A Guide to Different Types of Trusts and Understanding Them
If you are at or near retirement, then you probably have thought somewhat about your estate plan. But what about different types of trusts, or other estate planning strategies for that matter, that you might use as part of your plan?
It’s natural to aim for as efficient and tax-advantaged of a wealth transfer to your loved ones as is possible. Of course, you may already have a will and even some powers of attorney. However, there is still the probate process to contend with, and some type of trust is one way to help your assets avoid this.
A trust can allow your assets to be passed directly to your heirs without going through the publicity and expense of probate. It can accomplish many other legal purposes as well. Note that this doesn’t mean that a trust necessarily is the best option for your situation.
You will want to review different estate planning options and types of trust with experienced estate planning counsel and other experts in this area. They can help guide you on the legal implications of various options available, each one’s pros and cons, and what might make sense for your situation and goals.
A Quick Overview of Different Trusts
Before covering different types of trusts in depth, here’s a quick rundown of some common ones:
- Revocable living trusts
- Irrevocable living trusts
- Marital trusts
- Credit shelter trusts
- Charitable remainder trusts
- Generation-skipping trusts
- Special needs trusts
- Spendthrift trusts
- Testamentary trusts
- Totten trusts
- Qualified terminal interest property trusts
- Qualified residence trusts
Here is a list of common different types of trusts that are used today by retirees, with each type covered in more depth.
Revocable Living Trust
This kind of trust is drawn up by the grantor, or creator of the trust. The trustee then manages the assets in the trust for the beneficiary or beneficiaries.
In many cases, all three parties are the same person or couple. The terms of this kind of trust can be changed at any time at the discretion of the grantor.
Irrevocable Living Trust
The terms of this type of trust can’t be changed by the grantor or anyone else once the trust has been created. Irrevocable trusts are typically used by wealthy grantors who need to place some of their assets outside their taxable estate.
Irrevocable trusts often hold life insurance policies in them that are used to pay estate taxes without being taxed themselves. Generally speaking, the assets must have been placed in the trust at least three years before the grantor dies.
Otherwise, the assets in the trust will be pulled back into the grantor’s taxable estate.
Also known as an “A” trust, this trust allows one spouse to pass all their assets to the other spouse with no estate tax when the grantor spouse dies.
Credit Shelter Trust
Also known as a “B” trust, this irrevocable trust is used by married couples. The first spouse to die will bequeath a dollar amount of assets to this trust when they die that is exactly equal to the estate tax exemption. The rest of the deceased spouse’s estate will then pass to the surviving spouse.
The amount in the trust will effectively escape estate taxation when it is dispersed upon the death of the other spouse. These trusts are used to preserve the estate tax exemption of the first spouse to die, so that it doesn’t go unused.
If this trust isn’t used, then all the assets will pass to the surviving spouse. But the surviving spouse will only be able to use their own unified credit to shelter their assets from estate taxes.
A credit shelter trust thus preserves the unified credit of the first spouse to die so that it can be used as well. Credit shelter trusts are usually used in conjunction with marital trusts to ensure an efficient dispersal of assets.
Charitable Remainder Trust
This type of trust allows the grantor(s) to specify certain assets that they want to donate to charity after they die. They will receive the income that these assets produce while they are still living, with the trust corpus passing to the charity upon their death.
This type of trust allows the grantor(s) to pass some or all their assets to heirs that are at least two generations younger than them (grandchildren in most cases). This helps the estate owner to reduce estate tax liability tied to transfer of assets to their children.
Special Needs Trust
This type of trust is used to provide for the care of a beneficiary with special needs without affecting their eligibility for government benefits. In many cases, the trust will pay out a stream of income for the duration of the beneficiary’s life without taking out any principal.
Spendthrift trusts are designed to provide for beneficiaries who aren’t able to manage their own affairs well enough to be handed any of the trust corpus.
These trusts resemble special needs trusts. They will usually pay out a stream of income to the beneficiaries, but don’t give them access to any of the principal assets in the trust.
This type of trust is activated upon the death of the grantor. It’s irrevocable. Its primary use is to ensure that the beneficiaries don’t get the assets in the trust before the appointed time.
This type of trust sets up a payable-on-death account. It allows you to add a beneficiary to your bank or investment account, who will receive the assets in the account upon your death, without the assets going through probate.
Totten trusts are generally the simplest form of trust used today.
Qualified Terminal Interest Property Trust
Known informally as “Q-TIP” trusts, this type of trust is used by families where there has been divorce, remarriage, and stepchildren. In most cases, the grantor will allow the second spouse to receive income from the trust while they are living.
Then the assets are passed to the children from the first marriage upon the death of the surviving second spouse. Stepchildren may receive a share of the property as well in some cases, depending upon various factors.
Qualified Residence Trust
This trust is used to exempt a house or other piece of real estate from estate taxes. It can be especially beneficial if the property in the trust has the potential to appreciate substantially in price over time.
A Quick Wrap-Up on Trusts
A trust can accomplish many purposes. They can be used to specify how you want your assets to be given out, upon death, in ways that a will can’t usually accomplish.
A will can guide your assets through the probate process, whereas a trust can exempt your assets from probate. However, only a will can dictate what will happen to any children or other dependents once you are no longer here.
Both types of documents are usually necessary in order to maintain a well-crafted estate plan that covers all bases. Consulting with experienced estate planning attorneys and other professionals in this field can help you sort through your legal options.
Just One Piece of the Legacy Planning Puzzle
Of course, legal is only one aspect of an estate plan. Your legacy strategy also covers the assets that you wish to pass onto your heirs. There are a number of financial vehicles and financial strategies that can be tapped toward that goal.
An experienced financial professional who understands not only retirement issues, but also legacy planning issues, can help you prepare for this. Among other things, they can walk you through options that provide heirs with tax-advantaged proceeds at death, or even pay an enhanced death benefit that is guaranteed.
Looking for an experienced financial professional to help you? No sweat, many independent financial professionals are available at SafeMoney.com to serve you.
Use our “Find a Financial Professional” section to get started. You can connect with someone directly and request an initial appointment to discuss your retirement and legacy financial goals. Should you need a personal referral, call us at 877.476.9723.