trust are transferred from the decedent's estate into the newly created trust. A testamentary trust is irrevocable by definition — because the grantor is deceased it cannot be modified or revoked. Because the testamentary trust is created through a will it must go through the probate process — unlike a living trust it does not avoid probate and its terms are part of the public probate record. Testamentary trusts are commonly used to manage assets for minor children — where the grantor wants to provide for the children's financial needs but does not want them to receive outright ownership of assets until they reach a specified age — and for beneficiaries with special needs or financial management challenges who would benefit from ongoing trustee oversight.
The Uniform Prudent Investor Act — adopted by most states and the foundational legal standard for trust investment management — establishes the standard of care that trustees must meet when investing and managing trust assets on behalf of beneficiaries. The Act codifies five core principles that govern trustee investment conduct.
The risk and return trade-off principle requires trustees to make investment decisions considering both risk and expected return — recognising that some risk is appropriate to achieve returns adequate to meet the trust's purposes. The duty of prudence is evaluated not on an investment-by-investment basis but by looking at the total portfolio — an individual investment that appears risky in isolation may be appropriate as part of a diversified portfolio strategy.
The diversification duty requires trustees to diversify trust investments unless the trust document specifically authorises concentration or special circumstances make diversification clearly inadvisable. The Act recognises Modern Portfolio Theory's foundational insight that diversification reduces unsystematic risk without sacrificing expected return — making diversification the trustee's default obligation in the absence of specific trust direction otherwise.
The total return principle recognises that investment return encompasses both income — dividends, interest — and capital appreciation — and that trustees should seek to maximise total return appropriate to the trust's risk tolerance rather than optimising for income alone at the expense of overall portfolio performance. This total return approach replaced the older legal rule — the prudent man rule — that had required trustees to invest primarily in income-producing assets.
The duty of impartiality requires trustees to balance the competing interests of current income beneficiaries — who receive the trust's income distributions and therefore prefer income-generating investments — and remainder beneficiaries — who receive the trust's principal when it terminates and therefore prefer capital appreciation strategies. The trustee must manage the portfolio to serve both groups fairly rather than favouring either at the other's expense.
The delegation authority permits trustees to delegate investment functions to qualified investment advisers — and many bank trust departments and institutional trustees do engage investment advisers to manage the investment portfolio under the trustee's oversight. When the trustee delegates investment management to an adviser, the trustee remains responsible for the initial selection and ongoing monitoring of the adviser and must ensure that the delegation arrangement satisfies the prudent investor standard.
Investment advisers and broker-dealers frequently manage trust assets through investment advisory agreements or brokerage accounts established in the trust's name. The account opening process for trust accounts requires documentation of the trust's existence and terms — typically through a certificate of trust or a copy of the trust document — to verify the trustee's authority to open the account and the trustee's investment powers under the trust document.
The trustee — not the beneficiary — is the legal account holder and the party with legal authority to direct investments and execute transactions in the trust account. An investment adviser who receives investment directions from a beneficiary rather than the trustee is not acting on the authority of the legally entitled party — the trustee's written direction or documented delegation of investment authority to the adviser is required before the adviser can manage trust assets.
Under FINRA Rule 4512 and the know-your-customer obligations applicable to broker-dealers, the account opening documentation for a trust account must identify the trust as the account holder, document the trustee's authority, and collect the information necessary to satisfy anti-money-laundering customer identification programme requirements under the Bank Secrecy Act and FINRA Rule 3310.
For investment advisers under the Investment Advisers Act of 1940, the fiduciary duty owed to a trust account client runs to the trustee as the legal account holder — but the adviser must understand that the trustee's own fiduciary duty runs to the beneficiaries, and that the adviser's recommendations must be consistent with the trustee's ability to satisfy the trustee's prudent investor obligations to those beneficiaries.
The federal income tax treatment of trust income is governed by IRC Sections 641 through 692 — Subchapter J of the Internal Revenue Code — which establishes a comprehensive framework for taxing the income generated by trust assets and allocating that tax liability between the trust itself and its beneficiaries.
The fundamental principle of trust income taxation is the conduit principle — income distributed by the trust to its beneficiaries is generally taxed to the beneficiaries at their individual tax rates rather than to the trust. Income retained by the trust is taxed to the trust at the trust's own income tax rates — which are severely compressed relative to individual rates. For 2025 a trust reaches the top thirty-seven percent federal income tax rate at only fifteen thousand two hundred dollars of taxable income — far below the six hundred thousand dollar threshold at which the thirty-seven percent rate applies to married filing jointly individuals. This compressed rate structure creates powerful incentives for trust distributions — retained trust income is taxed at the highest rates very quickly, while distributed income allows beneficiaries to utilise their own potentially lower marginal rates.
Grantor trusts — trusts in which the grantor retains specified powers under IRC Sections 671 through 677, including all revocable trusts — are taxed entirely to the grantor rather than as separate entities. The trust's income, deductions, and credits flow directly to the grantor's personal return regardless of whether distributions are actually made.
The trust is tested on the Series 65 examination in the context of client account types, estate planning, the fiduciary duties of trustees under the Uniform Prudent Investor Act, and the tax treatment of trust income under IRC Subchapter J.
The key points to retain are these.
A trust is a legal arrangement in which the grantor transfers legal title to assets to a trustee who manages them for the benefit of the beneficiaries according to the trust document's terms. The three essential parties are the grantor — who creates and funds the trust — the trustee — who holds legal title and owes comprehensive fiduciary duties to the beneficiaries — and the beneficiaries — who hold beneficial interest in the trust assets and receive distributions according to the trust's terms.
The foundational distinction is revocable versus irrevocable. A revocable trust — most commonly a revocable living trust — allows the grantor to amend, modify, or revoke during their lifetime — assets are treated as the grantor's own for tax purposes under IRC Sections 671 through 677 — income reported on the grantor's personal return — no separate tax return required. Primary benefits are probate avoidance, privacy, and continuity of management during incapacity. An irrevocable trust permanently removes assets from the grantor's control and estate — assets excluded from the grantor's taxable estate for federal estate tax purposes — potentially protected from grantor's creditors — treated as a separate taxable entity filing its own Form 1041 under the compressed trust income tax rate schedule that reaches the thirty-seven percent top rate at only fifteen thousand two hundred dollars of taxable income in 2025.
A living or inter vivos trust is created and funded during the grantor's lifetime — may be revocable or irrevocable. A testamentary trust is created through a will and comes into existence only upon the grantor's death — irrevocable by definition — requires probate — commonly used for minor children and beneficiaries needing ongoing management oversight. The Uniform Prudent Investor Act governs trustee investment obligations — requiring risk-return analysis, portfolio diversification, total return investment approach, impartiality between current income and remainder beneficiaries, and permitting delegation of investment management to qualified advisers. Trust income distributed to beneficiaries is taxed to beneficiaries at their individual rates — income retained by the trust is taxed at the severely compressed trust rate schedule under IRC Subchapter J — creating strong incentives for trust distributions to avoid the top rates that apply at very low trust income levels.
