Types of Trusts and Their Benefits
Trusts are commonly created as part of a will to define how money and property will be distributed. A trust can be very helpful, but also very confusing. Understanding the different types of trusts is important and this post discusses the primary examples. It may be helpful to read the previous blog, “Trust Me, You Might Need to Read This,” as this will explain some of the terms used in this blog.
First, let’s look at two main differences in trusts.
The first difference is whether the trust was made during the person’s lifetime, a living or inter vivos trust, or if it is testamentary trust, which is created in a will and starts after the person’s death.
The second difference is whether the trust is revocable or irrevocable. A revocable trust can be changed or revoked. Once the grantor dies, a revocable trust becomes irrevocable. An irrevocable trust is one that cannot be altered, changed, or revoked. This means that once the grantor creates the trust, he cannot take it back.
The following is a description of the main types of trusts:
Constructive Trust
A constructive trust, also called an implied trust, occurs when circumstances come up that mess up the intention of the grantor or when a trust is necessary to prevent an injustice. For example, the grantor creates a trust but forgets to name the beneficiary, an unanticipated event happens that the trust doesn’t cover, or out of fairness a trust is necessary to protect the interests of the parties. In these situations, the court can decide that although the trust wasn’t formed properly, it was still the grantor’s intention to create the trust.
Educational Trust
An educational trust is simply what the name says; it is a trust that holds money to be used for education. The trust can be used during the grantor’s life or after his/her death. When the trust goes into effect determines the grantor’s tax consequences. If the grantor puts the trust into effect during his or her lifetime, then the funding of the trust might count for a gift tax. If the trust goes into effect after the grantor dies, then the trust isn’t subject to a gift tax but would count against the grantor’s federal estate tax exemption.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust’s main purpose is to exclude life insurance proceeds from the grantor’s estate, but still allow the money to go to the beneficiaries or to pay for the grantor’s estate tax liability. This trust, like many others, was created to decrease the size of the grantor’s estate lessening the amount of tax owed upon the grantor’s death.
Revocable Living Trust
As briefly discussed above, a revocable trust can be changed or terminated. Also, this is a living trust, which means it is an inter vivos trust created while the grantor is alive. These trusts can be used to avoid probate after the grantor’s death by allowing the property to immediately vest in the beneficiaries, so the property doesn’t need to be given through a will.
Special Needs Trust
When a beneficiary receives means-tested government benefits, like Medicaid, being left property from a trust could mess up their eligibility for such benefits. A special needs trust makes sure that doesn’t happen by allowing the beneficiary to receive the use of the trust property for certain purposes while still maintaining eligibility for the means-tested government benefits.
Tax Bypass or Credit Shelter Trust
The name explains the purpose; this trust is used to bypass estate taxes. It does this by bypassing the grantor’s or the spouse’s estate. How? When the property is placed in the trust, the property isn’t passed to the spouse when the grantor dies. Instead, the spouse is a beneficiary of the trust and normally receives all of the income from the trust and a portion of the principal. The remainder of the trust property is typically distributed to the grantor’s children upon the spouse’s death, thereby bypassing the spouse’s estate. If this trust is created as an inter vivos trust, the trust property may avoid being taxed to the grantor’s estate; however, the trust must be made three years prior to the grantor’s death to avoid being included in the grantor’s estate.
Testamentary Trust
A testamentary trust is a tool that a grantor uses to manage his or her property after the grantor’s death. A testamentary trust is most commonly created within a grantor’s will. This trust is revocable and only goes into effect after the grantor’s death. A testamentary trust does not avoid probate and the trustee will be the one to carry out the terms of the trust. The common way to use this trust is for a parent to leave money for their minor child. This money will be placed in the trust and managed by a trustee until the minor reaches a certain age, such as twenty-five.
THE TAKEAWAY: There are many types of trusts and they all have different purposes. If you are considering creating a trust, make sure to think through why you want the trust. This will help you understand which trust you should choose. The above descriptions are only an overview, so make sure to read more about your specific trust before you create one.
– The Business Team
Scott | Josh | Jeremy