A trust is a legal contract representing confidence placed in a person by making that person a nominal owner of a property to be held or used for the benefit of one or more others. There are a few different types of trusts, each one has critical differences from the others. There are revocable trusts, irrevocable trusts, asset protection trusts, charitable trusts, constructive trusts, special needs trusts, spendthrift trusts, and tax bypass trusts.
Types of Trusts
A revocable trust is a trust where provisions can be altered or canceled dependent on the grantor. During the life of this kind of trust, income earned is distributed to the grantor, with property transferring to beneficiaries after death.
An irrevocable trust is a trust which cannot be modified, terminated or amended without the permission of the beneficiaries. The grantor, after creating the trust and transferring assets into it, relinquishes all rights of ownership to the trust itself.
An asset protection trust is any trust which has funds be held on a discretionary basis. These trusts are often set up to protect the beneficiary from the effects of bankruptcy, divorce, and taxation.
A charitable trust is a trust used for charitable purposes. This type of trust has a varying degree of tax benefits in many countries.
A constructive trust is a trust which guards against unjust enrichment. It is not a traditional trust in the fullest sense of the word. This type of agreement orders a person who would have been unjustly enriched to transfer the property to the intended party.
A special needs trust is a legal arrangement on behalf of physically or mentally disabled or chronically ill person to receive income without interfering with their eligibility to receive public assistance disability benefits.
A spendthrift trust is a trust fund overseen by a trustee that controls assets left by the grantor. This is in case the beneficiaries overspend and are put into debt so that those they owe cannot garnish payment from the trust.
A tax bypass trust is a type of trust used to leave assets to survivors without having to pay estate taxes. Bypass trusts are often used by parents to pass assets to their surviving spouse and children.
Creating an irrevocable trust allows for exemption from paying estate taxes, and can remove taxable assets from the estate. This type of trust can be helpful in reducing tax liability of very large estates.
When applying for government benefits or assistance, assets owned by the individual applying count against him or her. Medicaid and Social Security Income are two programs that function in this way. The purpose of creating this type of trust is to protect the assets for a special needs child and is designed in such a way that it will not disqualify him or her from receiving government assistance or government benefits.
Using this trust is better than using a revocable trust for avoiding estate taxes, as the assets literally are transferred out of the grantor’s name, and thus are not counted as assets when estate taxes are tallied.
Disadvantages to this type of trust include loss of control over the asset, separate taxation due to being a separate entity, gift taxes, and income tax. If the goal of the person who needs the trust is to avoid paying estate taxes, this type of trust is ideal.