What Are the Most Common Types of Trusts?

Making plans for your family’s future can be a difficult task, especially when it means determining what should happen to your estate after your death. Choosing who you want to receive your assets and how to distribute those assets after you are gone can prove a harsh reality, and difficulties may be heightened by a lack of understanding of the intricacies of estate planning. However, developing a comprehensive estate plan is one of the most important tasks you will ever undertake.

For this reason, it is important to read up on your options as early as possible and begin planning your legacy while you are in prime condition to make such important decisions. Perhaps most importantly, it is crucial to understand that not all wealth transfer vehicles are created equal, and as with any financial tool, small details impact large sums of money. This is especially true when it comes to trusts.

What Is a Trust?

A trust is an estate planning tool that dictates how your assets will be managed during the wealth distribution portion of your life. Much like a will, it not only conveys your wishes for how your money will be distributed once you’ve passed away, but also who has the power to make decisions about your estate. However, while a will is a document that only goes into effect after your passing, a trust can contain directives that can be enacted at any specified time—even before your death.

Trusts provide a means of passing on assets while avoiding probate court and/or the legal processes that dictate the payment of taxes and debts of the recently deceased. This can make trusts a great solution for guarding your money to ensure your beneficiaries get the most support possible without the stress of the probate process. As a result, your beneficiaries will receive distribution of your assets much more quickly than with a regular will and testament.

How Do Trusts Work?

Trusts are legal arrangements, contracted between individuals, banks, or institutions and the people or organizations they want to support. As such, trusts do not have to follow all the usual rules for legacy planning documents. Trusts can hold a variety of asset types, including life insurance policies, real estate, investment accounts, bank accounts, and more.

Typically, trust administration is arranged through an estate planning attorney or other certified financial planner. With trusts, the grantors (also known as trustors) enter into a fiduciary relationship with a trustee (the person or group of people assigned to handle the trust) and their beneficiary or beneficiaries. This means that the solution they arrive at for the wealth transfer, whether it is set to occur during life or after death, must be mutually beneficial for both parties and upheld by the trustees.

How Are Trusts Categorized?

There are several different types of trusts, each with their own benefits and drawbacks. The types of trusts fall under a few broader categories, dictating the specific manner in which you would like money and/or property distributed, and to whom. Whether you are looking to create a source of annual income for yourself, leaving everything to your heirs, or donating to charity, you should consider if a trust is right for you and which type of trust suits your needs. The many categories of trusts include the categories below.

Living/Revocable Trusts

The first trust category is known as a living trust, also referred to as a revocable trust. These trusts can be changed and even dissolved or revoked during the course of the trustor’s lifetime. This gives the trustor more control over their assets during the traditional legacy planning and retirement years. Trustors can also choose to name themselves a trustee or beneficiary.

Living trusts can change, helping trustors escape difficult situations they did not foresee at the time when they made their decisions. These situations can include divorce, familial issues, and other significant shifts in financial situations that can affect previous legacy plans. Trusts can also change terms if the trustor experiences unexpected financial success, receives a large inheritance, or happens upon a sudden windfall. However, living trusts are subject to estate taxes as well as state death taxes.

Irrevocable Trusts

The category of irrevocable trusts is similarly self-descriptive—unlike revocable/living trusts, these trusts cannot be revoked or changed. However, irrevocable trusts provide considerable protection for assets, shielding them from estate tax and minimizing the tax liability of the estate.

As soon as a trustor dies, any revocable trusts are rendered irrevocable and the wishes expressed in the trust must be put into action. As with a revocable trust, a trustor can serve as their own beneficiary during their lifetime. However, unlike revocable trusts, irrevocable trusts can never feature a scenario where the grantor is also both the beneficiary and trustee.

Funded Trusts

Trusts can also be categorized depending on how assets are placed into the trust, and may take the form of either a funded or unfunded trust. A funded trust is a trust where the trustee has made asset contributions during their lifetime. Trusts can be funded in many different ways, including:

• Transferring bank accounts by naming the trust itself on your account title
• Opening a Certificate of Deposit (CD) in the trust’s name
• Funding from financial accounts like your retirement account, life insurance, health savings accounts (HSA), and medical savings accounts (MSAs)
• Transferring ownership of real estate property through use of a quitclaim deed (though permission may be needed if you have a mortgage or homeowner’s association)
• Getting a new title for property such as cars, motorbikes, and boats, which names the trust as the owner
• Endorsing Assignment of Property documents noting the trust as the owner of assets like jewelry, fine china, and any other expensive belongings you’d like to pass on to beneficiaries
• Retitling of business holdings to transfer your share of ownership to your trust

Unfunded Trusts

Unfunded trusts are created without any funding, consisting of only the trust agreement. While trusts can remain unfunded through the entirety of a trustor’s lifetime and after death, this situation is not advisable. Without the trustor deliberately transferring assets into the trust’s name, a revocable trust is nearly meaningless. While it is possible to create a pour-over will to fund the trust after your death, this can leave you and your beneficiaries at risk for some of the issues the trust was created to help you avoid.

Leaving your trust unfunded can result in:

• A trust funded by a pour-over needing to go through probate—defeating the purpose.
• Trustees having no power to manage any of your assets not retitled to show ownership by the trust.
• Assets not under the name of the trust may also not go to your intended beneficiaries, but instead pass through rights of survivorship which vary from state to state.

What Are the Kinds of Trusts?

Whether the trust is initially categorized as revocable or irrevocable, funded or unfunded, it can take many forms. Some of the main types of trusts are:

• Testamentary trusts. Testamentary trusts are established through the last will and testament of the trustor. This means that when the trustor passes away, the trust immediately becomes irrevocable. This action ensures beneficiaries can only receive access to the assets in the trust at the date specified by the trustor.
• Marital trusts. These trusts are established by one spouse for the other so that when they pass away, all the assets from the trust are passed on to the surviving party. These trusts help the survivor avoid estate taxes and other expenses through the rest of their lifetime. However, as the name implies, this protection is only extended to the surviving spouse. Any other heirs would still have to pay estate taxes on the remainder of the assets in the trust.
• Bypass trusts. Bypass trusts are also called “B trusts” or “credit shelter trusts.” Trusts like these are another great choice for married couples looking to reduce the impact of estate tax on their beneficiaries. These irrevocable trusts transfer assets from one spouse to another directly at the time of the other spouse’s death. These assets remain managed by the trustee, allowing the survivor to exclude the assets passed down from their estate tax. At the time of the surviving spouse’s death, any heirs and other beneficiaries will receive the remaining assets estate-tax-free.
• Separate share trusts. Separate share trusts allow trustors to name multiple different beneficiaries and set different terms for each.
• Blind trusts. These trusts keep the trustees in the dark regarding the identity or identities of the beneficiaries. This tool helps to avoid situations where conflicts of interest may interfere with the trust distribution process.
• Insurance trusts. These irrevocable trusts hold a life insurance policy as well, preventing it from being taxed with the rest of the estate. Trustors who chose this option no longer have the opportunity to borrow against their policy, but the death benefit can be used to help loved ones to pay off estate costs.
• Spendthrift trusts. This type of trust helps to keep the trustor’s assets safe from creditors looking to claim debts after their passing. They also allow for an independent trustee to manage the assets and keep beneficiaries from selling their interest.
• Generation-skipping trusts. Grandparents can transfer assets to beneficiaries two generations or younger than them with a generation-skipping trust. The trust skips over their children’s generation, and instead benefits their grandchildren or great-grandchildren.
• Credit shelter trusts. Credit shelter trusts allow trustors to pass down an amount up to the estate-tax exemption, with the remaining estate assets going to their spouse tax free. These credit shelters protect your funds from estate taxes forever, regardless of their growth potential.
• Special needs trusts. These trusts are a way for trustors to support loved ones who are disabled. The trust allows disabled or special needs individuals to benefit from payments without impacting their ability to collect government assistance like Social Security.
• Charitable trusts. This type of trust allows trustors to directly donate to specific non-profit organizations and other charities after their passing. This differs from the way that a standard estate plan works because it first pays out income to the named beneficiaries for a set amount of time and donates the remaining assets to the charity of choice.
• Qualified terminable interest property trusts. Qualified terminable interest property trusts are a way for trustors to disburse their assets to named beneficiaries on variable timelines. Typically, these trusts are chosen so that when someone dies, their spouse will receive guaranteed income payments for life with the children receiving the remaining balance.
• Totten trusts. Totten trusts are often called “payable-on-death” accounts, as they are created by and managed by the grantor, making them both trustor and trustee. These trusts are mainly used for bank accounts and cannot include any physical property. Because they require no written documentation and are typically cheap (if not free) and help trustors avoid expensive complexities like probate costs, Totten trusts are colloquially referred to as a “poor man’s trust.” They can be set up by having the title of accounts reference the trust, including language like, “Payable on Death to…” or “Trust For…”

What Is the Best Trust to Protect Assets?

For those seeking a solid asset protection strategy, there is another type of trust aptly named asset protection trust. These trusts are specifically set up to keep a trustor’s assets safe from debt collectors. When you suffer a loss and default on debts or file for bankruptcy, an asset protection trust cannot be included in the court proceedings. This is also a feature of bypass trusts. More broadly, irrevocable trusts can also reduce your estate taxes due to the fact that the IRS does not consider them to be personal assets when evaluating the estate for taxes.

Contact a Skilled Trust Attorney

If you are ready to begin estate planning or wish to include a trust as a part of your long-term asset protection and distribution strategy, look no further than Huber Law Group With a specialty in trust and estate law, our dedicated professionals are here to help you build an estate plan that suits your unique needs. Don’t wait until it is too late to protect your assets and your family from taxes and probate court—contact Huber Law Group today.

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