There are several kinds of trusts depending on the type of beneficiaries, the purpose of the trust, what assets are in the trust, how much power the trustee and beneficiaries have over the use of the trust’s assets and how much control the grantor has over the trust.

The most common distinction is between a testamentary trust and a living trust.

A testamentary trust, which may be created by a will, takes effect only when the grantor dies and the estate is probated. A change to a testamentary trust may require a change to the will.

A living, or inter vivos, trust takes effect during your lifetime. Living trusts may be either revocable, meaning the grantor can change or end them at any time, or irrevocable, meaning the trust cannot be changed once it is established or once a certain event occurs (for example, the death of a named person).

Bypass Trust (also called Credit Shelter Trust, Family Trust or Credit Equivalent Bypass Trust): This type of trust takes advantage of federal estate tax law to reduce or eliminate federal estate taxes. It uses a provision of the federal estate tax law, called the unlimited marital deduction, which allows you to leave an unlimited amount of property to your spouse free of federal estate tax. However, certain assets which remain in the surviving spouse’s estate will be subject to tax upon the surviving spouse’s death. This type of trust will ensure that the applicable exclusion amount is used by the descendent.

Qualified Terminable Interest Property Trust (QTIP Trust): This type of trust can help ensure that, after your death, children from a prior marriage are not disinherited by a subsequent spouse; it can protect your estate in the event your spouse remarries. The grantor places the property in a QTIP trust which still qualifies for the marital deduction. When the grantor dies, the surviving spouse does not inherit the property but receives income from the trust at least annually. At the surviving spouse’s death, the value of any assets remaining in the trust are taxed in that individual’s estate. Then the assets are distributed to the beneficiaries named in the trust, usually children from the grantor’s previous marriage.

Revocable Living Trust: A revocable living trust is often touted as an alternative to a will because a trust usually avoids probate. Probate, the legal validation of your will and your assets, can be a lengthy and expensive process depending on the applicable state law and your situation. However, you should not use a trust as a sole substitute for a will.

An important reason to use a revocable living trust is to manage your assets if you are disabled. This type of trust can be created with yourself as trustee and another individual and/or institution named as successor trustee. You have complete control over the assets in the trust until you become disabled or incapacitated. At that point, the trust becomes irrevocable and your successor trustee takes over using proceeds from the trust for your care and distributing the assets after your death as you directed in the trust agreement. The trust should include a definition of disability or incompetence, such as opinions by two or more physicians. In addition, a living trust could be accompanied by a “pour-over” will, which directs any assets not held in the trust be added to it at your death. Remember that assets held in a revocable living trust are considered part of your gross estate.

Advantages To A Living Trust
It can be more comprehensive than a power of attorney naming someone to act on your behalf should you become incapacitated. It will generally be universally accepted at financial institutions, whereas the power of attorney may not. You can specify in the trust how and where you wish to be cared for and give specific investment instructions to your trustee. If you become incapacitated without a living trust or durable power of attorney, a court must appoint a conservator or guardian for you — someone you may or may not want to manage your affairs. A trust may also be more readily accepted as expressing your wishes — and therefore less subject to challenges — than the actions of a court-appointed guardian or someone acting under your durable power of attorney. If you own property in more than one state, a living trust can transfer property directly to your heirs without the expense and delay of multiple probates. A living trust can help keep private the details of your estate. It does not usually become part of the public record as a probated will does.

Grantor-Retained Income Trust (GRIT): This irrevocable living trust is designed to reduce gift taxes and remove highly valued assets from your taxable estate. You receive income from assets placed in the trust for a set period; at the end of the term, the assets pass to your heirs. Assets placed in the trust may be your personal residence or income-producing assets. To benefit from this type of trust, you must live past the term of the trust so that the assets are given to the named beneficiaries and removed from your taxable estate.

Spendthrift Trust (also called a Minor’s Trust): This type of trust is used if you are concerned your heirs will not be able to manage the estate, either because they are too young or irresponsible. The trust can specify the investment objectives that the trustee must follow. The guidelines for distribution are also established.

Life Insurance Trust: If you are the owner of life insurance on your own life, proceeds from a life insurance policy will generally be included in your taxable estate. If your estate value is more than the current maximum exclusion amount, a life insurance trust often makes sense. An irrevocable living trust is established to own a policy on the grantor’s life and the trust is also named beneficiary of the policy. At the grantor’s death, the trustee can use the policy proceeds to provide for the beneficiaries, usually the grantor’s survivors. For large estates, a life insurance trust funded with a policy in the expected amount of the tax obligation can provide the funds to pay estate taxes.

However, a life insurance transfer from you to the trust must be made at least 3 years before your death. Otherwise, the trust proceeds will be included in your taxable estate. To prevent potential problems resulting from the 3-year rule, a new policy can generally be issued with either the trust or your spouse as owner.

Other Trusts
Generation-Skipping Trust transfers property to second-generation beneficiaries, usually grandchildren, without the trust proceeds becoming part of your children’s estates (Generation-Skipping transfer taxes may apply). Qualified Domestic Trust (QDOT) is for spouses who are not U.S. citizens. QDOT helps these spouses gain the benefits of deferring the marital deduction. Charitable Remainder Trust lets you give an asset, generally one with a low-cost basis, to a charity but generates income from the asset. Charitable Lead Trust provides income from an asset to a charity, while you reclaim the principal at the end of a set period of time.

Next: Selecting A Trustee

Updated Thursday, April 17, 2008

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