Five Types of Trusts You Need to Understand

August 18, 2021

Legal knowledge

A trust is essentially a legal document that establishes a relationship for assets to be held or managed on behalf of someone else. Many of us have heard about trust, but not everyone knows the difference between the different types of trusts and how they operate. Learning about the different trust options available will help you determine what is best for your needs.

1. Trusts Terminology: Grantor, Trustee, Beneficiary

First, you may want to familiarize yourself with the three key players in basic trust. The person who creates the trust is known as the grantor. They may also be referred to as the settlor or trustor. The grantor can be a person or an entity such as an organization. Trust & Will has a great article explaining the grantor’s role in estate planning. 

The trustee is the person or entity who manages the assets in the trust. The person can even be the grantor in some situations, and they can name a successor trustee to take over the responsibility in the event they cannot (usually incapacitation or death). Common entities named trustees are banks. A trustee carries multiple duties related to administering the trust and informing beneficiaries. Generally, a trustee has a duty to act prudently and with loyalty to the grantor’s wishes. In some instances, there can be multiple trustees. When this occurs, each Trustee must coordinate with their co-trustees to ensure everyone is acting in accordance with their duties. 

The beneficiary is the individual or party that receives the benefit of the trust. They will receive the property, profits, money, or assets managed in the trust document. A lot of people name children, extended family members, and other name entities like charities as beneficiaries. Let’s get into some of the common types of trusts. 

2. Revocable/Living Trust

Revocable trusts have many nicknames, such as living trust, inter vivos trust, or loving trust. The reason it’s associated with life is that it’s a trust created during the grantor’s lifetime. It can be drafted in a way that lets the creator revoke or make changes to the trust. As described in Investopedia’s article, the grantor can have a lawyer draft it to make changes to the instructions of the trust and how it’s managed, remove assets named in the trust, or terminate the trust altogether. While a revocable or living trust is beneficial should you intend on amending the terms during your lifetime, this type of trust does not help you avoid estate taxes. Revocable trusts are subject to estate taxes because your power to revoke or amend them causes the property to remain categorized as your personal estate. When forming a trust, it’s important to consider whether you are looking to reduce the property’s tax burden or if you are looking for a flexible trust arrangement that allows you to make changes when necessary. If taxes are not of your concern, revocable trusts are likely a good route to consider. 

3. Irrevocable Trust

Irrevocable trusts, as the name suggests, cannot be changed or revoked by the grantor once it is created. The creator of an irrevocable trust is giving up control over the assets that are placed in it. The beneficiary is the only one able to make or approve of changes. Regarding estates, grantors benefit from irrevocable trusts because they relieve certain tax liabilities. Since the grantor is surrendering control over the assets, those assets are no longer part of the grantor’s taxable estate. They are free from the estate’s property taxes as well as any income the property may generate.

4. Charitable Trust

Charitable trusts are a type of irrevocable trust, and one many of us hear of. These types of trusts are established for some charitable purpose. Generally, charitable purposes include organizations that seek to relieve issues of poverty, advance education, promote public health, or otherwise benefit the public welfare. However, sometimes a once valid charitable purpose may become unlawful, impossible to achieve, or wasteful. In these situations, the will does not necessarily become invalid. Rather, a court may modify the terms of the charitable trust to allocate the assets in a manner consistent with the settlor’s original charitable purpose. For example, if Sally creates a charitable trust with the intended beneficiary being the local library near her home, but the library shuts down before the grant takes effect, a court may decide to allocate Sally’s grant to a similar but different local library. 

Many donors enjoy establishing a charitable trust because it is essentially a win-win situation. The charity receives money, and the donor gets a tax break! Western and Southern Financial Group discuss charitable trusts in more detail. Two primary types of charitable trusts are lead trusts and remainder trusts.

Charitable lead trusts essentially have the donor continue to control. Anything from the trust’s assets (money) either goes directly to the charity or is divided between the charity and the donor’s beneficiary. This also reduces a beneficiary’s liability for taxes once it is inherited.

Charitable remainder trusts have the donor give up control for a specific amount of time. The assets can be given for periods that last a few years or even beyond the donor’s death. This allows the donor to have the trust’s assets be distributed to beneficiaries for a set amount of time and then have the remainder given to a charity or vice versa.

5. Testamentary Trust

Testamentary trusts are created within the grantor’s last will, so it does not go into effect until the grantor’s death. People usually make testamentary trusts for their children. Assets like money or property are left in this trust to be managed by another adult (trustee) until the child becomes an adult. It can even have conditions that a person must meet before receiving the benefit of the trust. This usually helps grantors ensure their beneficiaries will be taken care of after passing away.

6. Spendthrift Trust

Spendthrift trusts prevent beneficiaries from being irresponsible with the assets placed in the trust. The language of a spendthrift provision in a trust stops the beneficiary from accessing assets in the trust, such as money, and not promising the funds from the trust to creditors. However, once funds are given to the beneficiary, a spendthrift trust does not prevent creditors from having availability to it. A trustee can have payments distributed to the beneficiary monthly, yearly, or on a discretionary basis. For example, giving a certain amount of money for certain needs as the trustee sees fit. That is why it is extremely important to have your lawyer carefully outline the trustee’s control and power within the terms of the trust. There are several exceptions for when a spendthrift trust is not valid, which will deem it enforceable. First, a spendthrift provision may not be enforceable against a spouse seeking alimony. Second, a spendthrift provision can not be enforced against attorney fees. Lastly, a spendthrift provision is unenforceable against claims by the government such as the IRS. 

Now that you have a better sense of what trust you may want to create, head over to Trusli and let us find you lawyers to get it done!

Five types of trusts you need to understand infographic
Five Types of Trusts You Need to Understand