Types of Trusts

Types of Trust

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May 10, 2016

Trusts provide an effective estate and financial planning tool. The benefits provided from trusts rest in their ability to provide flexible asset management options while in some cases offering a way to reduce exposure to creditors and tax liability. Further trusts offer an estate-planning alternative to wills in which individuals can manage and alter their estate plan while still living. Further trusts offer the potential for cost savings as estate assets held in trust do not need to be administered by a probate court, which ultimately reduces the cost and time needed to distribute estate assets.

Functionally, trusts involve three elements, a grantor (the person funding the trust), a trustee (the person or institution administering the trust) and the beneficiary (person(s) receiving assets from the trust). How the trust operates, such as how trust assets will be managed and the conditions under which assets will be distributed to beneficiaries is governed by the trust agreement. The trust agreement is normally established by the grantor to be carried out by the trustee.

Currently, there is a wide range of trusts available. The variety of trusts available to financial and estate planners reflects responses to many estate and financial planning problems. As such, the variety of legally recognized trusts available today can conceivably address a number of estate and financial planning problems.

There are several different types of trusts. Trusts can be classified into four categories:
1 – revocable trusts;
2 – irrevocable trusts;
3 – living trusts; and
testamentary trusts.
A trust may have a combination of these characteristics. Whether a trust is revocable or funded during the life of the grantor will determine how it functions, the protection is offers from creditors and how trust assets are taxed.

Revocable and Irrevocable Trusts
An irrevocable trust cannot be altered or terminated by the grantor after it has been created, whereas a revocable trust can be altered or terminated by the grantor after it has been created. An irrevocable trust can be altered or terminated only under limited conditions and requires the consent of the trustee, the beneficiaries and in some cases court approval. The practical effect of a trust being irrevocable relates to whether trust assets are viewed as being owned by the trust or by the grantor. Generally, irrevocable trust assets are taxed as if they are not in the possession of the grantor. As such, the trust incurs tax liability, which can be less than if an individual tax liability. Conversely, the tax liability for assets held in a revocable trust is taxed to the grantor. The treatment of irrevocable trust assets as being separate from the grantor’s assets also applies to protection offered from creditors. The assets in an irrevocable trust will not be treated as attachable by a creditor, whereas revocable trusts can be attached to creditor claims.

Living and Testamentary Trusts
Trusts vary according to when they are funded. Living trusts or Inter Vivos Trusts are created while the grantor is still living. A living trust would involve a grantor placing assets in a trust, while living, to transfer to a beneficiary while the grantor is still alive or to be transferred for an extended period including after the grantor’s death. Commonly, living trusts are revocable so that the grantor can take an active role in managing trust assets, for example investing assets so that they increase in value or removing assets from the trust. A living trust is contrasted with a testamentary trust that is included in the terms of a will and takes effect when the grantor dies. For example, a testamentary trust may be contained in a will and structured to place assets in trust upon the death of the grantor. Often testamentary trusts are used to transfer assets to a minor before they reach adulthood and presumably are better equipped to manage their finances. Unlike a living trust, a testamentary trust will require administration by a probate court since it is included in a will. However, the operation of the trust itself will require probate involvement.

Beyond the broad categories of trusts discussed above, there are many trusts with specific purposes tailored to address particular estate and financial planning needs. The type of trust suitable to a particular situation will depend on the assets being placed in trust, tax liability considerations and long and short term planning goals.


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