The terminology of trusts
Deciphering the language around estate planning.
Different types of irrevocable trusts
This is often referred to as a qualified terminable interest property (QTIP) trust or “A trust,” one-half of a trust strategy commonly known as an “A/B trust.” A marital trust is an irrevocable trust that allows assets from a deceased spouse to be transferred to a surviving spouse in trust, but free of estate taxes at the first spouse’s death. The surviving spouse is the only current beneficiary of the marital trust, but the grantor may direct the disposition of trust assets at the death of the surviving spouse.
Credit shelter trust
A credit shelter trust, which is sometimes referred to as a family trust, a bypass trust or a “B trust” – part of the A/B trust strategy mentioned above – is designed to reduce or even eliminate federal or state estate taxes due on the estates of married couples by “sheltering” one spouse’s federal or state estate tax applicable exclusion amount from taxation at the death of the surviving spouse. The applicable exclusion amount is the maximum dollar amount that is excluded from federal or state estate taxes at a decedent’s death. The surviving spouse is usually the beneficiary of a credit shelter trust, but the grantor can also designate children and grandchildren as beneficiaries.
Special needs trust
A special needs trust is a trust for the current benefit of an individual with a disability or other special needs. Special needs trusts are structured in a way that the assets within the trust are not considered assets of the beneficiary, allowing the beneficiary to qualify for governmental benefits (such as medical and housing benefits) that they might be eligible to receive.
An irrevocable spendthrift trust allows you to leave an individual a sum of money but limits their direct access to the funds. Instead, a trustee would then distribute the inheritance based on guidelines you provide in the trust agreement. This could be in the form of an allowance, or for specific expenses, such as college or medical expenses, or to buy a home or start a business. Assets within a spendthrift trust are generally sheltered from attachment by a beneficiary’s creditors.
Irrevocable life insurance trust
This type of trust is created in order to own a life insurance policy on the grantor’s life, but remove the proceeds from the grantor’s estate for estate tax purposes. Instead of paying the policy premiums directly, a grantor makes a gift to the trust and the trustee uses this money to pay the insurance premiums. Instead of beneficiaries automatically receiving the insurance proceeds immediately upon the policyholder’s death, funds are paid to the trust and the trustee distributes them based on the trust instructions. Irrevocable life insurance trusts are often created and funded to offset the payment of anticipated estate taxes.
Named after the Tax Court case that litigated this form of trust in the 1960s, this is an irrevocable trust that allows the grantor to make a gift to a beneficiary in trust, while still qualifying for the annual gift tax exclusion.
Designed primarily to pass wealth from generation to generation without incurring gift taxes or estate taxes, a dynasty trust’s defining characteristic is its duration. Many trusts will terminate at some point either by design or legal mechanism, but a dynasty trust can last for generations, and in some cases, forever.
Charitable remainder trust
A charitable remainder trust pays an income stream for a term of years or for a beneficiary’s lifetime. At the end of the trust’s term (or the death of the beneficiary), all remaining assets pass to a charity the grantor designates. Assets within the trust are removed from your taxable estate and you receive a partial income tax deduction at the time the trust is created.
Depending on your individual needs and financial situation, you can choose a trust structure, or multiple types of trusts, that can help you achieve your estate planning goals. An Edelman Financial Engines planner can work with you and your attorney to help you weigh the pros and cons to determine what type of trust makes sense as part of your overall integrated wealth plan.
The use of trusts involves a complex web of state laws, tax rules and regulations. Consider involving your legal and tax advisors prior to implementing any estate planning strategy.
The information regarding estate planning should not be construed as tax or legal advice and is for general informational purposes only. Neither Edelman Financial Engines nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to include your qualified tax and/or legal professionals in these discussions and decisions to help determine the best options for your particular circumstances.