Which Trust is Right for You? Different Types of Trusts Explained

VIDEO TRANSCRIPT

People often think of trusts as the domain of the extraordinarily rich. While wealthy individuals do often set up trusts, the truth is, trusts are useful legal arrangements for many families in their estate planning — not just wealthy ones.

Of course, there are many different types of trusts. Understanding how they work can help you decide which trust is right for you and your family. 

What is a trust?

A trust is a legal agreement between two parties, where one gives the other the right to hold property or assets on behalf of a third party. Let’s talk about the parties involved.

• The grantor (or trustor). This is the person who sets up the trust. Their property and/or assets are going into the trust. 

 

• The trustee. This is the person who will manage the trust. They have a fiduciary duty to act in the best interests of the trustor and future beneficiaries of the trust.

 

• The beneficiary. This is the person (or people) who will receive the assets in the trust at a set time. For estate planning purposes, that triggering event is generally the trustor’s death. 

 

See: How to set up a living trust?

Why use a trust for estate planning

Drafting a will is a pretty simple process, so why use a trust? 

Trusts create many benefits for estate planning. The primary benefits include:

• Avoiding probate
• Maintaining privacy about assets
• Defining exactly when beneficiaries get assets (for example, when they turn 25)
• Ensuring a smooth transition of authority to the trustee
• Potentially protecting assets from creditors 

 

Setting up a trust is more complicated than drafting a will, but trusts also provide more protection than wills. 

For many families, the benefits of a trust balance out the upfront time and cost. Let’s talk about the different types of trusts and who might want to use them.

(Check out our six-part video series on whether you need a trust.)

Revocable vs irrevocable trusts

There are two main types of trusts — revocable and irrevocable. All the other trusts we talk about will fall into one of those two categories, so let’s nail them down. 

Revocable trust

The type of trust you’ve probably heard about (and the one most commonly associated with estate planning) is a revocable living trust. 

A revocable trust is called that because it’s one that you can revoke. During your lifetime, you maintain control over the assets you place in the trust. You can take things out of the trust, modify the terms, or dissolve the trust entirely. It’s up to you. 

So the biggest benefit of a revocable trust (as opposed to an irrevocable trust) is flexibility. You can do what you want with it until you pass away. You can name yourself the trustee or co-trustee and name someone else as the successor trustee. They’ll take over when you die or if you’re unable to manage the trust because of injury or incapacitation. 

Of course, if the trust could be modified forever, there wouldn’t really be a point to having it. Once the revocable trust’s grantor dies, the trust becomes irrevocable. Now it’s purpose is solely to provide for the beneficiaries.

And like with most trusts, the assets in a revocable trust do not have to go through probate.  

See: Is There a Downside to a Revocable Living Trust?

Irrevocable trust 

In opposition, an irrevocable trust, once made, cannot be revoked or modified — even during the life of the grantor. 

Irrevocable trusts are less common in estate planning. They’re used primarily as safeguards for sheltering assets from creditor claims, certain tax liabilities, or Medicaid. 

Special types of trusts

Many types of trusts have specific utility to address a particular estate planning issue. These are some of the most common. 

Charitable trust

If you’ve ever thought of leaving a positive legacy after you die, perhaps you’ve considered a charitable trust. 

Charitable trusts are irrevocable trusts that allow you to pass assets along to a charitable organization in one of two ways. With a charitable lead trust, you can set aside certain assets for a specific charity. The remaining assets would go to your other beneficiaries. 

With a charitable remainder trust, you receive income from the assets you placed in the trust while you are alive. When you die, the remaining assets pass to the charity you chose. 

Spendthrift trust

A spendthrift trust is the perfect option for grantors who want to leave assets to a beneficiary but are concerned about that beneficiary’s maturity or ability to manage the money. 

With a spendthrift trust, the beneficiary has only restricted access to the funds in the trust. Depending on the terms of the trust, the beneficiary may get a regular payment from the trustee, have to ask the trustee for funds, or have to ask the trustee to purchase things for them with the funds in the trust. 

Because there is restricted access to the trust, the assets in the trust are also protected from creditors. That makes it a particularly useful option for beneficiaries who have a history of running up debt. 

 

See: Trusts for Beneficiaries with Financial Issues

Special needs trust

Leaving money to someone with special needs can be a complicated endeavor. A grantor may want to make sure their disabled child has every advantage and provide for them in their will or a trust. 

Unfortunately, inheritance can make a beneficiary ineligible for government assistance, like Medicaid or supplemental security income — even if the inheritance isn’t enough to cover the costs that those benefits help with. 

To get around that issue, special needs trusts leave assets in the control of a trustee, not the beneficiary. Because the beneficiary doesn’t have control over the funds, they are not considered for the purposes of government program eligibility. 

The trust ends when the beneficiary dies or the trust is empty, whichever comes first.

Testamentary trust 

Unlike the other trusts we’ve discussed, a testamentary trust exists as part of a will. 

A testator (the drafter of a will) may include instructions to set up a testamentary trust when they are planning to leave assets to someone that will not be able to manage them. The most common examples are minor children or adults with disabilities. 

Once the testator dies and their will goes through the probate process, the testamentary trust is created. 

The trust creates conditions for the beneficiaries’ inheritance of the assets in the trust. For instance, a minor may not get access to the trust assets until they turn 25. The trust could have further restrictions — until they turn 25, they can not use the funds at all. Or until they turn 25, they can only use the funds for educational purposes. 

Why use a testamentary trust instead of a traditional living trust? Some people choose a testamentary trust because it requires less maintenance during their lifetime. It’s only established once they’ve died. 

See: At What Age Should My Child Inherit Money?

Generation-skipping trust

Generation-skipping trusts are irrevocable trusts used primarily for their tax benefits. 

They do exactly what they say they do — skip one generation (generally, the grantor’s children) to pass assets along to the next generation (generally, the grantor’s grandchildren). 

Of course, some people may be motivated by a deep love for their grandchildren. But grantors generally use these trusts so their family can avoid paying estate tax twice. For instance, with a traditional living trust, the children would inherit. If the amount of their inheritance surpassed the estate tax exemption, they would have to pay taxes on it. If they then passed their assets along to their own children in an amount that also surpassed the estate tax exemption, their children would have to pay taxes on it. 

For families that have significant generational wealth, a generation-skipping trust can help keep more of that wealth in the family.  

See: Is there a difference between setting up a trust for your children and a trust for your grandchildren?

 

Whatever type of trust matches your estate planning needs, Siedentopf Law can help you set it up. And if you’re not sure what type of trust is best for your family, we can help you figure that out too.