Common Types of Trusts
Trusts fall into two categories; revocable and irrevocable. Revocable trusts are often called living trusts, and they can be canceled or revoked at any time. Irrevocable trusts are permanent, once created and funded they cannot be canceled or modified.
Revocable Living Trusts
These common trusts are normally used to avoid probate. The grantor, trustee and beneficiary (the person giving the assets to the trust and the person controlling those assets once they are in the name of the trust, and the person getting the benefits of those assets) can be the same person. Revocable living trusts retain the estate tax exemption on assets owned individually, so there is little downside to forming this type of trust. Assets must be retitled (your home, car, etc) into the name of the trust in order for this strategy to work, and this retitling often falls short, especially as time passes. These trusts also usually contain a ‘pour over’ provision or are accompanied by a pour over will so that assets not retitled can still pass into the trust at the time of the trustee’s death, but this often triggers probate anyway. If you or a loved one has a revocable living trust it should be reviewed routinely by an estate attorney to keep it up to date.
Irrevocable Trusts
These trusts are permanent - they cannot be changed or canceled. And one person cannot be grantor, trustee and beneficiary.
Irrevocable Income Only Trusts
These trusts transfer assets away from the grantor while preserving the proceeds. This is sometimes helpful for shielding assets for Medicare eligibility rules, protection from creditors, or providing an income stream for disabled dependents. Once placed in the trust assets are no longer available to the grantor, only the income generated remains accessible. At the death of the grantor the assets are inherited by the grantor’s beneficiaries.
Irrevocable Life Insurance Trusts
This trust holds a life insurance policy for the grantor. The payout of the insurance goes to the trust, not the estate and so is not subject to estate tax. This type of trust is also used to replace the value of assets given to charity or used in an Income Only Trust. Because it’s irrevocable you cannot change the beneficiaries of the life insurance once the trust is set up. Another challenge with this type of trust is that the premiums are often considered a taxable gift to the trust. Transferring an existing policy into the trust has a similar problem of tax, based on the cash value of the policy at time of transfer, and if the grantor dies within 3 years the trust is not eligible to receive the payout, it is considered paid to the estate. Some people get around these gift tax problems with a Crummey Trust, named after the Crummey family who successfully defended a provision against gift taxes. The IRS considers gifts to a trust as taxable, because it holds that the beneficiaries (usually the children of the grantor) do not have a present interest in the gift. The Crummey provision allows the children to withdraw the gift anytime within thirty days of the gift. After thirty days, the trust holds the gift and can use it to pay premiums, schedule payouts over time, or whatever. This provision means that gifts to the trust are subject to the gift tax exclusion, currently $12,000 per year.
Irrevocable Generation Skipping Trusts
This trust holds the assets after the grantor dies, and the immediate beneficiaries receive only the income from the assets. After the immediate beneficiaries die the assets are inherited from the trust by their children, the original grantor’s grandchildren. This arrangement allows the assets to grow for a generation without the impact of estate taxes.
Trustees
The irrevocable trusts generally require a third party trustee to manage the assets of the trust. This is a service offered by banks and financial institutions that varies in cost. For example, a life insurance trust requires no decisions and so typically has lower trustee fees associated.
These are just some of the many trust types out there, all designed to help you protect your assets from taxation and waste. Seek the help of a specialist attorney when arranging trusts: good advice can often save a fortune, whereas bad advice can lose one.