A trust is an estate planning tool used to transfer assets to your heirs, also known as beneficiaries, after your death. Once you’ve established a trust, you can designate an individual or institution, known as a trustee, to manage the account for the benefit or your beneficiaries.
There are many different types of trusts. Some become effective as soon as you set them up, and others are only enforceable after you die.
Established correctly, and a trust transfers your assets to your heirs easily, keeps your property away from the probate process, and can reduce or eliminate taxation on the assets you list in the trust.
Be sure you also understand what probate is and how trusts factor into the probate process.
The Two Main Types of Trusts
Trusts are generally classified as either revocable or irrevocable. Both are living trusts, which means they’re established during your lifetime. Revocable vs irrevocable trusts differ in the amount of control you have over assets and beneficiaries, as well as the tax benefits available.
1. Revocable Trust
A revocable trust can be changed or canceled at any time by the creator (grantor), who often acts as the trustee. The assets in the trust are still owned by the grantor and, therefore, any revenue generated by the trust must be reported on their personal taxes. Revocable trusts become irrevocable when the trustor dies.
2. Irrevocable Trust
An irrevocable trust cannot be modified or revoked by the grantor without the permission of its beneficiaries. Once an irrevocable trust is established, the grantor relinquishes ownership and control of the assets listed in the trust, which are then transferred out of their personal estate.
Despite this inflexibility, irrevocable trusts offer asset security and tax advantages, making them an attractive type of living trust for people with large or complex estates.
However, the tax implications of an irrevocable trust can be complex. Consult an attorney before deciding what type of trust is right for you.
Other Different Types of Trusts
All trusts are either revocable or irrevocable, but within those classifications are many different kinds of trusts to suit your specific needs. Here are some of the most common types of trust funds for you to consider:
13 Additional Types of Trusts
A testamentary trust, or will trust, is set up through a provision in your last will and testament. It’s used to appoint a trustee to manage and distribute your assets upon your death. After the probate process determines the will’s authenticity, the executor transfers the assets into the testamentary trust.
This type of trust allows you to set limitations and stipulations on when and how the assets can be accessed by beneficiaries. For example, your child has access to funds for education when they turn 18 years old.
Special Needs Trust
A special needs trust is established to meet the financial requirements of a dependent with special needs, and appoints them as the beneficiary. It funds the beneficiary’s medical care or day-to-day needs while retaining the dependent’s entitlement to government benefits. There are two main types of special needs trusts: first-party and third-party.
Qualified Terminable Interest Property Trust (QTIP Trust)
A QTIP trust divides your assets among your beneficiaries at different times. A common approach is to allocate income from the trust to your spouse upon your death and then to your children when your spouse dies. A QTIP trust restricts your spouse from accessing the full principal amount of the assets, but rather allows them to access income from your trust for the remainder of their lifetime.
The trustees of a blind trust manage the assets in the trust without the beneficiaries’ knowledge. The beneficiaries have no input into how the assets are handled. This kind of trust is useful if conflicts are likely to arise between the trustees and beneficiaries, or among the beneficiaries themselves.
A spendthrift trust is useful if you believe your heirs will squander their inheritance, because it allows you to specify when and how your beneficiaries may access assets designated to them. For example, you could state that beneficiaries may only receive income earned by the assets rather than access the full principal amount of the assets.
A charitable trust is established during the trustor’s lifetime, and distributes assets to the chosen charity or non-profit organization upon the trustor’s death. This type of trust account allows the charity to avoid or reduce estate taxes or gift taxes.
A charitable trust can also be incorporated into a standard trust, so that the trustor’s heirs receive part of the estate and the charity receives the remainder.
Along with a trust, your estate plan should include a power of attorney (POA).
A Totten trust is also called a payable-on-death account. You deposit money in a bank account or other security, and name a beneficiary for the account who will inherit the funds upon your death. This kind of trust is revocable, and the beneficiary doesn’t have access to the accounts while you are alive.
Asset Protection Trust
As the name would suggest, an asset protection trust (APT) is the best type of trust to protect your assets against creditors, legal disputes, or judgments against your estate. This type of trust account allows the trustee to hold your assets so that they’re protected from taxation, divorce, bankruptcy, and other judgment creditors.
A constructive trust is applied by a court when it determines that a party secured possession of assets unfairly, referred to as “unjust enrichment.” The court creates a constructive trust which is considered an “implied trust” since the grantor didn’t establish it during their lifetime. The purpose a constructive trust is to transfer assets that were intended to go to someone else to the rightful owner(s).
A tax by-pass trust (also know as a tax by-pass trust) is set up for individuals who don’t want their estate to be subject to federal estate taxes multiple times. It’s often used by married couples to pass assets to the surviving spouse, and then onto children after the surviving spouse passes.
A by-pass trust splits your assets into “trust type A & B.” Trust A is a revocable marital trust that the surviving spouse has full ownership of. Trust B is an irrevocable family trust of which the surviving spouse doesn’t own the assets, but can receive income from them during their lifetime.
Spouses can inherit each other’s assets tax-free, but when the second spouse dies, any estate remaining (beyond a tax-exempt limit) is taxable to their children at a rate of up to 55 percent. A by-pass trust can prevent taxation of the entirety of the trust.
If you have a small estate, you might want to use a last will and testament instead of a trust.
If you would prefer your estate go to your grandchildren rather than to your children, you can set up a generation-skipping trust. By transferring the assets to your grandchildren instead of your children, the assets avoid estate taxes. However, you have the option to give your children access to income generated by those assets.
Credit Shelter Trust
Credit shelter trusts allow affluent couples to minimize or even eliminate their estate tax bills by transferring assets from one spouse’s estate to the surviving spouse’s estate.
The transferred assets don’t increase the value of the second spouse’s estate since the trust is owned and managed by a trustee. However, the surviving spouse is allowed access to income from the trust and has the right to access the assets in the trust under specific circumstances such as medical emergencies or to fund education.
When the second spouse dies, the assets are not subject to estate taxes when transferred to the remaining beneficiaries.
Life Insurance Trust
A life insurance trust is an irrevocable trust designed to hold the proceeds of your life insurance policy. The main benefit of this kind of trust is that it allows your life insurance payouts to be invested and distributed by the trustee without incurring estate taxes for the beneficiaries.
Conclusion: What type of trust do you need?
With many different trust structures available, it can be difficult to decide which one is right for you. Each kind of trust described above has unique features, but they all share common benefits:
- Reduced estate taxes
- Allocation of your assets to your preferred beneficiaries
- Avoidance of court fees and probate
- Protection from creditors
Whichever type of trusts you choose to protect your asset, you can be assured that you’re making a necessary, responsible choice for your loved ones.
Remember that a revocable trust is ideal if you want to control your assets, beneficiary choices, and retain the option to terminate your trust. If you’re ready, create your revocable living trust today.