Trusts can be confusing, if not down-right intimidating.
That's because there are so many different types of trusts, with so many different purposes, and with so many different names. If you didn't know better, you'd think there were a million different types of trusts, with each one having its own rules and regulations.
But, that's not the case at all! As intimidating as trusts appear to be, there is a relative simplicity that runs through them. We will simplicity the various types of trusts that exist today, and help you understand them.
Basic Concept of a Trust
In order to understand the nature of trusts and the many different types of trusts that exist, it is important to understand the basic concept of a trust. In a general sense, a trust is nothing more than an arrangement whereby one person agrees to hold property for the benefit of another. We create trusts all the time without even thinking about it.
For example, how many times have you given money to a babysitter in case he or she needed something for the kids? In a strictly legal sense, your babysitter accepted the money and agreed to hold it and use it for their benefit. That is the essence of a trust - someone agrees to hold money or property for the benefit of someone else.
Every type of trust you'll ever confront - regardless of the name given to it - must have the same basic components:
Someone must create the trust. We call this person the "grantor." Other people call the creator of a trust the "donor," or the "settlor," or the "trustor." All these terms are used interchangeably.
Some other person or entity must agree to hold money and/or property for the benefit of someone else. We call this person the "trustee." There may be more than one trustee and the trustee need not be a person. It may be a corporation with trust powers, such as a bank.
Some money and/or property must actually be held by the trustee for the benefit of someone else. We call this money or other property the "principal" of the trust. Some people also call this money or other property the "corpus" of the trust. The principal (or corpus) of the trust never stays the same; some is spent by the trustee, some is invested - earning dividends and interest, and some of the principal appreciates and/or depreciates in value. Collectively, we call all of this money and property the "trust fund."
Someone else must benefit from the trust. We call this person the "beneficiary" of the trust. There may be more than one beneficiary. In that case, they are collectively called the "beneficiaries."
4 Basic Components of a Trust
Living Trusts vs. Testamentary Trusts
One of the most basic classifications of trusts is whether they become effective during the grantor's lifetime or whether they become effective only after the grantor's death.
A trust that becomes effective during the grantor's lifetime is called a "living trust." Living trusts do avoid probate if properly funded.
A trust that is created under a Last Will and Testament is called a "testamentary trust." A testamentary trust can only become effective after the testator's death and does not avoid probate.
Revocable Trusts vs. Irrevocable Trusts
When we talk about revocable trusts and irrevocable trusts we're only talking about living trusts. A testamentary trust is always revocable because it doesn't become effective until after the testator's death.
So, what's the difference between a revocable living trust and an irrevocable living trust?
A revocable trust can be amended, revoked, terminated or changed at any time by the grantor.
An irrevocable trust cannot be amended, revoked, terminated or changed by the grantor or anyone else once it becomes effective.
That seems rather obvious. But, just what is the significance of all that?
Simply put, if you put some or all of your property into a revocable trust, you can get the property back any time you want. You can also change the terms and conditions upon which some or all of the beneficiaries will receive benefits under the trust.
An irrevocable living trust is a different story. If you transfer some or all of your property to an irrevocable living trust, you are giving up all your rights to that property. That's because an irrevocable trust is, by definition, one that you no longer have the right to amend, revoke, terminate or change.
Many elderly persons, who are concerned about the high cost of nursing homes, also transfer their property to an irrevocable trust. We cover this in more detail in the LOVING CARE STRATEGIES secotion.
Many high-net-worth individuals also use irrevocable trusts to protect their property from the claims of creditors.
Perhaps one of the most common uses for an irrevocable living trust is the avoidance of federal estate taxes.
Purpose of Trusts by Components
While the two basic classifications of trusts (i.e., living vs. testamentary and revocable vs. irrevocable) cover the various types of trusts in existence today, there is still one other form of classification that is used to distinguish one type of trust from another - that is, the purpose of the trust.
Every trust is established for a specific purpose, and that purpose will dictate the form and the basic provisions of the trust.
Knowing the purpose of the trust will give you almost all the information you need about that trust without ever having to look at the trust instrument.
Here is a short list of the more common types of trusts according to their purpose.
An A/B Trust is any type of trust that splits into two separate and distinct trusts upon the death of the grantor.
1) Credit Shelter Trust, which is designed to hold as much of the grantor's property as is sheltered from the federal estate tax by virtue of the unified credit.
2) Marital Trust, which is designed to hold the remainder of the decedent's property, which is sheltered from the federal estate tax by virtue of the unlimited marital deduction.
These separate and distinct trusts are designed to eliminate or reduce the federal estate tax liability of a married couple over the deaths of both spouses.
An A/B Trust arrangement can be created under a living trust or a testamentary trust, since these provisions do not take effect until after the grantor's death.
Asset Protection Trusts
An "Asset Protection Trust" is a type of trust that is designed to protect assets from the claims of creditors.
A "By-Pass Trust" is another name for a Credit Shelter Trust, because the property placed in this trust is not subject to federal estate tax in the surviving spouse's estate. In other words, it "by-passes" the surviving spouse for federal estate tax purposes.
A By-Pass Trust can be created under a living trust or a testamentary trust.
Credit Shelter Trusts
A Credit Shelter Trust is a type of trust that is used by married couples in order to avoid federal estate taxes upon the death of the first spouse to die.
A Credit Shelter Trust can be created under a living trust or a testamentary trust.
A "Charitable Trust" is a type of trust that has one or more charitable beneficiaries.
A Charitable Trust can be created under a living trust or a testamentary trust; however, if any distributions are to be made during the grantor's lifetime, then the Charitable Trust must be an irrevocable living trust.
Charitable Remainder Trusts
A "Charitable Remainder Trust" is a trust that provides for payments of income and/or principal to one or more non-charitable beneficiaries for a fixed number of years or for life (lead interest). At the end of the lead interest, the remainder of the trust assets passes to one or more qualified charities (remainder interest).
Dynasty Trusts are often designed to last forever, with generation after generation receiving distributions from the trust.
A Dynasty Trust may be created under a revocable or irrevocable living trust or even a testamentary trust.
Generation Skipping Trusts
A "Generation-Skipping Trust" is a type of trust that is specifically designed to hold the amount of property that is exempt from the generation-skipping tax under the federal estate tax laws.
A Generation-Skipping Trust may be created under a revocable or irrevocable living trust or even a testamentary trust.
Life Insurance Trusts
A "Life Insurance Trust" is a type of irrevocable trust that is designed to hold life insurance on the life of the grantor or another person.
Life Insurance Trusts are attractive to individuals and couples with estates large enough to be concerned with federal estate taxes.
A Life Insurance Trust is always an irrevocable living trust.
A "Revocable Trust" is a type of living trust in which the grantor retains the right, during his or her lifetime, to amend, change, revoke or terminate the trust within his or her sole discretion. A Revocable Trust is generally created to avoid probate or to provide for management of one's assets in the event of incompetence.
Special Needs Trusts
A "Special Needs Trust" is a trust that is established for a person who is receiving government benefits. The intent of a Special Needs Trust is to provide a source of funds for such person without disqualifying such person from such government benefits.
A Special Needs Trust may be created under a revocable or irrevocable living trust, or a testamentary trust.
A "Testamentary Trust" is a trust created under a Last Will and Testament. A Testamentary Trust is amendable and revocable at any time during the testator's lifetime, but becomes irrevocable upon the testator's death. Testamentary Trusts cannot be used to avoid probate or to provide management of the testator's property in the event of his or her incapacity.
A "Totten Trust" is an informal type of trust that is created during the lifetime of the grantor by depositing money into an account at a bank or other financial institution in the grantor's name as the Trustee for another person. Money deposited into this type of bank account is not considered a completed gift until the grantor's death, or the happening of some other event that unequivocally reflects the gift during the grantor's lifetime.
Simply put: A Trust is a legal arrangement in which a certain amount of property or assets is held by a person or entity (e.g. bank) for the benefit of one or more other people.
Why Would You Create One?
To maintain control of assets in the event of incompetence (if you become unable to manage your assets due to a decline in health or mental fitness)
To save on estate taxes
To avoid probate
When significant amounts of assets are involved, Trusts may also be established to maintain control over assets even after the original owner has died. For example, a Trust may be set up with the sole purpose of paying college tuition for a grandchild. In this scenario, the money in the Trust cannot be used for any purpose other than paying college tuition and cannot be used on behalf of anyone other than the grandchild.
Please consult with an estate planning attorney for all the details.
The above is provided for informational purposes only and does not constitute any legal advice. Please contact an estate planning attorney for all legal estate planning advice.