Trusts are legal entities created to endow property to a beneficiary while being managed by a trustee. There are many different types of trusts that can provide a variety of benefits to your estate.
Below you’ll find useful trust information with some of the more commonly used trusts to employ while planning your estate.
Revocable Living Trust
A revocable living trust, sometimes called a living trust, declares that you are holding certain property in trust. A living trust is an important tool to avoid probate. With this type of trust you may, at any time, take property out of the trust or revoke the trust entirely. During your lifetime, a revocable trust is treated as a fictional entity. You pay taxes on any trust income during your lifetime, and your creditors may access trust assets to pay your debts.
Upon your death, the trust becomes an irrevocable trust and takes on new life as a separate legal entity. Any property in the trust not owned by you or your estate at the time of your death is not subject to probate. However, the probate court has authority to resolve disputes about the trust, and the trust usually remains liable for your debts, including any estate taxes.
A living trust does not save or defer any estate taxes by itself, but provisions can be added to serve that purpose. For example, if a husband and wife jointly create a revocable trust and one spouse dies, the trust might be split into two parts. One part contains the surviving spouse’s property and remains revocable; the other becomes irrevocable and is usually earmarked for the surviving spouse’s use. Upon the death of the surviving spouse, any balance remaining in the trust passes to the couple’s children. Ultimately, many types of trust arrangements are possible, with different legal and tax consequences. You should talk with an attorney to decide which is best for you.
With a revocable living trust, the grantor, the person putting property in to the trust, can act as the trustee, but he or she needs to be careful to act in accordance with substantial requirements. These requirements are called fiduciary duties and include:
- A duty to administer the trust.
- A duty of loyalty to administer the trust solely for the beneficiaries’ benefit.
- A duty to be impartial, if there is more than one beneficiary.
- A duty to use special skills.
- A duty to delegate responsibly.
- A duty to be a responsible investor.
- A duty to control and protect trust property.
- A duty to keep records.
- A duty to collect trust property.
- A duty to inform and report to the beneficiaries.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust (ILIT) is specifically designed to hold life insurance. It is structured to prevent the policy proceeds from being subject to estate tax at your death, or to creditor claims during your lifetime. An ILIT can also be used to provide liquidity to pay estate taxes or to pay off debts upon your death. If you have life insurance and establish an ILIT, the trust can be maintained after your death, and provide income in a manner that you specify.
Qualified Personal Residence Trust
A qualified personal residence trust (QPRT) transfers a personal residence or a vacation home while providing estate and gift tax benefits. A QPRT allows you to transfer ownership of your home to your children as a taxable gift at a fraction of today’s value. By paying gift tax now you can avoid estate tax later. A QPRT is also a great vehicle to protect your home from creditors because the home is no longer titled in your name.
Grantor Retained Annuity Trust
A grantor retained annuity trust (GRAT) is a tax-favored trust that transfers property to your heirs without gift or estate taxes. To establish a GRAT, you transfer chosen assets to a fixed-term irrevocable trust. In return for the assets, the trust is required to pay you an annuity for a term of years specified during the creation of the GRAT. At the expiration date, the GRAT terminates and the assets in the GRAT are distributed to your beneficiaries free from estate or gift tax. The GRAT results in tax benefits only if you outlive the chosen term.
Intentionally Defective Grantor Trust
An intentionally defective grantor trust (IDGT) is an estate-freezing device that works well in down markets. As an alternative to a GRAT, it allows you to make tax-free or discounted gifts by excluding trust assets from an estate. The grantor sells an asset that is expected to appreciate to the trust and receives a promissory note in exchange. Because the trust is defective, no gain is recognized upon the sale.
Special Needs Trust
A special needs trust (SNT) allows you to pass assets to loved ones currently receiving SSI, Medicaid or other public benefits. A SNT makes it possible to bestow assets without jeopardizing the continuation of benefits. Public benefits only provide for basic necessities. A SNT permits you to supplement those benefits with quality-of-life items such as: education and tutoring, transportation, hobby supplies, vacations, entertainment, electronics, and a special diet or personal care needs.
A charitable lead trust (CLT) provides income or annuity payments to one or more qualifying charities for a predetermined period of time. Any value greater than the specified annuity is passed back to the grantor or another non-charitable beneficiary.
A charitable remainder trust (CRT) allows you to reduce your taxable income by donating assets to a trust that then pays you for a predetermined length of time before being transferred to a designated charitable beneficiary. When creating a CRT, you can specify the length of time the trust will generate income for you either in years, or for the lifetime of a chosen beneficiary. At the end of this period time, the property is transferred to your chosen charity. A CRT is typically exempt from income tax on its earnings. By transferring highly appreciated assets to a CRT, you can avoid paying income tax on the subsequent sale of those assets.
Business Retention Trusts
If you’re considering transferring ownership of your business, a trust can help provide liquidity for continued operation while preempting disputes over control and ownership.
An electing small business trust (ESBT) is useful because the trust is allowed to be a shareholder of an S corporation. The ESBT can have multiple beneficiaries and is not required to distribute all income; some can stay with the business. The drawback is that income is taxed at the highest ordinary income rate and is hit by a 20% long-term capital gains rate.
Like the ESBT, a qualified subchapter S trust (QSST) is permitted to be a shareholder of an S corporation. This shareholder trust must distribute all of the income and can only have one beneficiary.