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Simon's ABCs of Trust

Simon's ABCs of Trust

December 02, 2022

Some basics of trusts…. for example, a living trust, an irrevocable trust and a life insurance trust. Questions, direct message me…


TRUST BASICS Generally, a trust is a relationship (among a grantor, trustee and a beneficiary) where an asset held by an individual or entity for the benefit of another, trusts come in all shapes and sizes, and serve many purposes. In this chapter I’ll intro- duce you to some common forms of trusts that are used to convey wealth from one generation to another. These are just the basic structures; your financial advisor and trust attorney can help design a trust expressly for your needs.

Before I get to specific trusts, I should mention that you may hear the term “express trust.” An express trust is simply one where the trustor or settlor (you) deliberately chooses to create a trust. You’re not forced to do it by a court or other entity. You create an express trust by signing a trust document (this can be either be your will or a trust deed). Most trusts are express trusts; other broad categories of trusts include resulting trusts, implied trusts, and constructive trusts, which are generally not relevant to the purpose of leaving your legacy.

Here are some common forms of express trusts. In subsequent chapters I’ll discuss them in greater detail.

◆◆ Bypass trust. In the United States, a bypass trust is generally an irrevocable trust (established during lifetime or at death) that is designed to pay trust income and/or principal to your spouse for the duration of your spouse’s lifetime where the remaining assets generally pass to your children or other future heirs. The gift or bequest of assets to a bypass trust for the benefit of your spouse and children is generally tax- free, and upon your death, the assets in the bypass trust may be excludible from your estate if the trust was established during your lifetime and was designed to be excludible from your estate.

◆◆ Directed trust. Normally, one trustee is sufficient to oversee a trust. However, in our increasingly complex world of financial management, an increasing number of high net worth individuals are creating trusts governed by multiple participants or agents, each of whom has a specialty. Together these participants have carefully defined authority to direct the activities of the trustee.

◆◆ Dynasty trust, or generation-skipping trust. Generally, in a dynasty trust, eventual ownership of the assets is passed down to your grandchildren or lower generations, skipping your children. Your children never take title to or possession of the assets. There may be some estate tax advantages to a generation-skipping trust. Your children need not be cut out completely; the income from the trust may be disbursed to your children, while leaving the assets intact to be given to your grand- children on a certain date or under other designated conditions.

◆◆ Fixed trust. In a fixed trust, you designate what your heirs are to receive. The trustee has little or no power to make changes. Some common examples of fixed trusts are:

– A remainder trust, which grants a specific sum to the future heir(s) upon your death.

– A trust for a minor, in which the future heir receives the assets when he or she reaches a certain age. An Internal Revenue Code Section 2503(c) Minor’s Trust is a trust established to hold assets in trust for a child until the child reaches age 21. 

– A life interest, in which a future heir receives a sum at regular intervals, such as monthly or quarterly.

◆◆ Hybrid trust. This type involves paying fixed amounts to your future heirs, with the assumption that there may be a sum left over. Once the fixed amounts have been paid out, the trustee may then determine how any remaining assets are to be paid to your future heirs.

◆◆ Incentive trust. If you want to establish conditions that must be met by your future heir or heirs, an incentive trust uses asset distributions as an incentive to either encourage or discourage certain behaviors. You may wish, for example, that your child earns a college degree before receiving benefits from the trust. In contrast, a discretionary trust may leave such decisions up to the trustee.

◆◆ Intentionally defective grantor trust (IDIT). It’s not really defective; however, under the tax laws  you continue to pay income taxes on the assets in the trust. However, for estate tax purposes the value of your estate does not include the value of the assets in an IDIT if properly structured.

◆◆ Inter-vivos trust or living trust. This simply means that the trust has been established while you’re still alive, rather than upon your death.

◆◆ Irrevocable trust. This means that the terms of the trust cannot be revised or amended. An irrevocable trust may not be altered by the trustee or the beneficiaries of the trust. In rare cases, a court may change the terms of the trust because unanticipated changes have made the trust difficult to administer or uneconomical. In addition, various states may permit modification (e.g., by decanting, merger, etc.) of the trust under specific statutes or case law.

◆◆ Life insurance trust. Generally, is an irrevocable trust in which the primary asset is a life insurance policy. Upon the insured’s death, the trustee invests the proceeds from the insurance policy and administers the resulting assets in the trust for one or more trust beneficiaries.

◆◆ Offshore trust. A commonly used term used to describe a trust located outside the United States.

◆◆ Private and public trusts. In a private trust, you name one or more of your future heirs as beneficiaries. In a public trust (also called a charitable trust), you generally name a charitable organization as the beneficiary. For example, a charitable trust may be set up to benefit a museum, church, or hospital. The charity may receive only the income from the trust, or a percentage of its value, or, at some date, the assets themselves. There are strict requirements under the tax laws that must be followed in setting up charitable trusts.

◆◆ Revocable living trust. A form of living trust that may be altered, amended, or revoked by you (i.e., the grantor or settlor) at any time, provided you are not mentally incapacitated. In some cases a living trust is used to reduce administrative costs associated with probate and to provide efficient administration of a person’s estate. Revocable living trusts that spell out how you want your assets managed while you’re alive and distributed after your death are quickly becoming a preferred form of estate document for many families.

◆◆ Simple trust. Generally, there are two different types of simple trusts. In a simple trust the trustee has no responsibilities beyond conveying assets to your future heirs, as determined by the trust. Another term for this is bare trust. By contrast, all other trusts are special trusts (see below), where the trustee has active duties beyond those of a simple trust. The other meaning is in Federal income tax law, where a simple trust is one in which all net income must be distributed on an annual basis.

◆◆ Spendthrift trust. A special trust or trust provision in which the trustee has the authority to determine how the trust funds will be allocated to the presumably irresponsible future heir and limits a the beneficiaries’ creditor’s rights to the assets of the trust as long as the assets remain in the trust.

◆◆ Split interest trusts including GRATs, GRUTs and QPRTs. These are trusts that may provide certain income, gift and estate tax advantages. There are several types, including:

– Grantor retained annuity trust (GRAT). You transfer assets to trust, retaining the right to a fixed annuity (payment) for a term of years, payable at least annually. At the end of the trust’s term, the assets pass to the beneficiary(ies). If you survive the term, the assets are excluded from your taxable estate. Alternatively, if you die during the term, some value of the assets may be includible in your gross estate.

– Grantor retained unitrust (GRUT). Similar to a GRAT, you receive an annual payment that is determined as a percentage of the value of assets in the GRUT each year, known as a unitrust. If the assets increase in value, so do your payments.

– Qualified personal residence trust (QPRT). Generally, is a trust that owns a personal residence for a term of years. Similar to a GRAT, the grantor must live beyond the trust’s term; otherwise the value of the personal residence is included in the grantor’s gross estate. The trust makes no payments to you during the trust's term; however, the grantor has the right to live in the residence during the QPRT term

– Qualified domestic trust (QDOT). The purpose is to preserve the marital deduction when the surviving spouse is not a United States citizen and the trust assets may be subject to the federal estate tax if the marital deduction is not available.

– Spousal lifetime access trust (SLAT). This is a type of irrevocable trust that can permit indirect access trust assets, while simultaneously keeping the value of the assets out of your gross estate.

◆◆ Standby trust or pour over trust. A trust that is created before death but receives assets upon someone’s death (e.g., the grantor’s death), according to provisions of the grantor’s last will and testament.

Simon Says...

You should work closely with your estate planning team to determine if a trust can help you reduce transfer tax exposure and control how your assets are distributed to your spouse, future heirs, or a charitable organization