A trust is an important part of the estate planning and wealth management process. It can help shelter your assets from taxes or lawsuits and provide income to your family if after you pass away. However, it isn’t always easy to choose the right type of trust for your needs.
To help make the estate planning process simpler, we break down some of the most common types of trust funds in this guide.
First thing’s first: What is a trust?
A trust is a legal document used to establish a “container” that holds assets, like money or property that an estate planning lawyer can draw up. The trust’s assets are then managed by you (aka, the grantor or trustor) or a trustee, another person or organization tasked with overseeing your trust and trust administration until its assets are transferred to your beneficiaries.
You can choose from several different types of trusts that benefit spouses, family members, and charitable organizations; you can even create a pet trust. You can also establish specific terms for your trust. For instance, you may name your grandchild as the heir of your vintage sports car — but only after they graduate from college.
Why should you establish a trust?
Financial trusts aren’t a mandatory part of estate planning. However, they may help protect your assets and loved ones. They can also streamline the property distribution process after your death.
Establishing a trust account makes it easier to transfer belongings to the people or organizations you choose, while reducing the tax burden they might face. Some trusts also shield your assets from probate, lawsuits, and the IRS.
And if you’re thinking about setting up a trust, consider purchasing a life insurance policy to ensure your assets go to your loved ones. Life insurance benefits are typically disbursed tax-free, and your beneficiary can use the proceeds to pay estate taxes or other debts your estate may owe.
You also have the option to set up certain trusts using life insurance. For example, if you have a loved one with special needs, you might not have enough money to fund a special needs trust on your own. With life insurance, you can apply for a death benefit that will provide financial security for your beneficiary, such as your spouse, children, or a charitable organization.
Learning about your options can help you plan for your loved ones’ future. Let's take a look at some of the most common types of trusts to consider during the estate planning process.
9 Different Types of Trusts for Estate Planning
Not sure which trust is right for you? Consider the following common types of trust accounts.
Revocable trust
A revocable trust allows the grantor — the person who created the trust — to change or end the trust at any point during their lifetime. Revocable trusts are also known as living trusts or revocable living trusts.
These trusts are set up by you while you’re still alive. Often, the assets in a revocable living trust transfer to your beneficiaries after you pass away. Most trusts can be revocable.
Having a revocable living trust in place can help you avoid probate, which is the process a court takes to finalize your legal and financial matters after your death. Probate can be lengthy and expensive for your loved ones. Estates in probate also become a matter of public record.
One downside of a revocable trust is that the assets held in one are considered personal assets to creditors and for estate tax purposes. This means if you owe money when you pass away, creditors can access to your trust’s assets to pay off those debts. You may also owe taxes on your estate if your trust assets meet the minimum value requirements.
Living trust vs. revocable trust: What’s the difference?
Living trusts and revocable trusts are often used interchangeably, which can cause some confusion. But a living trust is simply another name for a revocable trust.
Like a revocable trust, a living trust is one you set up and manage during your lifetime. You can update or dissolve a living trust at any time. After you pass, thetrust assets in a living trust are transferred to your beneficiaries.
Irrevocable trust
Once you create an irrevocable trust you cannot change or terminate it. You can establish an irrevocable trust during the estate planning process. Most trusts can be irrevocable.
An irrevocable trust offers your assets the most protection from creditors and lawsuits.
Assets in an irrevocable trust aren’t considered personal property. This means they're not included when the IRS values your estate to determine if taxes are owed. And, if you file bankruptcy or default on a debt, assets in an irrevocable trust won’t be included in bankruptcy or other court proceedings.
Pro tip: A revocable trust becomes irrevocable when you pass away. This allows you to change the trust’s terms or update your beneficiaries while you’re alive, guaranteeing your wishes are carried out. However, it doesn’t prevent your estate from entering probate.
Testamentary trust
A testamentary trust is one you create through your will. Also known as a will trust or a trust under will, testamentary trusts don’t activate until you pass away. Your last will and testament includes instructions on how your trust is created, managed, and distributed. It also ensures your beneficiaries only receive their inheritance at a certain time.
It’s important to understand that assets in a testamentary trust always go through the probate process. As a result, your estate becomes a matter of public record, which means your beneficiaries will lose some of the privacy that comes with other types of trusts.
Special needs trust
If you have a disabled loved one(s), a special needs trust can provide them with income after your passing without disqualifying them from government benefits, like Social Security Disability Income.
Keep in mind that your special needs beneficiary doesn’t control the funds. Instead, a trustee — or someone you choose to manage the trust — does.
Spendthrift trust
Spendthrift trusts distribute assets to your beneficiaries over time, rather than in a lump sum. Your beneficiaries receive payouts over a specified period, which can help ensure your savings last.
The funds in a spendthrift trust aren’t considered your beneficiary’s personal assets until they’re disbursed. This means creditors can’t access money in the trust in the case of loan default or bankruptcy.
Charitable trust
If you want to donate money in a tax-efficient manner when you pass away, a charitable trust may be a good option. Assets included in the trust aren’t considered personal assets, sothe charity will not have to pay an estate tax.
You can typically choose from two types of charitable trusts: charitable lead trusts and charitable remainder trusts (CRT).
Charitable lead trusts allow you to set aside specific assets for one or more organizations. Then, you can distribute the rest of your property to your beneficiaries — like your spouse or children. Charitable lead trusts are irrevocable, which means you can’t change the terms once they’re established.
A charitable remainder trust is an irrevocable trust you can use as a source of income until your death. When you establish a CRT, you place assets into the trust, such as money, real estate, or stocks.
You can draw income from this funding source for the rest of your life. When you pass away, the remaining assets in your CRT will be distributed to one or more charitable organizations.
Asset protection trust
This type of trust keeps your assets safe from creditors. If you file bankruptcy or default on a debt, assets in this trust won’t be included in bankruptcy or other court proceedings.
Asset protection trusts can be expensive to establish. However, they provide more security than any other type of trust — except for an irrevocable trust.
Bypass trust
A bypass trust is a popular option for married couples. This trust allows you to leave assets to your spouse estate-tax-free. Following the death of one spouse, the assets in a bypass trust are split into two parts: a revocable marital trust and an irrevocable family trust.
When the first spouse passes, their assets are placed in the family trust. The surviving spouse owns the marital trust, though they can receive income from the family trust during their lifetime.
Then, when the surviving spouse passes away, their assets go to their beneficiaries — again avoiding estate taxes and the probate process.
Totten trust
A Totten trust is essentially a payable-on-death (POD) bank account. It’s a revocable trust that you can set up with your bank by simply filling out paperwork and naming a POD beneficiary. This helps you maintain control of the account during your life while avoiding probate after you’ve passed away.
Considering a trust for your estate plan?
Establishing a trust as part of your estate plan helps protect your assets and prevent your loved ones from undergoing the probate court process. However, it’s essential to select the right type of trust — and set up a trust document with the help of an experienced estate planning attorney.
Contact your human resources representative to learn more about your company’s legal services benefit plan. A legal services benefit, or legal insurance, gives you access to a network of experienced attorneys at an affordable monthly rate.
With legal insurance, you may be able to save on estate planning costs when you hire an estate planning attorney. Most importantly, you can move forward with confidence, knowing you’ve prepared for the future and protected what matters most.
