Common Types of Trusts
Whether you’re seeking to control how your assets are distributed after your death, avoid probate, plan for incapacity, minimize transfer taxes, or protect assets from potential creditors, trusts can help you accomplish many estate planning goals. Their power is in their versatility–many types of trusts exist, each designed for a specific purpose. Here are some brief descriptions of the most common types.
Living trust
A living trust (also called an inter vivos trust) is a trust you create during your lifetime rather than after your death by the terms of your will (that type is called a testamentary trust). Living trusts are revocable–you keep control over the trust assets, and can change the trust or even dissolve it at any time. This type of trust is useful if you want assets to avoid probate and shield them from public scrutiny, and/or if you want to provide for someone else to manage your assets should you become incapacitated. Living trusts, however, will not minimize taxes or protect assets from creditors.
Irrevocable trust
An irrevocable trust is one that, once created, you generally can’t change or dissolve, and you must give up total control over the trust assets. But, irrevocable trusts can provide certain tax advantages and asset protection. The following are all irrevocable trusts designed to achieve particular objectives.
Bypass trust
When a person leaves his or her entire estate to a surviving spouse, assets pass free from federal estate tax because of the marital deduction. When the surviving spouse dies, his or her estate passes free from estate tax to the extent of his or her lifetime exemption (currently $2 million). If this is the case, a couple’s combined taxable estates may be higher than need be because the lifetime exemption of the first spouse to die has not been used.
A bypass trust (also called a credit shelter trust) can solve this problem. The first spouse to die funds the trust with assets equal in value to the exemption amount. Those assets “bypass” the surviving spouse’s estate (though the surviving spouse can receive all income and some principal), and pass to descendants estate tax free at the surviving spouse’s death.
QTIP trust
A QTIP (qualified terminable interest property) trust (also called a marital deduction trust) is, like the bypass trust, used by spouses to minimize estate taxes. It holds assets of the first spouse to die that are in excess of that spouse’s lifetime exemption. Transfers to a proper QTIP are tax free under the marital deduction, even though assets do not pass outright to the surviving spouse. Trust assets are held for the surviving spouse’s benefit, then pass to descendants as part of the surviving spouse’s estate (and may be sheltered from estate tax by the surviving spouse’s lifetime exemption). For maximum estate tax savings, a QTIP trust is often paired with a bypass trust. This is known as an A/B trust arrangement.
Because the first spouse to die names the ultimate beneficiaries, a QTIP is often used to provide for children of a previous marriage.
Irrevocable life insurance trust (ILIT)
The proceeds of your life insurance policy will be subject to federal estate tax if you own the policy, or your estate receives the proceeds. Often, this asset pushes an estate over the exemption amount.
An ILIT, created to hold a life insurance policy and its proceeds, is a separate legal entity. Using an ILIT removes the proceeds from your estate because the trust entity owns the policy and is the named beneficiary of the proceeds.
Charitable remainder trust
A charitable remainder trust allows you to give money or property to charity while continuing to receive income (fixed or variable) from the property for life or for a period of time up to 20 years. You and/or other beneficiaries receive distributions from the trust annually, and the charity receives the remaining assets when the trust ends. You get an immediate income tax deduction for the charitable interest (subject to the usual limitations), as well as gift and estate tax deductions. You also avoid capital gains tax on the donated assets.
A word of caution
A trust is not a do-it-yourself arrangement. Trusts must be properly structured and carefully drafted to achieve the desired results. Be sure to consult an experienced estate planning attorney.