education | protecting your wealth
Types of Trusts: Which Is Right for You?
By Kent Thune, CFP®
With the right kind of planning, creating a trust can provide you — as well as your beneficiaries — a host of benefits. While some individuals choose to bequeath assets and property to loved ones through wills, trusts may offer a greater deal of control and security. They may also be more cost-effective. Depending upon the size of your estate and the state of residency, wills can cost anywhere from a $150-$1,000 or more to set up.
The four main types of trusts include living trusts, testamentary trusts, revocable trusts and irrevocable trusts. These agreements may provide tax advantages, may help you better control how, when and to whom your assets will be distributed in the future, and potentially allow your heirs to avoid the public (and expensive) probate process.
Living Trusts: Often used to designate a trustee who will manage assets on behalf of the eventual beneficiaries.
• Tighter control of assets
• Avoid probate
• Less expensive than will
Testamentary Trusts: These trusts are typically created through a will and map out how assets should be distributed upon the trustor's death.
• Can help protect funds until recipients are old enough to be financially responsible
• Flexibility to change terms
• Simple to understand and set up
Revocable Trusts: These trusts allow a trustor to alter or cancel the provisions they set forth up until their death, and avoid the need for probate.
• Avoid probate
• Flexibility to change terms
• Uninterrupted management of assets
Irrevocable Trusts: Once created, the terms of these trusts are unable to be modified or terminated by the trustor without the beneficiaries' permission.
• Assets can be removed from the trustor's taxable estate
• Avoid probate
• May offer legal protection from creditors
What Is Trust Ownership?
When you use trust ownership, an asset (such as a home) is placed into a trust. The name of the trust is listed as the owner's name on the title or deed.
Trust ownership allows you to set up specific instructions for that distribution of property. You can stipulate that your heirs will only receive the asset if certain conditions are met or after they reach a certain age. With financial assets, trusts can control how often (and when) money is distributed. Or with real estate, a trust can instruct how that property may or may not be used according to your wishes.
This is different from other types of ownership rights and definitions, including sole ownership, joint tenancy and tenants in common. As a sole owner, you have exclusive ownership rights. As tenants in common, you share an equal amount of ownership with another party. In situations with joint tenants, all parties have an ownership stake but the amount each owns can vary. Depending on how the trust is set up, trustees could control the asset on behalf of the beneficiaries until the assets are distributed.
Keep in mind that you may not need to create a trust and use it to serve as the "owner" of your property if you jointly own an asset with the person you wish to have inherit it. If you're married, you would likely be "joint tenants in common" with your spouse for a property you share. In this situation, the home would immediately pass to your spouse's sole ownership — without any additional legal process — should something happen to you.
Understanding the 4 Main Types of Trusts
When beginning your search, it's important to understand the key features and benefits of each of the four main types of trusts. They provide unique benefits, such as the control of assets and the ability to bypass probate — as well as other financial advantages — so you should give ample thought to your current situation and future plans. Once you have a clear picture of your needs, you should work with an estate planning professional to discuss appropriate terms.
Here's a deeper dive into each of the main four types of trusts and the benefits they offer.
1. Living Trusts
A living trust, sometimes called an inter vivos trust, is established while the trustor is still living and is commonly used to ensure the distribution of assets to beneficiaries after the trustor dies. Similar in design to revocable trusts, these can be amended prior to the trustor's death.
These are the key features and benefits of living trusts:
- Control of assets: Living trusts provide greater control of assets than a will. Examples include directing assets to a charity, providing for children from a previous marriage, managing assets until beneficiaries are of a certain age or providing for a beneficiary with a disability.
- Bypass probate: Property held in this type of trust can avoid probate, allowing disbursements to be made faster. The probate process is public and potentially expensive, so bypassing it may help to avoid publicity, save time and protect assets from creditors and lawsuits.
- Save money: Avoiding probate costs may help save your heirs money when inheriting your assets.
2. Testamentary Trusts
A testamentary trust is established after death, and the terms are dependent on the wording of your last will and testament. This type of trust is often more straightforward, so they are often best for those who don't wish to control the beneficiaries' use of inherited assets. However, as a testamentary trust is typically generated through a will, associated assets are usually subject to probate.
Here are the main advantages and attributes of testamentary trusts:
- Ability to protect funds: Assets can be protected until minor beneficiaries are old enough to be financially responsible. This may be helpful if you're looking to include a child as a future beneficiary.
- Flexibility: With this type of trust, you don't have as much control as you would with a living trust, but you have the flexibility of changing the terms of your will during your lifetime.
- Simplicity: Since testamentary trust provisions are established by a will, they can be easier to create. Keep in mind, though, heirs will likely have to navigate the probate process.
3. Revocable Trusts
A revocable trust is a type of living trust because it is established during the trustor's lifetime. The terms allow for changes, enabling a trustor to add or remove trustees and beneficiaries as they see fit. The trustor can earn interest on the trust while alive, and then property is transferred to beneficiaries after their death. This type of trust may not be ideal for individuals who want to transfer tax liability.
These are the main reasons most people consider revocable trusts:
- Bypass probate: The primary purpose of a revocable trust is the bypass of probate. This results in faster, more private disbursements.
- Flexibility: This type of trust allows for terms to be changed at any time during the trustor's lifetime.
- Uninterrupted management of assets: If your assets were previously transferred into the trust, there is no need to change management or re-register securities upon your death or disability.
4. Irrevocable Trusts
An irrevocable trust is a type of living trust that, depending upon individual state law, may be extremely difficult to change or cancel once it is created. It's important to understand that by transferring estate assets to an irrevocable trust, you also transfer the tax liability. Accordingly, the trust is treated — and taxed — as a separate entity from the trustor. This may be especially advantageous if you have a large estate (the 2020 exemption for estate tax is $11.58 million).
Here are the key features and benefits of irrevocable trusts:
- Tax advantages: Because these trusts are treated and taxed as separate entities, assets can be removed from the trustor's taxable estate during their lifetime, thereby enabling the benefit of eliminating tax liability on the income those assets generate.
- Bypass probate: Property held in an irrevocable trust will bypass probate.
- Legal protection: Irrevocable trusts may offer legal protection from creditors and anyone else seeking a judgment against your estate.
What to Do Before You Set Up a Trust
Before you set up a trust, there are a few basic steps to take to maximize the benefit for you and your beneficiaries. Here are the necessary preparations:
- Consider the type of trust: Once you prioritize which benefits are most important to you, choosing the right type of trust will help to maximize those advantages.
- Choose your trustee: One of the benefits gained from controlling the assets in your estate is choosing a trustee, which is the person or entity that will administer or manage the assets.
- Identify beneficiaries: Before establishing the trust, decide who will inherit your trust property. Beneficiaries are typically family members or a charity.
- Choose assets to hold in the trust: You may not want to hold all of your assets in a trust. For example, you may want to focus only on items that you want to bypass probate.
Keep in mind that trust types are categorized as either living or testamentary — and they can be either revocable or irrevocable. As there are multiple types of trusts, and each has its unique features, it's important to determine the best type of trust for your needs. You should consider working with an estate attorney or financial professional to help choose the right trust for you.
Once you've identified the best type for your situation, you may be able to convert an existing account into a trust. Citizens Access provides a great deal of flexibility and security by allowing customers to convert any Citizens Access account into a trust.