Type of Trusts: Estate Planning for Your Family

Posting by Joel C. Susco, CPA, Principal

Trusts are an important component of estate planning, as they allow you to preserve your wealth for future generations. There are many different types of trusts (an almost overwhelming amount); your unique family and financial situation, and your goals, will help determine which trust is best for you and your heirs.

Revocable vs. Irrevocable Trusts

Before we provide an overview of the main types of trusts, it is important to note this overall distinction and the associated tax consequences. A revocable trust allows you to retain control of the assets you place in the trust. If is flexible and the terms can be revoked or changed at any point in your lifetime; it typically becomes irrevocable when the grantor (the creator of the trust) dies, unless a successor grantor has been appointed.

Revocable trusts are treated like any other asset you own, meaning that there is no creditor protection in the case of a lawsuit, and all assets in the trust at your death are subject to federal estate taxes and state inheritance taxes.

On the other hand, an irrevocable trust places the assets out of your control, and it cannot be altered after it has been executed. Irrevocable trusts are often structured so the assets are not subject to estate taxes.

Common Types of Trusts

A common way of looking at trusts is by their purpose. Again, the type of trust chosen for your estate plan is based on a review of your family and financial goals in tandem with the possible tax consequences of the trusts. While this is by no means a comprehensive list, these are some of the more common trusts used for estate planning purposes:

  • Bypass Trust. Also known as a “B” Trust or a Credit Shelter Trust, this is an irrevocable trust that is designed to provide income and principal to the Grantor’s spouse for the duration of the spouse’s life. It is referred to as a bypass trust because the assets transferring to this trust skip (“bypass”) the estate tax due at the death of the Grantor and would then be subject to estate tax when the spouse passes away. Assets transferred to the surviving spouse are permitted a marital deduction and avoid estate tax at the time of the Grantor’s death.
  • A/B Trust. This refers to any type of trust that splits into two separate trusts upon the Grantor’s death. These are implemented to help married couples minimize total estate taxes.
  • Irrevocable Life Insurance Trust. This trust removes your life insurance from your taxable estate, providing liquidity for the estate and/or the trust’s beneficiaries.
  • Charitable Trusts. There are a number of charitable trusts with different structures to accomplish different philanthropic goals. These trusts split the income between your designated beneficiary and the charity of your choosing.
  • Generation-skipping Trust. This type of trust allows you to distribute trust assets to grandchildren or later generations in a tax-advantageous way.
  • Dynasty Trust. These types of trusts are usually created to last indeterminately, with distributions being made for many generations.
  • Qualified Terminable Interest Property (QTIP) Trust. This trust is created to provide income for a surviving spouse, but that spouse is not given the right to determine the beneficiaries upon his/her death. It provides significantly flexibility to the executor of your estate and is often used when estate planning in a second (or third or beyond) marriage in order to provide assets to both a surviving spouse and children.
  • Grantor Retained Annuity Trust (GRAT). This is an irrevocable trust that provides a tax-free way to make large financial gifts to family members during your lifetime, utilizing quickly appreciating assets.
  • Special Needs Trust. This trust is established for an individual receiving government benefits with the goal of providing income for that individual without disqualifying him/her from receiving those government benefits.

Again, this is not a comprehensive list. As you can see, there are a number of different types of trusts, and your financial situation and goals will determine which one is right for your unique situation. Many families choose a combination of trusts to achieve their goals and leave a financial legacy.

This is a common ending to our insights shared here on dcfamilybusiness.com, but I would encourage you to talk to your CPA and/or lawyer. Proper estate planning requires a dedicated team of legal and financial professionals that will get to know your family’s situation and help you choose the trust(s) and strategies you need for your estate plan.

Finally, perhaps the most important issue to note is that estate planning is not a “once and done” effort. As your financial situation changes, the economy fluctuates, and tax laws change, your estate plan will need to be updated and modified. As we have seen in recent years, the tax code is an open book. The current federal estate tax exemption is $5.34M, providing the flexibility to structure and re-structure your family’s legacy as you see fit.

Once you’ve determined the best strategy and created and funded the necessary trust(s), don’t rest on your laurels – check in with your advisors and be proactive about your estate plan and the financial legacy you want to leave for your family.

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