Unless you look at tax laws and think “pff, childs’ play!” you’re probably looking to make things in your life a bit easier. Trusts can do that. This post defines what a trust is and describes the types of trusts and the benefits of using trusts. Read on for three relatively simple ways that you can protect your assets and your family.
We can identify trusts as falling into one of two categories. Trusts are generally defined by when they go into effect. The categories are:
- inter vivos (living) trusts
- testamentary trusts
Living trusts are those you set up while you are alive. Simple enough. On the other hand, testamentary trusts are those you set up in your will. They come into being after your death when the will comes into play.
Things get a bit more complicated from there because no matter which one of those two categories a trust falls into, the law further classifies all trusts as either:
- irrevocable; or
If you create a revocable trust, you retain control over the assets you put into the trust. You can change the terms of the trust or revoke the trust at anytime you want. A Grantor Trust is a revocable trust because the Grantor retained certain rights, such as the right to revoke the trust, the right to receive income/principle, and functions as the trustee.
If you create an irrevocable trust, you relinquish ownership of the assets and you cannot change the terms of the trust without your beneficiary’s agreement to the change (consent). The trade-off is that the assets in the trust are not taxable under the estate tax laws.
Anyone can create a trust with the help of legal counsel or a bank’s trust department. You need 3 things to create a trust:
- a trustee willing to hold legal title of the assets;
- assets that you can put into the trust; and
- a legal document called a trust agreement.
The trust agreement sets out the terms of the trust, such as the purpose for which the trustee holds the assets, the names of the people you want as beneficiaries and what events will trigger the transfer of the assets to the trust beneficiaries. Pretty simple.
Now, let’s review a couple of the more complicated trust arrangements that people set up for particular purposes.
This trust type protects your beneficiary against creditors. Despite its name, a spend-thrift trust does not mean that the trustee cannot make distributions to creditors if the beneficiary chooses to pay his bills. Certain states also permit creditors to claim against even a strongly worded spendthrift trust. Some states have exceptions to the spend-thrift rules, such as child support, alimony obligations, and debts owed to governments.
Third-party Special Needs Trusts
These trusts protect beneficiaries who suffer from disabilities. The terms of these trusts can vary greatly under particular state rules and from beneficiary situation to situation. Most special needs trusts provide that the trust will not interfere with other public benefits like Supplemental Security (disability) or Medicaid. A self-settled special needs trust is one set up by the beneficiary himself out of his own assets, such as a personal injury settlement or an inheritance. The self-settled trust is more difficult in terms of the trust agreement terms and in the trust’s administration.
These trusts are useful to avoid taxes on assets after your death. Under the terms of this trust, you transfer a lot of money to the trust naming your grandchildren as beneficiaries under the trust. The money transfers to them tax-free after your death.
Qualified Terminable Interest Property Trusts
That’s quite a mouthful but what it means is relatively simple. If your family is like a lot of modern families, you may have had several divorces and remarriages in the family that produced step-children and step-grandchildren. You get the picture. You may want to transfer your assets to particular people — and not to other people who may satisfy the classification as heirs under a will.
You can do this by setting up a Qualified Terminable Interest Property Trust. The transfer of assets under the trust is outside the will so the trust eliminates disgruntled heirs from contesting asset distribution. It works like this: if married at your death, your surviving spouse will receive income from the trust. After your spouse dies, the beneficiaries you named under the terms of the trust (for example, your children from your first marriage) will receive the principle or the remainder of the trust.
There are many trusts that serve other purposes. We determine the type of trust by reference to the trust agreement terms, not by the trust’s name. Important: Only an attorney can prepare a trust agreement for you. You can, however, consult with your tax advisor to understand the purposes of various kinds of trusts and the tax implications of your chosen trust.
If you have any questions regarding trusts and their tax consequences, please contact us. We look forward to sharing our ideas with you.