TYPES OF TRUSTS
Trusts take effect during your lifetime (inter vivos) or after
death (testamentary). Trusts can also be revocable or irrevocable. There are too many varieties of trusts to give
a complete breakdown, but following are some of the
most common types of trusts:
REVOCABLE TRUSTS
(also called a Living Trust or a Revocable Living Trust)
A revocable living trust is a trust created during the grantor’s lifetime that takes effect upon disability or death. It
can be changed or revoked any time prior to then; the
main benefit is the flexibility it offers. It serves as a “will
substitute” in many cases, but most people will still need
a will to name guardians for minor children and to make
sure all assets pass to the trust at death. During life, you
maintain control of assets you put in the trust (typically
the grantor serves as the trustee), and you pay income
tax on any income earned by the trust assets. In addition, assets in a revocable trust are included in your
taxable estate, as they remain under your control. A revocable trust becomes irrevocable at death.
tability.” Under portability, a deceased spouse’s unused
exemption amount can be used by the surviving spouse.
Note that an estate tax return must be filed in order
to elect portability and use this benefit. Some couples
might still need a credit shelter for other nontax reasons,
such as to remove an appreciating asset from the estate,
seek creditor protection, or provide greater control over
the ultimate disposition of the assets.
SPECIAL NEEDS TRUST
Having assets pass to a beneficiary through a special
needs trust instead of outright distribution can offer
many benefits. One consideration is how an inheritance
would affect the beneficiary’s ability to qualify for Medicaid or other publicly funded disability programs. A special needs trust can allow distributions for needs not
covered by government assistance; things that improve
a person’s quality of life such as vacations and entertainment. A special needs trust, can be designed to provide
for a beneficiary with special needs without disqualifying
the individual from valuable government benefits. It is important that a special needs trust be created by a local
attorney with expertise in your state’s law.
IRREVOCABLE TRUSTS
QTIP TRUSTS
As a general rule, if the goal is to reduce estate taxes, the
trust must be irrevocable. An irrevocable trust takes effect immediately and can be changed only in very limited
circumstances or by court order. Therefore, it’s important
for your estate planning attorney to include as much flexibility as possible when the trust is created.
QTIP stands for Qualified Terminable Interest Property.
A QTIP trust can address some of the needs of today’s
blended families. A QTIP trust enables the grantor to
provide for a surviving spouse while maintaining control
of how the trust’s assets are distributed once the surviving spouse dies. Income, and sometimes principal, from
the trust is distributed to the surviving spouse to ensure
that he or she is taken care of for the rest of his or her
life. Upon the death of the surviving spouse, the assets
are then passed on to beneficiaries of the first spouse’s
choice as specified by the trust. For example, you and
your spouse both have children from previous relationships; you can leave assets to a QTIP trust to provide
for your spouse; and upon his or her death, the assets
could then pass to your children.
A key feature of irrevocable trusts is that the assets belong to the trust, so that they are not included in your
gross estate when determining estate taxes. Assets in
an irrevocable trust do not go through probate because
they are no longer owned by the grantor.
CREDIT SHELTER TRUSTS
The purpose of the credit shelter trust is to receive assets from your estate after your death; these assets will
be sheltered from the estate tax.2 Typically, this type of
trust is structured so that upon death, the assets (up to
the amount of the estate tax exemption amount, $5.34M
for 2014) are transferred to the trust for the benefit of
the trust beneficiaries. In the past, this has allowed the
assets passing to the trust to escape estate tax in your
estate and your spouse’s estate because the trust assets are not included in his or her estate.
For many couples, a credit shelter trust is no longer necessary for federal estate tax purposes, because of “por-
IRREVOCABLE LIFE INSURANCE TRUST (ILIT)
An ILIT is a trust funded by an insurance policy(s). Even
though a life insurance death benefit is not subject to
income tax, it is considered part of your estate for estate
tax purposes if you own the policy at death. An insurance policy death benefit could use a large portion of
both your federal and state estate tax exemption if the
policy is owned personally. An alternative is to establish
an ILIT and name a trustee (you can’t be the trustee,
but your spouse or children could). Once established,
you give the trust a cash gift used to purchase the life