Trusts play a big part in estate planning today. There are many different types of trusts. What you do not know about them can hurt you and your beneficiaries' financial health.
A trust is a legal entity–just like a corporation or a person. It holds assets for a beneficiary. A trust document states the purpose of the trust and how it is to be carried out. A trustee is the person (or entity) that carries it out. The grantor creates and generally funds the trust. That's essentially it!
A trust can be revocable or irrevocable. Revocable means that the grantor can decide to revoke the trust and take all the assets back for his use. In fact, such a revocable trust is really an extension of the grantor and taxed as if all the trust assets and their income were his.
Revocable trusts serve to avoid probate. Probate-the court process of transferring assets in a deceased's name by will or intestate-is a very public process. Trusts are not subject to probate–being a separate entity from the deceased–and can privately pass assets according to the terms of the trust. The benefit of a revocable trust is that it allows the grantor to control the assets and income of the trust as he wishes while he is alive.
An irrevocable trust–once created by the grantor-is no longer under his control. It is controlled solely by the trust document and the trustee. In this case, it is taxed as a separate entity–unlike the revocable trust–and has an existence all of its own. In our tax system, whoever has the ability to control an entity is taxed and responsible for what that entity does. The irrevocability of a trust breaks that connection, relieving the grantor of any subsequent tax or control issues.
The legal separateness of an irrevocable trust allows key benefits. First, the grantor determines how the assets he puts in it are to be handled and distributed to his assigned trust beneficiaries-according to how he writes up the rules of the trust document. Second, the trust-as a separate entity-can survive him indefinitely allowing his wishes to continue beyond his death. Third, the beneficiary (the object of the trust) benefits from the trust. Lastly, the trust is legally protected from others who may try to invade it or take the trust assets.
Trusts created under estate planning have a clear objective to achieve. Examples of such trusts are:
- Spendthrift protection
- Charitable trust
- Life insurance trusts
- Asset protection trusts
- Bypass Trusts
- Qualified Personal Residence Trust (QPRT)
- Qualified Terminal Interest Property Trust (QTIP)
- Generation-Skipping Trust
- Irrevocable Life Insurance Trust ILIT