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Types of Trusts
Is estate planning as one of your resolutions for 2020? With this year’s events and challenges, you’ve probably thought about an update your current estate plan. Regardless, you likely have discovered that there are many different “types” of trusts. Selecting the right type of trust will depend on what you want to accomplish and your unique circumstances. In this article, we provide an overview of the most common types of trusts. The right one can protect your family.
Revocable or Irrevocable? There are many different types of trusts which serve different purposes, but the two basic categories of trust are “revocable” trusts and “irrevocable” trusts. Their names reflect two chief characteristics: the revocable trust can be changed and controlled by the trustmaker (also known as a grantor, trustor, or settlor). The irrevocable trust cannot be changed and the trustmaker gives up the control over the trust and its assets. However, it should be noted that the irrevocable trust has certain tax and other benefits not offered by the revocable trust.
Individual or Joint Revocable Living Trust. This is also called an “inter vivos trust.” A revocable living trust is a legal arrangement created while the “trustmaker” is alive. This trustmaker appoints someone to act as the trustee and to follow the instructions in the trust document itself. The trustmaker “funds” the trust with his or her assets. The means of funding will depend on the nature of the assets, but each ultimately results in the trust owning the assets while the trustmaker is living or upon his or her death. The trustmaker is often the initial trustee until incapacity or death. People often elect to have a revocable living trust to avoid probate and protect their privacy.
Testamentary Trust. This type of trust is actually created under a last will and testament to manage the inheritance. Accordingly, a testamentary trust does not go into effect until the death of the testator (also known as a “testatrix,” if female). For example, a testamentary trust may provide restrictions and guidance regarding the distributions of income and principal for the beneficiary. Similarly, a revocable living trust becomes irrevocable upon the death of the trustmaker and, like a testamentary trust, may provide restrictions and guidance to protect the inheritance from and for the beneficiary. But, of course, a testamentary trust guarantees your estate has to be probated.
Charitable Lead Trust or Charitable Remainder Trust. If you are charitably inclined and also believe in taking care of your loved ones, then a charitable lead trust (CLT) or a charitable remainder trust (CRT) may let you have your cake and eat it too. A CLT allows you to ultimately preserve assets for your loved ones, while paying out funds from the trust to charity during your lifetime or a set number of years. Thereafter, the contributed assets return to your loved ones. A CRT, on the other hand, works in reverse. You and your spouse retain a lifetime income from the trust assets, and the “remainder” passes to charity when the last spouse dies. Along the way, you and your loved ones may enjoy significant income and estate tax benefits.
Discretionary Trust. This kind of trust is similar to a blank check, but in a good way. The trust names a trustee and one or more beneficiaries. The trustee can distribute as much or as little money or assets to any of the beneficiaries as the trustee wishes. The beneficiaries do not own the assets in the trust, unless and until the trustee distributes those assets to them. The beneficiaries have no legal right to demand any of the funds. A discretionary trust can be the “inheritance trust” for beneficiaries under a revocable living trust or a testamentary trust.
Special Needs Trust. A special needs trust, also known as a “supplemental needs trust,” allows the trustee to use trust assets to pay for some goods and services for a person with special needs, without jeopardizing the beneficiary’s eligibility for government assistance. There are restrictions on how the trustee can use the trust distributions for the beneficiary.
Qualifying Income Trust (QIT). Also known as a “Miller Trust,” this type of trust offers a way for people who need to qualify for Medicaid to pay for a nursing home but who make more money than Medicaid allows. The excess income goes into a trust, which is why Medicaid does not count that amount toward the income limit. The limits and rules will vary by state. Any assets remaining in the trust when the beneficiary with special needs dies, will pass to the government to reimburse the government for public assistance benefits provided during his or her lifetime. If any funds are left over after the reimbursement to the government, the trust can distribute such remaining trust assets according to the instructions in the trust document. Some states allow special needs trusts that do not require a government payback.
Spendthrift Trust. What if you have an heir who is likely to blow through assets quickly when he or she receives an inheritance? Whether addiction issues, cognitive impairment, mental illness, or financial immaturity, you do not want the beneficiary to end up draining the inheritance and ending up destitute. This is a perfect scenario for a spendthrift trust, whereby your trustee can distribute trust assets according to your trust instructions. In addition, assets held in a trust with “spendthrift provisions” are protected from the beneficiary’s creditors.
Life Insurance Trust. A life insurance trust can help avoid the expense and delays of probate over life insurance proceeds, in the event you die before your children become adults. You name your trust and trustee as the owner and beneficiary of the life insurance policy. The trust document instructs the trustee regarding how to manage the life insurance proceeds and when to distribute the money to your children. Set up properly, the life insurance proceeds will not become part of your estate for purposes of calculating any estate taxes.
This has been a very brief overview. These are just some of the more common trusts available. There are other trusts specifically designed to address nearly every estate planning objective you may have, from estate tax minimization to asset protection.
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