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What is a Trust?
Submitted by Headwater Investment Consulting on October 1st, 2015By Kevin Chambers
A trust is a fiduciary arrangement that designates a trustee that holds assets on behalf of a beneficiary. There are two main ways to classify trusts. First is the determination of when a trust becomes effective: Living Trusts vs. Testamentary Trusts.
- A living trust is established by one or more people, known as the grantor(s), during the grantor(s) lifetime. If properly funded during the lifetime of the grantor(s), a living trust may avoid probate and estate taxes.
- A testamentary trust is stipulated in a Last Will and Testament to establish a trust after the person’s death. Since a testamentary trust only comes into effect after the Will has gone through probate, the trust is also subject to probate and estate taxes.
A second method to classify trusts is based on the rights of the grantor(s): Revocable Trusts vs. Irrevocable Trusts.
- Revocable trusts help assets avoid probate but allow the grantor(s) to maintain control over the assets during their life. Revocable trust assets are treated just like all of your other assets. Revocable trusts usually are still subject to estate taxes.
- Irrevocable trusts cannot be altered by the grantor(s) after it has been created. Therefore, the grantor(s) lose control of the assets. Irrevocable trusts are not subject to estate tax but are subject to annual gift tax limitations.
Trusts can be further classified according to their purpose. Trusts can be set up to care for a child with disabilities or as a part of estate planning. Depending on the specific purpose, many trusts have certain income tax and estate tax stipulations. Here are some basic types of trust based on purpose, as defined by Fidelity Investments:
Basic types of trusts:
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Marital or “A” trust |
Designed to provide benefits to a surviving spouse; generally included in the taxable estate of the surviving spouse |
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Bypass or “B” trust |
Also known as credit shelter trust, established to bypass the surviving spouse’s estate in order to make full use of any federal estate tax exemption for each spouse |
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Irrevocable life insurance trust (ILIT) |
Irrevocable trust designed to exclude life insurance proceeds from the deceased’s taxable estate while providing liquidity to the estate and/or the trusts’ beneficiaries |
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Charitable lead trust |
Allows certain benefits to go to a charity and the remainder to your beneficiaries |
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Charitable remainder trust |
Allows you to receive an income stream for a defined period of time and stipulate that any remainder go to a charity |
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Generation-skipping trust |
Using the generation-skipping tax exemption, permits trust assets to be distributed to grandchildren or later generations without incurring either a generation-skipping tax or estate taxes on the subsequent death of your children |
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Qualified Terminable Interest Property (QTIP) trust |
Used to provide income for a surviving spouse. Upon the spouse’s death, the assets then go to additional beneficiaries named by the deceased. Often used in second marriage situations, as well as to maximize estate and generation-skipping tax or estate tax planning flexibility |
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Grantor Retained Annuity Trust (GRAT) |
Irrevocable trust funded by gifts by its grantor; designed to shift future appreciation on quickly appreciating assets to the next generation during the grantor’s lifetime |
Trusts can be a good way to control your wealth and make your estate process easier and more tax efficient for your beneficiaries. However, considering that so many variations exist, it is important to talk with an attorney to find if a trust, and what type of trust, is appropriate for your situation.
