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Categories of Trusts
All trusts essentially fall into one of each of the three different categories. All trusts are either revocable or irrevocable, simple or complex, grantor or non-grantor trusts. Every trust falls into one of each of these three categories. It completely depends on the meaning, purpose and wishes of the grantor, whomever created the trust, as to which of these three categories are used in the formation. Each of these categories carries with it very consequential outcomes, depending on which ones are chosen.
Both revocable and irrevocable trusts are considered living trusts, or “inter-vivos” trusts, in the sense that they are established during one’s lifetime. However, when one thinks of a living trust, they are generally speaking of a trust that can be modified at any time by the grantor, reverting the property back into his or her name if they so desired. In contrast, irrevocable trusts are set up whereby the grantor can never revoke assets back to their name, with only one rare exception. The whole purpose of the irrevocable trust is to give an asset to the management of someone, a trustee, for the purpose of a beneficiary, without ever planning to own it again.
Technically speaking though, an irrevocable trust could be modified but only with unanimous consent of the beneficiaries, and possibly causing tax implications to the grantor. This is the only exception, and it’s rarely ever done. Getting beneficiaries to agree on reverting assets that were once given to them is a very rare thing that almost never happens. So, when you think of an irrevocable trust, remember that it’s something that never changes, where as a living trust could change.
Nevertheless, living trusts basically only have one benefit. They help assets bypass probate and pass on to someone without having to go through the hands of a Probate Court. That is basically the only benefit of a living trust. The only other benefit of a living trust is that some living trusts enjoy some degree of anonymity, depending on if the grantor uses a name not associated with him or his or her family. Living trusts get no tax advantages or asset protection. Remember that. In fact, there are times when judges even rule that assets placed in a living trusts were put there under an unaccepted practice called “Alter Ego,” and therefore creditors are able to gain access to assets in living trusts. This is why we say there is no asset protection. And, from a financial planning standpoint, a good financial planner who understands estate planning will usually not recommend a living trust in a comprehensive financial plan. There are simply too many downsides.
Therefore, from a definition standpoint, financial planners will not view irrevocable trusts as “living trusts,” even though the grantor is still alive. Technically speaking, we consider all irrevocable trusts to be in a separate category from living trusts. We like to say they are opposite from living trusts, because the assets inside them can never revert back into the name of the grantor without invalidating the entire trust. Therefore, in summary, a revocable trust can be changed, and an irrevocable trust cannot. But there is something much more important about trusts than who owns what, when you are looking to set up a trust. We like our clients to think bigger than getting a living trust, and just avoiding probate. This is why good financial planners need to steer clear of living trusts when helping manage assets for their clients. Way more important than the title of the assets or avoiding probate is that a trust, properly constructed, can provide bullet-proof asset protection and unbelievable tax benefits. Providing clients with these two massively important benefits is what separates financial planners from professional financial planners. Professional financial planners understand estate and trust planning. What good is it to help a client mangage and grow assets, when only one lawsuit can come along and take everything away from them?
Average financial planners think products and strategy. They consider a problem and think about a strategy or a product to fix or eliminate a problem. However, professional planners do not do this. Professional financial planners never consider a product or a strategy first to fix or eliminate a problem. Professional planners will first take a step back and look at the big picture. They don’t think products and strategy. They think planning and details. More important than a strategy is having a comprehensive plan that understands the details. The details are what make or break a strategy. Details are what comes back to bite you, defeating any strategy. In fact, a strategy is only as good as the details that make it work or not. Not considering details is what makes plans fail, and this is why professional financial planners are usually sought after when the outcome really matters. Super wealthy people don’t want strategy. They usually seek out professional planning. They can’t afford mistakes. They know a little price to pay on the front end of big decision or change can make all the difference in the world.
So, when looking for a trust, it’s important to know the different types and if they have financial planning value or not. We know that all trusts are either revocable or irrevocable. Next, let’s see other types and see what makes them valuable.
Why You May Want A Professional Trustee
It is difficult at best for one individual to possess all of the characteristics necessary to manage a trust. Our trust management professionals are trained and educated to fulfill the duties of a trustee and deliver responsive service to the client.
Understand accounting, laws, court decisions and regulations pertaining to trusts, insurance and taxes
Be experts with investments and the management of all types of assets
Be responsive, proactive, and impartial while acting in the best interests of each client and beneficiary
Always protect and preserve the trust property
Be available, attentive, reliable, and ethical
Assume potential liability for the mismanagement of a trust account
Testamentary Trusts
Some people say that there are only two types of trusts, living trusts and testamentary trusts. That’s because the one who created the trust is only one of two options: dead or alive. If the grantor is still alive then some say that it’s called a living trust. But technically, a testamentary trust is something that isn’t established at all, yet, until a judge rules that that it is “established.” A testamentary trust is simply the desire of someone who write in their will that “I want this to happen…when I die.” Therefore, from a financial planning standpoint, assets that are believed to be in a trust, through a testamentary designation in a will, that hasn’t even been established, are benefiting from absolutely nothing. And, many financial planners do not consider a testamentary trust to even be a type of trust, because technically speaking it hasn’t even been established. It’s something that may or may not happen. A testamentary trust, or will trust, is set up through a provision in a last will and testament. It’s used to appoint a trustee to manage and distribute your assets upon your death. This type of trust is completely antithetical to the entire purpose of a trust. It makes no sense in financial planning to ever set up a testamentary trust. Trusts are set up to do one thing: to give someone control from the grave. When people die, they want their assets either managed or distributed in a particular way. This is the true meaning and purpose for a trust. However, a testamentary trust is only initiated through a will, which requires a probate court to validate it.
However, most people who set up trusts don’t want probate courts involved at all. They expect the trust to operate on its own, nevermind being dragged into a probate court, letting the probate attorney rob it blind, and the worst part is that the assets are usually “unmanaged” for a period of time until a judge finally “validates” the trust. It’s the dumbest way on the planet to set up a trust.
Therefore, a testamentary trust isn’t something that exists at all, yet. When someone dies, then after the probate process determines the will’s authenticity, the appointed executor transfers the assets into the testamentary trust and the trust is created. It’s not an efficient way to transfer ownership or manage assets when someone dies.
A Totten trust is another form of a trust that technically doesn’t exist either. However, it’s an extremely effective way to manage an asset without ever even needing to set up an official trust. Totten Trusts are also called a payable-on-death account. Many banks and financial institutions call them TOD Accounts (Transfer on Death). It’s not a special type of account. It’s simply any regular account, but it includes a form you fill out when you set up the account and the institution formally identifies your wishes for any money in that account in the event that you pass away. It is as simple as depositing money in a bank account or in another security and name a beneficiary for that account who will inherit the funds upon your death. This kind of “Totten” trust is revocable, and the beneficiary doesn’t have access to the accounts while the grantor are alive. In fact, most beneficiaries of this arrangement don’t even know that they’ve been named as a beneficiary. Only upon your death would the beneficiary have access to the funds. It’s the most effective way to manage assets without actually setting up a trust.
A special needs trust is established to meet the financial requirements of a dependent with special needs and appoints them as the beneficiary. It funds the beneficiary’s medical care or day-to-day needs while retaining the dependent’s entitlement to government benefits. There are two types of special needs trusts: first-party and third-party. Leaving assets to a loved one with special needs requires careful planning. A special needs trust can ensure the special needs person continues to receive SSI (Supplemental Security Income) and Medicaid benefits. Without a special needs trust, a substantial testamentary gift to an adult special needs person can impair their ability to collect social security income. Because property is left to the trust, and not the special needs person, they are still eligible for important benefits. Special needs trusts continue until the trust assets are exhausted or until the beneficiary’s death. The trustee, whom you select, can take care of a variety of personal expenses for the special needs loved one, including, but not limited to, education, personal care attendants, vacations, and out of pocket healthcare.
A QTIP trust divides your assets among your beneficiaries at different times. A common approach is to allocate income from the trust to your spouse upon your death and then to your children when your spouse dies. A QTIP trust restricts your spouse from accessing the full principal amount of the assets, but rather allows them to access income from your trust for the remainder of their lifetime. If you are part of a family in which there have been divorces, remarriages, and stepchildren, you may want to direct your assets to particular relatives through a qualified terminable interest property trust. Your surviving spouse will receive income from the trust, and the beneficiaries you specify (e.g., your children from a first marriage) will get the principal or remainder after your spouse dies.
A blind trust is a financial vehicle that allows public officials to place their assets under the management of an independent party, often a bank. Officers and directors of corporations can also make use of a blind trust. This arrangement is designed to avoid potential conflicts of interest for the public official, and to avoid the appearance of impropriety.
President Donald Trump announced that his business holdings will be placed in a blind trust in the care of his three oldest children while he became President of the U.S. Trump’s holdings include real estate, hotels, golf courses, and numerous other investments in the United States and abroad. While Trump, through his attorneys, refers to the arrangement as a blind trust, scholars are quick to point out that the trust will not be managed be an independent party, a requirement for blind trusts. As the Trump trust issue unfolds, we wanted to revisit trust basics and the interests they serve.
The problem with Trump’s proposed plan is that his children, who will manage the trust, are not true independent parties, and it is possible for Trump to exercise a degree of control over his assets. The blind trust differs substantially from other types of trusts. In the most basic form, a trust transfers asset from a person to the trust and creates rights in those assets for a third party beneficiary. The trustees of a blind trust manage the assets in the trust without the beneficiaries’ knowledge. The beneficiaries have no input into how the assets are handled. This kind of trust is useful if conflicts are likely to arise between the trustees and beneficiaries, or among the beneficiaries themselves.
Spendthrift Trust (or a Trust with a Spendthrift Provision)
A spendthrift trust is useful if you believe your heirs will squander their inheritance, because it allows you to specify when and how your beneficiaries may access assets designated to them. For example, you could state that beneficiaries may only receive income earned by the assets rather than access the full principal amount.
Many people create trusts to provide for minor children, individuals who lack management skills, or adults with special needs. Because an outright gift would be infeasible in these circumstances, a trust created for the benefit of others can serve the settlor’s intentions. Parents can create a trust for the benefit of their minor children. Most minors lack the maturity to effectively manage property and, more importantly, do not have legal capacity to manage financial affairs in most instances. A trust allows the settlor to provide for the minor children without the child having control over the gift.
A charitable trust is established during the trustor’s lifetime and distributes assets to the chosen charity or non-profit organization upon the trustor’s death. This type of trust account allows the charity to avoid or reduce estate taxes or gift taxes. A charitable trust can also be incorporated into a standard trust, so that the trustor’s heirs receive part of the estate and the charity receives the remainder.
As the name would suggest, an asset protection trust (APT) is the best type of trust to protect your assets against creditors, legal disputes, or judgments against your estate. This type of trust account allows the trustee to hold your assets so that they’re protected from taxation, divorce, bankruptcy, and other judgments from creditors.
A constructive trust is applied by a court when it determines that a party secured possession of assets unfairly, referred to as “unjust enrichment.” The court creates a constructive trust which is considered an “implied trust” since the grantor did not establish it during their lifetime. The purpose a constructive trust is to transfer assets that were intended to go to someone else to the rightful owner(s).
A marital trust (or “A” trust) can be established by one spouse for the benefit of the other. When the first spouse passes away, assets in the trust, along with any income the assets generate, are passed on to the surviving spouse. A marital trust would allow the surviving spouse to avoid paying estate taxes on those assets during their lifetime. The surviving spouse’s heirs, however, would be responsible for paying estate tax on any remaining trust assets that are eventually passed on to them.
Married couples may also establish a Bypass or Credit Shelter Trust (also known as “B” trust) to reduce the estate tax impact for their heirs. This is a type of irrevocable trust that transfers assets directly from one spouse to another at the time of the first spouse’s death. The surviving spouse, however, does not hold the assets directly. The trustee manages them instead, which allows those assets to be excluded from the spouse’s estate. When the surviving spouse dies, any remaining assets goes to their beneficiaries, free of estate tax.
A tax by-pass trust is set up for individuals who do not want their estate to be subject to federal estate taxes multiple times. It is often used by married couples to pass assets to the surviving spouse, and then onto children after the surviving spouse passes.
A by-pass trust splits your assets into “trust type A & B.” Trust A is a revocable marital trust that the surviving spouse has full ownership of. Trust B is an irrevocable family trust of which the surviving spouse doesn’t own the assets but can receive income from them during their lifetime.
Spouses can inherit each other’s assets tax-free, but when the second spouse dies, any estate remaining (beyond a tax-exempt limit) is taxable to their children at a rate of up to 55 percent. A by-pass trust can prevent taxation of the entirety of the trust.
Credit shelter trusts allow affluent couples to minimize or even eliminate their estate tax bills by transferring assets from one spouse’s estate to the surviving spouse’s estate. With a credit-shelter trust (also called a bypass or family trust), you write a will bequeathing an amount to the trust up to but not exceeding the estate-tax exemption. Then you pass the rest of your estate to your spouse tax-free. And there is an added bonus: Once money is placed in a bypass trust, it is forever free of estate tax, even if it grows.
The transferred assets do not increase the value of the second spouse’s estate since the trust is owned and managed by a trustee. However, the surviving spouse is allowed access to income from the trust, and they have the right to access the assets in the trust under specific circumstances such as medical emergencies or to fund education. When the second spouse dies, the assets are not subject to estate taxes when transferred to the remaining beneficiaries.
If you would prefer your estate go to your grandchildren rather than to your children, you can set up a generation-skipping trust. By transferring the assets to your grandchildren instead of your children, the assets avoid estate taxes. However, you have the option to give your children access to income generated by those assets.
A life insurance trust is an irrevocable trust designed to hold the proceeds of your life insurance policy. The main benefit of this kind of trust is that it allows your life insurance payouts to be invested and distributed by the trustee without incurring estate taxes for the beneficiaries.
