What Are the Different Types of Trusts?
Summary: Trusts are powerful estate planning tools, but before you create one, you need to know which kind is right for you and how they work. Click through for an overview of the different types of trusts so you can make an informed decision.
Trusts are used in estate planning to transfer assets to beneficiaries. Trusts have some advantages over wills, including skipping probate. That’s pretty basic. But it gets complicated when you try to figure out which type is right for you. Know the options available to help you make an informed decision.
Living trust. You create it when you’re alive to transfer assets to beneficiaries.
Testamentary trust. This is set up after you die. The terms of the trust are established in your will and can be changed any time until your death. It’s simpler and more flexible than a living trust.
Revocable trust. This is a living trust because you create it while you’re still alive. The terms of the trust can be altered during your lifetime.
Irrevocable trust. This trust can’t be altered after it’s created. You transfer assets out of your taxable estate. Income from the assets isn’t taxable while you’re alive and assets aren’t taxable to the estate when you die.
Charitable trust. This is irrevocable and set up to benefit you, your beneficiaries and a qualified charity. There are two types of charitable trusts. A charitable lead trust is set up to provide financial support through an annuity to a charity you’ve chosen; the remaining assets go to your beneficiaries. A charitable remainder trust creates an income stream for you and your beneficiaries with an annuity for a specified time; the remainder of your assets go to the selected charity.
Qualified terminable interest property trust. A QTIP trust is set up to provide income to a spouse after the grantor has died, after which the balance is distributed to other heirs. This trust is useful when there are beneficiaries from a previous marriage.
Grantor retained annuity trust. This is an irrevocable trust set up for a specific period; for example, to minimize taxes on large financial gifts to family members. You pay the taxes on the assets when you establish the trust and receive an annual annuity payment for the term of the GRAT. When that term ends, your beneficiaries receive the remaining assets.
Irrevocable life insurance trust. This may be useful for high net worth families. Although life insurance proceeds typically avoid probate anyway, an insurance benefit may be taxable. The ILIT removes life insurance proceeds from a taxable estate, transferring the death benefit immediately to beneficiaries.
Irrevocable funeral trust. This sets aside money for burial and funeral costs; a funeral home can serve as trustee. Typically, the grantor funds this with cash, bonds or life insurance.
Spendthrift trust. As the name suggests, this protects inherited assets from a beneficiary’s out-of-control spending. The assets in the trust belong to the trust so neither the beneficiary nor their creditors have direct access or control of them. You can just funnel some money over to the beneficiary each year and direct what the money can be spent on.
Special needs trust. This is suitable for dependents who, perhaps because of a disability, are unable to provide for their own financial requirements.
Generation-skipping trust. This transfers money directly to grandchildren, skipping over the middle generation. Wealthy families may save on estate taxes this way by allowing their own children to avoid them.
Totten trust. Although many trusts are complex to set up and appropriate for the wealthy, this trust — also called a payable-on-death account — is simple to create and useful for even those with a modest net worth. The grantor simply opens a bank account and makes deposits and withdrawals, as with any bank account. At the grantor’s death, the money goes to whoever is listed as a beneficiary, bypassing probate. The grantor can change the beneficiary at any time and even close the account entirely if the situation changes.
So what’s right for you? Talk to a qualified professional who can help you decide what trust might be right for you and how to coordinate it with your overall estate plan. You’ll be glad you did — and so will your beneficiaries.