It is a fiduciary relationship in which the grantor (sometimes called settlor, trustor, trustmaker) gives another party, known as the trustee, the right to hold title to property or assets for the benefit of a third party (the beneficiary).
To be valid and enforceable, certain things must exist:
- there must be a trustee
- there must be a beneficiary
- the trust must be funded
There are several types of trusts. Here are just a few:
- Bypass. Commonly referred to as a credit shelter trust, family trust, or B trust, a bypass trust contains a portion of a deceased spouse’s accounts and property and uses the deceased spouse’s lifetime exclusion amount to reduce or eliminate estate tax. Because the estate tax is calculated at the first spouse’s death, this trust is bypassed for estate tax purposes at the second spouse’s death.
- Charitable Lead. This provides a stream of income to a charity of your choice for a period of years or a lifetime. At the completion of the period of years, or at death, whatever is left goes to you or your loved ones with significant tax savings.
- Charitable Remainder. This one provides a stream of income to you for a period of years or a lifetime and then gives the remainder to the charity of your choice with significant tax savings once the period of years or death has occurred.
- Special Needs. This allows you to provide money or property for the benefit of someone with special needs without disqualifying them from receiving governmental benefits. Federal laws allow special needs beneficiaries to receive certain types of benefits from a carefully crafted trust without defeating eligibility for government benefits.
- Generation-Skipping. A generation-skipping trust allows you to distribute your money and property to your grandchildren, or even to later generations, without taxation, by using your lifetime exemption to offset any tax that could be due.
- Grantor Retained Annuity. A grantor retained annuity trust is irrevocable. That means it provides you with an annuity for a specific amount of time based on the value of the property in the trust and upon completion of the annuity period, the remaining money and property is transferred to those you have named. This type of trust is used to make large financial gifts to your loved ones of accounts or property that are expected to grow in value at a higher rate than the annuity rate being paid back to you.
- Irrevocable. This type of trust cannot be modified or terminated without the permission of the beneficiary. The grantor, having transferred her assets, effectively removes all of her rights of ownership to the assets. She can no longer amend it.
- Irrevocable Life Insurance. An irrevocable life insurance trust is designed to own high-value life insurance and receive the payment of the death benefit upon the trustmaker’s death. The benefit of this type of trust is that the life insurance proceeds are excluded from the deceased’s estate for tax purposes. However, the proceeds are still available to provide liquidity to pay taxes, equalize inheritances, fund buy-sell agreements, or provide an inheritance.
- Marital. A marital trust is designed to protect the accounts and property for the surviving spouse’s benefit, as well as qualify for the unlimited marital deduction. These accounts and pieces of property are excluded from estate tax at the first spouse’s death but are included in his or her estate for tax purposes.
- Qualified Terminable Interest Property. A qualified terminable interest property trust initially provides income to the surviving spouse and, upon the surviving spouse’s death, the remaining money and property are distributed to other named beneficiaries, while still allowing the trust to qualify for the unlimited marital deduction. These are commonly used in second marriage situations and to maximize estate and generation-skipping tax exemptions and tax planning flexibility.
- Testamentary. A testamentary trust is one created in a will. It is created upon the individual’s death and is commonly used to protect the money and property on behalf of a beneficiary as opposed to transferring the money and property to the beneficiary outright. It can be used when a beneficiary is too young to manage their own money or property, has medical or drug issues, or may be incapable of responsibly managing their own money. This trust can also provide asset protection from lawsuits, or a claim by a divorcing spouse brought against the beneficiary. Unlike a revocable living trust or one that is irrevocable, where property should be transferred during the trustmaker’s lifetime to work property and avoid probate, testamentary trusts require the sometimes lengthy and expensive probate process before the instrument is created.
There are many types of trusts available. Since not all trusts are created equal, understanding what you need to meet your goals is critical.
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