A trust is an estate planning tool 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, a trustee, to manage the account to benefit your beneficiaries.
There are many different types of trusts. Some become effective when you set them up, while others are only enforceable after death.
Established correctly, a trust can:
- transfers your assets to your heirs easily,
- keeps your property away from the probate process
- 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.
Types of Trusts
A revocable trust can be changed or canceled by the creator (grantor), who often acts as the trustee. The grantor still owns the assets in the trust; therefore, they must report any revenue generated by the trust on their taxes. Revocable trusts become irrevocable when the trustor dies.
Related: Setting Up a Trust: Living Trust Cost & Checklist
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 transferred out of their 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.
Related: Revocable vs. Irrevocable Trusts
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.
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 to protect them from taxation, divorce, bankruptcy, and other judgment creditors.
A charitable trust is established during the trustor’s lifetime. It distributes assets to the chosen charity or non-profit organization upon the trustor’s death. This trust account allows the charity to avoid or reduce estate 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.
Your estate plan and trust should include a power of attorney.
A court applies a constructive trust when it determines that a party secured possession of assets unfairly, referred to as “unjust enrichment.” The court creates a constructive trust, considered an “implied trust,” since the grantor didn’t establish it during their lifetime. The purpose of a constructive trust is to transfer assets intended to go to someone else to the rightful owner(s).
A tax by-pass trust (also known 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. Married couples often use it to pass assets to the surviving spouse and then onto children after the surviving spouse dies.
A bypass trust splits your assets into “trust types A & B.” Trust A is a revocable marital trust owned by the surviving spouse. Trust B is an irrevocable family trust in 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. Still, when the second spouse dies, any estate remaining (beyond a tax-exempt limit) is taxable to their children at up to 55 percent. A bypass trust can prevent taxation of the entirety of the trust.
You might use a last will instead of a trust if you have a small estate.
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 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 beneficiaries can access the assets. For example, your child has access to funds for education when they turn 18.
Related: Trust vs. Will: Do I Need a Will or Trust?
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.
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 helpful if conflicts are likely between the trustees and beneficiaries or among the beneficiaries themselves.
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 can access income from the trust and assets 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.
A spendthrift trust is helpful if you believe your heirs will squander their inheritance. 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 from the assets rather than access the entire principal amount.
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 death and then to your children when your spouse dies. A QTIP trust restricts your spouse from accessing the total principal amount of the assets. Still, it allows them to access income from your trust for the remainder of their lifetime.
You can set up a generation-skipping trust if you prefer your estate to go to your grandchildren rather than your children. By transferring the assets to your grandchildren instead of your children, the assets avoid estate taxes. However, you can give your children access to income generated by those assets.
Conclusion: What type of trust do you need?
With many different trust structures available, deciding which is right for you can be challenging. Each kind of trust described above has unique features, but they all share expected benefits:
- Reduced estate taxes
- Allocation of your assets to your preferred beneficiaries
- Avoidance of court fees and probate
- Protection from creditors
Whichever type of trust 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 and beneficiary choices and retain the option to terminate your trust. If you’re ready, create your revocable living trust today.