Types of Trust Vehicles
A Guide to Different Wills & Trusts
If you have been doing research on the subject of wills & trusts and estate planning, you have likely run into a lot of different acronyms and trust-types. It can be hard to keep track of them all! The most common type of trust that most people encounter is the revocable living trust. A trust can be created for a variety of reasons including for income or estate tax purposes, veterans benefits planning, Medicaid planning, asset protection planning, charitable planning, or for business succession purposes. Our Boca Raton wills & trusts attorneys have prepared this guide to help you understand some of the other types of trusts:
- Asset Protection Trust: An asset protection trust is generally a generic name used to referred to a trust that has been set up for asset protection purposes such as to reduce exposure to lawsuits and malpractice claims, bankruptcy, creditors, divorce or remarriage, or nursing home expenses.
- Charitable Lead Trust: Under a charitable lead trust, a designated charity receives income from the assets held by the trust and the assets then later pass to beneficiaries named by the settlor. Charitable lead trusts may be used for tax planning purposes to take advantage of charitable deductions associated with the gifts being made.
- Charitable Remainder Trust: A charitable remainder trust is essentially the converse of a charitable lead trust. With a charitable remainder trust, the settlor or a beneficiary designated by the settlor receives income from the trust for a specified period of time, such as the settlor’s lifetime or a designated period of years. When the income beneficiary’s interest ends, the trust assets then passed to a designated charity. Again, charitable remainder trusts may be used for tax planning purposes to take advantage of charitable deductions associated with the charitable bequests being made.
- Credit Shelter Trust: In our office, we tend to call these the “Family Trust”. They are also sometimes referred to as a “bypass trust.” Without getting too bogged down in estate tax law, it s an estate tax planning tool used in estate plans for married couples to ensure that as a couple, they both receive maximum use of their estate tax exemption (or as we like to call it, your estate tax “coupon”).
- Education Trust: This is a tool sometimes used by parents or grandparents that want to set aside funds for college expenses while receiving estate tax benefits. Similar benefits can also be obtained through the use of a qualified tuition program, known as a 529 plan.
- Equestrian Trust (ET): An equestrian trust is a form of Pet Trust (see below) for horses.
- Grantor Retained Annuity Trusts (GRATs), Grantor Retained Unitrusts (GRUTs): These are trusts that provide certain tax benefits. Generally, the settlor transfers a highly appreciating asset to a trust for less than its full value. With a GRAT, the settlor receives a set amount of income per year for a period of years. With a GRUT, the payments are instead based upon a fixed percentage of the value of the trust assets. GRATs and GRUTs may be used to remove the full value of the asset and its future appreciation from the settlors taxable estate to reduce estate taxes.
- Intentionally Defective Grantor Trust (IDGT): Intentional or not, who wants to be told they have a defective trust, right? The name of these trusts refers to the somewhat contradictory tax treatment that they receive. The trust terms are drafted such that the assets held by the trust will not be counted as part of your taxable estate, thus saving estate taxes. But at the same time, the trust agreement includes an intentional ‘flaw’ that allows you to continue paying the income taxes on the assets (and by making such payments yourself instead of by your children, this continues to further reduce your taxable estate). This can be a particularly appealing tax planning option if interest rates are low and/or values of the assets have depreciated such as during a real estate or stock market downturn.
- Irrevocable Trust: Irrevocable trusts are used for many different reasons. With a revocable living trust, you have the right to amend any or all of the terms or revoke it entirely. At its most basic level, an irrevocable trust means that somewhere in the trust document there is a power that you gave up permanently and cannot change without either court approval or the approval of all of the trust beneficiaries. For example, you may have given up the right to withdraw principal or change the beneficiaries. Thus, these trusts tend to be a bit more “set in stone,” but the degree to which they are set in stone depends on their purposes. For example, some of the irrevocable trusts that we use for Medicaid planning and veterans benefits planning still have some flexibility. Other irrevocable trusts are used for tax planning purposes and are much more rigid because the IRS rules require them to be.
- Irrevocable Income-Only Trust: This is a type of living trust commonly used for Medicaid planning or veterans benefits planning purposes under which a person transfers assets to a trust irrevocably, but retains the right to continue receiving any income generated by the trust assets (such as interest and dividends). The settlor also typically retains the right to continue using and living in any real estate held by the trust.
- Irrevocable Life Insurance Trust (ILIT): This is a common form of irrevocable trust used for estate tax planning purposes. An irrevocable life insurance trust holds a life insurance policy as its main asset. Typically, under the federal estate tax rules, the death benefits of any life insurance policies that you own will be counted as part of your gross taxable estate and may be subject to estate taxes. If properly executed, upon the settlor’s death, the proceeds of the policy pass to the trust for distribution to the beneficiaries specified in the trust agreement and are not counted in the settlor’s taxable estate for federal estate tax purposes. There are very strict rules for how an ILIT must be set up and managed on an annual basis for it to work effective, so it is strongly advised that you seek professional assistance in setting one of these up.
- Pet Trust or Pet Care Trust: This is a trust used to set aside a certain amount of funds to provide for the continued care of one’s pets such as horses, dogs, case, or other pets. A pet trust allows you to leave detailed instructions about how you want the pet provided for, who will provide care and ensures sufficient financial resources to provide such care without burdening your loved ones with such responsibility or financial burden.
- Qualified Personal Residence Trust (QPRT): A QPRT is an irrevocable trust that holds the settlor’s primary residence or a vacation home as its only asset. The settlor retains the right to live in the residence or use the vacation home for a fixed number of years. While the transfer of the property to the QPRT is a taxable gift, if the settlor/taxpayer lives until the end of the trust term, the value of the residence or vacation property plus any later appreciation will pass to the trust beneficiaries without being included in the settlor’s taxable estate.
- Qualified Terminal Interest Property Trust (QTIP): No, it’s not the thing you use to swab your ears. A QTIP is frequently used in a will or trust for a couple in a second or third marriage, with children from the prior marriages. A QTIP typically provides income to a surviving spouse but ultimately the principal assets to the children upon both spouses’ deaths. For example, let’s assume that a husband and wife are in a second marriage and the husband has children from his first marriage. If husband simply left all of his assets to his wife, she could spend them all or leave them to her own children (effectively disinheriting the husband’s children). Instead, husband could set up a QTIP to provide that if dies before his wife, his wife will receive all income (such as interest and dividends) from his assets for the rest of her life, but upon her death, the balance of the assets will pass to his own children from his first marriage.
- Special Needs Trust/Supplemental Needs Trust (SNT): A special needs trust, also referred to as a supplemental needs trust, is used to set funds for a disabled or special needs individual while preserving that person’s eligibility to receive government health and disability benefits. Many public programs require that a recipient be both medically eligible and financially eligible. As such, if the disabled or special needs individual received a direct inheritance from you, it may cause him or her to lose the government benefits. Under a special needs or supplement needs trust, the assets or inheritance are instead held in trust and are used to supplement rather than replace the federal, state or local benefits that the person is receiving. This could include paying for things such as an automobile, electronics such as a computer or ipod, certain types of care, education and classes, and other improvements to their quality of living.
- Self-Settled Trust: A self-settled trust, also known as a self-settled special needs trust, a “first party” trust, or a D(4)(a) trust (a reference to the section of the Social Security Act that sets out the rules for these trusts), is a special needs trust funded with the disabled person’s own assets for his or her own benefit. For example, if a person is left severely disabled from a car accident and wins a lawsuit, the funds received from the lawsuit settlement may be placed in a self-settled trust so that the disabled beneficiary can still receive certain public health and disability benefits. A self-settled trust is established on behalf of the disabled individual by the person’s parent, grandparent or guardian and the disabled individual must be under the age of 65 years. The self-settled trust must also be irrevocable and includes a ‘payback’ provision specifying that upon the disabled beneficiary’s death, the trust funds must first be used to payback and Medicaid liens for benefits provided during the beneficiary’s lifetime. The balance of any remaining trust funds may then pass to the beneficiary’s family members.
- Spend Thrift Trust: This is a reference to a type of asset protection trust set up for children or beneficiaries that protects the trust assets in the event that the child gets divorced or is subject to a lawsuit, bankruptcy or similar. It prevents the child’s creditors from reaching the trust assets. While a spend thrift trust can protect a child from many threats, it will not be effective against a court order or judgment for child support or for IRS tax liens.
- Trusts for Minors: Under the law, a person cannot legally “own” title to property unless they are 18 years of age or older. Without instructions from you, if a minor, such as young children or grandchildren receive an inheritance from you, a financial guardian would be appointed by the probate court to manage the accounts and then they were be given to the child at age 18. Most parents and grandparents feel that this is too young to give a child access to their account and also want to have control over who will manage it. As a result, they may include a Trust for Minors in their will or living trust that selects a trustee to hold the assets on the minor’s behalf while they are under a specific age, such as 21 or 25. While the child is under the specified age, the trust agreement sets out instructions for how the funds may be used—such as for the care, upkeep and education of the child as well as how and when some or all of the trust assets should be distributed outright to the child or grandchild.
This is by no means an exhaustive list of all of the types of trusts available and many lawyers have even coined different names or terms for the same types of trusts, but this should give you a good idea of the most common types of trusts that you are likely to encounter. If you need further information, contact a wills & trusts attorney at our Boca Raton law firm.