8 Trusts You Should Know About

A trust is a legal arrangement in which assets are transferred from an individual’s estate into the trust, managed by a trustee, for the benefit of beneficiaries. Setting up a trust gives you control over how your wealth will be protected and, ultimately, transferred to your beneficiaries. Many types of trusts are available, and each may be treated differently from state to state. That’s why you should consult a financial professional with estate planning experience who can guide you toward the trust that best fits your needs and goals as well as help you carefully select your trustee. You may need to consider a professional trustee in some cases, especially for more complex trusts like dynasty or charitable trusts.

Let’s explore eight common types of trusts you may consider in your estate planning process.

Revocable Living Trust
If you create a revocable living trust, you set up a legal process that assigns someone the power to make financial decisions on your behalf if you are incapacitated due to illness or injury. The person you choose to manage your trust, the trustee, will only have the authority to make decisions about the money or property included in that trust if you are no longer capable of managing it.

You may assign yourself as the only beneficiary while alive or identify a co-beneficiary who can also receive money or property during that time. Those you assign to receive assets within the revocable living trust after you pass away are residuary beneficiaries. Because it is a revocable trust, you can change instructions and assets within the trust or cancel it altogether.

The benefits of a revocable trust include:

• Avoidance of the probate process, preserving time, costs, and privacy
• Flexibility and control over assets in the trust during your lifetime
• Protection of your assets if you become incapacitated
• The ability to amend or revoke the trust at any time

Some drawbacks are:

• Potential complexity at setup
• A need for ongoing management
• Lack of protection against current or future creditors
• No estate tax benefits

Irrevocable Trust
Unlike the revocable trust, an irrevocable trust is very difficult to change or cancel, as it requires permission from the beneficiary or a court order. Money, property, or other assets that you place into this trust are permanently removed from your estate to be managed and distributed to your beneficiaries by your trustee when you pass away.

The benefits of an irrevocable trust are:

• Avoidance of the probate process, preserving time, costs, and privacy
• Reduction of the grantor’s tax liability, as assets held in the trust are exempt
• Protection of assets from creditors and legal judgments

Again, the drawbacks are:

• Lack of flexibility
• Loss of control over the assets by the grantor (which is what provides the benefits of asset protection and tax advantages)

Testamentary Trust
This type of trust is created based on instructions left in someone’s will, is subject to probate, and is not active until the grantor’s death. Unlike the previous types on this list, a testamentary trust is established after the grantor passes away by the executor of their will, and the named trustee manages the grantor’s assets on behalf of the beneficiaries until predetermined conditions outlined in the will are met.

For example, assets left to a child or teenager may not be distributed to them until they reach a certain age. A will can create separate trusts for each beneficiary or create a family trust stipulating that distributions should be based on needs.

Benefits of a testamentary trust include:

• The ability for parents or guardians to distribute assets among children if the parents pass away
• Unlimited beneficiaries
• Protection of assets until beneficiaries are responsible enough to use them
• Potential for growth of assets during their time in the trust
• The ability to change the trust’s instructions while the grantor is alive
• Lower initial costs, as establishment costs come out of the estate after the grantor passes

Some of the downsides of a testamentary trust are:

• Mandatory probate process, which takes time
• Possibility that instructions left in the will could be unclear
• Assets become public record during probate
• Court fees, as trustees must meet with the probate court annually until the trust expires

Special Needs Trust
Sometimes referred to as a supplemental needs trust or SNT, a special needs trust is established to benefit people with a physical or mental disability or a chronic illness. The funds in the trust can be used for whatever the beneficiary needs – commonly for things like home care, medical expenses, and housing and transportation costs. The assets someone receives through a special needs trust do not reduce their eligibility for government benefits provided by Social Security, Supplemental Security Income, or Medicaid.

Third-party special needs trusts are the most common. A grantor can set up a revocable standalone or irrevocable standalone or testamentary trust for a named beneficiary. First-party special needs trusts can be set up and funded by the beneficiary as a means of protection from losing government assistance. Still, these require a Medicaid repayment provision that ensures any remaining assets in the trust after the beneficiary passes away will be used to repay Medicaid before further distribution. There are also pooled special needs trusts, which gather funds from families, donors, and members of the community and distribute them to named beneficiaries within the trust.

Benefits of a special needs trust include:

• Avoidance of the probate process, preserving time, costs, and privacy
• Financial support for the beneficiary without affecting access to government support
• Tailoring to the beneficiary’s specific needs and requirements

Drawbacks include:

• Strict rules on disbursements to maintain the beneficiary’s eligibility for other benefits
• If the beneficiary has the power to revoke the trust, assets are considered an available resource for Supplemental Security Income (SSI) and Medicaid purposes.
• The need for careful management to comply with legal requirements

Dynasty Trust
Dynasty or perpetual trusts are designed to pass on wealth from generation to generation while avoiding gift tax, estate tax, and generation-skipping transfer tax for as long as the assets remain in the trust. It is an irrevocable trust for which the grantor sets the rules. As the grantor, after you have funded the trust, no one can change its terms. For this type of trust, most grantors appoint a bank or other financial institution as the trustee. When the last-named beneficiary of this type of trust passes away, the next generation of children can assume the beneficiary role. How long a dynasty trust can last varies from state to state.

Benefits of a dynasty trust include:

• Avoidance of the probate process, preserving time, costs, and privacy
• Preservation of generational wealth
• Protection from estate taxes and creditors

Potential drawbacks include:

• An inability to amend the trust once established
• Ongoing management responsibilities for the trustee
• The duration of a dynasty trust is often up to state regulations

Charitable Trust
If you wish to leave your assets to a tax-exempt nonprofit or charitable organization that is close to your heart, you can set up a charitable trust. Two main types are available – a charitable lead trust and a charitable remainder trust.

A charitable lead trust is an irrevocable trust established with a gift, cash, or securities that distributes funds to the organization for a specific number of years. The trust can be established with a gift of cash or securities made to the trust. As the donor, you could benefit from a stream of income during the life of the trust, deductions for gift and estate taxes, and income tax deductions. If you choose to fund this trust with cash, you can claim a deduction of up to 30% of your adjusted gross income (AGI) in any year, and unused deductions can typically carry over for the next five years. For appreciated securities or other assets, you are also limited to no more than 30% of AGI in the year you make your donation. When a charitable lead trust expires, the remaining assets revert back to you, your heirs, or your designated beneficiaries.

A charitable remainder trust is also irrevocable and funded with cash or securities, but the remaining assets in the trust revert to the charity upon your death or the expiration of the trust period. There are two types. A charitable remainder annuity trust distributes a fixed amount as an annuity each year, and you can’t make additional contributions after your first. A charitable remainder unitrust distributes a fixed percentage of the trust’s value, recalculated annually, and you can keep contributing to it.

Benefits of charitable trusts include:

• Tax-efficient support for a charity or nonprofit you value
• Upfront income tax benefits for you
• Avoidance of capital gains taxes for donated appreciated assets
• Tax deductions based on market value of appreciated assets
• Potential income for donor and heirs
• Reduced estate taxes

Drawbacks may include:

• Lack of control over assets after donation
• Your income reducing the amount going to the charity
• Contribution size requirements to provide income to the charity, you, and your heirs

Spendthrift Trust
A spendthrift trust limits your beneficiary’s access to assets. The incremental release of funds helps guard assets against irresponsible spending as well as creditors.

Whether revocable or irrevocable, a spendthrift trust permanently designates the trust itself as the sole owner of its assets instead of transferring ownership to your beneficiary upon your passing. Assets are released from the trust over time on a schedule you set, which can provide income to your beneficiaries while protecting your assets.

Benefits include:

• Avoidance of the probate process, preserving time, costs, and privacy
• Protection of assets from potentially irresponsible beneficiary behavior
• Protection of beneficiaries from creditors

Potential drawbacks:

• Need for an attorney to create
• Ongoing maintenance
• Separate tax returns

Funeral Trust
This type of trust is created to set aside and protect assets that will be used for a funeral, burial/cremation, and other related expenses. When the grantor dies, the trust pays out the assets to a specified funeral home. It can be revocable or irrevocable.

Potential benefits of a funeral trust include:

• Allows for any specified person or entity to handle funeral arrangements
• If irrevocable, will be excluded when counting assets to determine Medicaid eligibility
• Can cover the funeral, burial/cremation, and related expenses: flowers, transportation, headstone, etc.
• Can provide protection from creditors

Possible disadvantages include:

• Risk of losing funds if the funeral home goes bankrupt or mismanages funds
• Risk of losing funds if you move out of state
• Effects on Medicaid eligibility (if revocable)
• Taxable interest

Broaden Your Budgeting Boundaries
Trusts are valuable tools in estate planning, and the above article gives a good overview of the common types. If you are ready to consider creating a trust, talk to a trusted financial professional with estate planning experience who can advise you on which type of trust would fit your estate planning needs and goals and explain how each type of trust is handled in your state.