Types of Trusts and Living Trusts

Testamentary Trusts

A Testamentary Trust is created under a Last Will and Testament. It exists in the Will only until the death of the Testator. The property and assets then pass to the Trust. This type of trust is amendable and revocable at any time during the Testatorís lifetime, but becomes irrevocable upon the Testatorís death.

Since a Testamentary Trust does not come into existence until the Testatorís death, it cannot be used to avoid probate or to provide continuity or management of the Testatorís property in the event that he/she becomes incapacitated.

After the Testamentary Trust goes into effect, the Trustee that was chosen by the Testator looks after the funds in the Trust. He/she will continue in this capacity until the Trust expires. The Trust can be set to expire at the time of a specific event, such as when a Beneficiary reaches a certain age, or finishes college.

If the originally chosen Trustee declines the responsibility, the court may appoint someone, or people or friends of the Beneficiaries involved may volunteer to perform as a Trustee.

Testamentary Trust Advantages

These types of trusts offer flexibility when assigning a Trustee. The Testator may name any individual he/she chooses as the Trustee to the Trust. It is advisable to discuss this with close, trustworthy friends and family to determine the best person for the position. It is also possible to establish multiple Testamentary Trusts under a Will and name different Trustees for each of them.

A Testamentary Trust is considered its own legal entity, so it is taxed separately from the individual Beneficiaries. This provides certain tax benefits, especially when bequeathing part of the estate to minor children. These trusts can also meet the needs of minor children by providing regular payments until the children reach a certain age. The funds can also be earmarked to pay for education and/or other specific expenses.

They can provide protection from creditors and litigants in professional negligence claims, which ensures that the Beneficiaries receive the full inheritance that the Testator has determined. Special conditions can be set up so that it also protects spendthrifts and intellectually impaired Beneficiaries, as well.

A Testamentary Trust can also be used to reinforce how the Testator wants his/her property distributed. With these trusts one can distribute the payments from the Trust over a period of time rather than transferring the money in one lump payment. This can be helpful when providing income for minor children and Beneficiaries with disabilities.

They are similar to Family Trusts, but offer considerably more tax advantages for minor Beneficiaries than Family Trusts.

Setting up a Testamentary Trust

Bear in mind that there will be ongoing administrative costs required for maintaining a Trust. Determine whether you possess enough sole assets and the income generated by your estate would be sufficient for a Testamentary Trust to be beneficial to you and your family. It is advisable to consult with your accountant, attorney and/or financial advisor to make this determination and review the advantages and disadvantages of setting up a Testamentary Trust.

If you choose to proceed, ask your attorney to create a Testamentary Trust under your Will. If you are not certain, another alternative is having a Testamentary Trust included as an option in your Will, and the Trustee will make the decision of whether or not to implement the Trust after your death.

Arrange for a Testamentary Trust for each of your Beneficiaries. This will result in each of them being within the lowest possible tax bracket when taxes come due.

Set up a Spousal Testamentary Trust to take care of your spouse after your death. You can have your attorney structure the Trust so that the remaining assets pass to your children or any other parties you choose after your spouse dies.

You and your spouse should draft your Wills at the same time so that they mirror one another and include the Spousal Testamentary Trust. If one spouse passes before the other, the surviving spouse should review his/her Will again and provide for the Testamentary Trust to have new Beneficiaries. Visit Us at Google+ Copyright HG.org

Revocable and Irrevocable Trusts

Revocable Trusts

A Revocable Trust (also referred to as a Revocable Living Trust) is a type of Trust in which the Grantor retains the right during his/her lifetime to amend, change, revoke or terminate the Trust within his/her sole discretion. The assets funded into a Revocable Trust will still be considered the Grantorís own personal assets for creditor and estate tax purposes. Therefore, it offers no credit protection from legal judgments and all assets held in the name of the Trust at the time of the Trustorís death will be subject to both state and federal estate taxes.

A typical Revocable Living Trust becomes irrevocable when the Grantor dies, and can also be designed to break into separate Irrevocable Trusts for the benefit of a surviving spouse, or into multiple Irrevocable Lifetime Trusts for the benefit of children or other Beneficiaries.

Irrevocable Trusts

An Irrevocable Trust cannot be altered, changed, modified or revoked after its creation (absent extreme extenuating circumstances). Once a Grantor transfers property to an Irrevocable Trust, the Grantor can no longer take the property back from the Trust.

Though, by design, an Irrevocable Trust cannot be changed, there are certain exceptions that allow Beneficiaries or the Trustee to modify the Trust. One example is when an estate plan includes a Trust Protector who can look over the trust details to make changes. In addition, if the assets in a Trust are sold, the Trust is terminated.

Irrevocable Trusts come in two forms: Living Irrevocable Trusts and Testamentary Irrevocable Trusts. A Revocable Trust generally becomes an Irrevocable Trust after the Grantor dies.

Tax Issues

Federal Gift and Estate Tax:

Although a Trust is a separate legal entity, it may or may not be treated as a separate entity for transfer tax purposes. The distinction is often based on whether the Trust is revocable or irrevocable.

A Revocable Trust is treated as if the Grantor is the owner and is included in the Grantorís taxable estate when he dies. Transfers from the Grantor to the Revocable Trust are not treated as gifts or bequests. Transfers from the Trust to anyone else will be treated as a gift or bequest from the Grantor at the time of the distribution. When a revocable trust becomes irrevocable, then a gift or estate transfer occurs at the time it becomes irrevocable.

The assets in an Irrevocable Trust are not included in the Grantorís estate, unless the Grantor has retained certain powers over those assets. Transfers to the Trust during life are treated as gifts to the Trust. The Trust then stands as a separate taxable entity and pays taxes on its accumulated income. Transfers made upon death are treated as bequests. Gifts to an Irrevocable Trust are treated as gifts to the Trust Beneficiaries.

Discretionary and Incentive Trusts

Trusts offer a great deal of flexibility in their drafting to accomplish various estate planning goals. The amount of freedom the Grantor allows the Trustee when making distributions from the Trust assets is one of these areas of flexibility. This offers yet another classification for trusts: Discretionary and Incentive trusts.

Discretionary Trusts

With a Discretionary Trust, the Grantor delegates most or limited discretion to the Trustee to decide when and how much income or property is to be distributed to a Beneficiary. A Discretionary Trust normally provides the Trustee with general guidelines for administration of the Trust, but leaves the specifics of the Trust management to the discretion of the Trustee, giving him/her a great deal of leeway. Discretionary Trusts are often used with the establishment of a Family Trust.

In a Fully Discretionary Trust, the Trustee has a great deal of freedom in deciding how best to handle the Trust property and the timing and amount of distributions to Beneficiaries. This is a very common type of Trust used in estate planning because it is extremely flexible and it is the least costly to draft.

Incentive Trusts

An Incentive Trust provides guidelines and limits for distributions based on the class, status and/or behavior of the Beneficiaries. The Grantor sets these guidelines and limits according to his/her intent for the management of the Trust property.

With these types of trusts, distributions are often conditional and will only be made when the Beneficiary meets certain conditions. Therefore, the Beneficiary has an incentive to act or behave as the Grantor requires them to.

Some common Incentive Trust provisions include: completion of college, attending a particular school, or maintaining a specific GPA; getting married or re-married, having children, or living in a specific location; working in a specific field, joining the family business, starting a new business, or attaining a specified income level; and avoiding negative behavior, such as drug and alcohol abuse, gambling, or criminal behavior.

Family Trusts

Family Trusts are set up to combine assets, protect them from creditors and reduce tax exposure during a transfer of assets to family heirs. They are usually established by a single family member or a couple, to be distributed to selected Beneficiaries as outlined in their Will.

The purpose of a Family Trust is to progressively transfer significant assets to the Trust, so that legally the Trustor owns no assets personally, but through the Trust, still has some control over and gets the benefit of said assets.

The assets are given to a Trustor, who holds the money and other property in a separate account. A Trustee, who can be a family member or an outside holding company, administers the Trust for a set period of time. The Trustee is responsible for collecting the money and distributing it at regular intervals to heirs, regardless of whether the original owner is living or dead.

Family Trusts can be set up while one is still alive, with a Declaration of Trust contained in a Trust Deed, or upon death, by the terms of a Will.

Placing assets in a Trust works around the estate tax that would otherwise take a substantial portion of assets during an ordinary inheritance process.

Types of Trust Arrangements

There are many different types of trusts. They are often designed to serve specific purposes, which dictate the form and basic provisions of the Trust. Many Trusts establish ďsub-TrustsĒ, as well. While Trusts can be structured to handle different situations, it is important to be knowledgeable and careful in their design to ensure they work as designed.

The two basic major classifications of trusts are Living Trusts vs. Testamentary Trusts and Revocable vs. Irrevocable Trusts. Another way to classify trusts is by their purpose.

Tax Issues

Income tax law classifies trusts in three categories:
  • Grantor-type Trust: treated as if the Grantor owns the trust property, so the Grantor is subject to tax on the income of the trust.
  • Simple Trust: Living and Testamentary Trusts where the Trust distributes all of its income every year to a Trust Beneficiary. The Beneficiary is subject to tax on the income of the trust. In a Simple Trust no amounts are to be paid, permanently set aside, or used for charitable purposes; and it must not distribute any amounts that are allocated to the principle of the Trust. The Trust is treated as a pass-through entity, and will report the distribution, the taxable portion and the type of income to the IRS and the Beneficiary.
  • Complex Trust: where the Trust may accumulate income. If it behaves as a pass-through, as in a Simple Trust, the Beneficiary pays the tax. If it accrues income, it is subject to tax on the income it collects.

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