What Are the Different Types of Trust Funds?

Trust funds are versatile financial planning instruments that allow individuals to manage and distribute their assets effectively. While the term “trust fund” often brings to mind substantial wealth, these arrangements are accessible to a broader range of individuals seeking to ensure their financial legacy. Trusts provide a structured way to control how assets are managed during one’s lifetime and how they are distributed after death. They can serve various purposes, from protecting assets to minimizing tax implications, offering a flexible approach to financial stewardship.

Understanding Trusts

A trust is a legal arrangement where a person transfers assets to another party to hold and manage for the benefit of a third party. This fiduciary relationship involves three fundamental roles:
The “Grantor” establishes the trust and contributes assets, dictating the terms and conditions for management and distribution.
The “Trustee” manages the trust’s assets according to the Grantor’s instructions, acting in the best interests of the beneficiaries. A Grantor can sometimes serve as their own Trustee but must name a successor.
The “Beneficiary” receives benefits from the trust’s assets, either immediately or in the future, according to the trust’s terms.
Assets are transferred into a trust by changing legal ownership from the Grantor’s name to the trust’s name.

Revocable and Irrevocable Trusts

Trusts are commonly categorized by their flexibility: whether they can be changed or canceled after creation.

Revocable Trust

A “Revocable Trust” allows the Grantor to modify, amend, or terminate the trust during their lifetime. The Grantor retains control over the assets within a revocable trust and can add or remove assets or change beneficiaries at any time. Assets held in a revocable trust are generally still considered part of the Grantor’s taxable estate for estate tax purposes. One primary reason for establishing a revocable trust is to avoid the probate process, which can be time-consuming and public. Upon the Grantor’s death, assets held in a revocable trust can typically be distributed to beneficiaries more quickly and privately than assets passed through a will. While providing flexibility and probate avoidance, revocable trusts do not typically offer protection against creditors or lawsuits during the Grantor’s lifetime.

Irrevocable Trust

In contrast, an “Irrevocable Trust” cannot generally be altered, modified, or revoked by the Grantor once it is established, without the consent of the Trustee and/or beneficiaries. The Grantor relinquishes ownership and control over the assets transferred into an irrevocable trust. This lack of control has significant implications for asset protection and estate tax planning. Assets placed into an irrevocable trust are typically removed from the Grantor’s taxable estate, potentially reducing estate tax liability upon death. This type of trust can also shield assets from future creditors, legal judgments, and lawsuits, as the assets are no longer considered the Grantor’s property.

Living and Testamentary Trusts

Another significant classification of trusts is based on when they become effective.

Living Trust

A “Living Trust” is created and becomes effective during the Grantor’s lifetime. This type of trust allows the Grantor to manage their assets within the trust while they are alive, providing a mechanism for asset management and distribution. It can also provide for potential incapacity, as a successor trustee can manage assets if the Grantor becomes unable. A primary advantage of a living trust is its ability to bypass the probate process upon the Grantor’s death. Assets titled in the name of a living trust are not subject to court-supervised probate, leading to a potentially faster and more private distribution to beneficiaries. However, for a living trust to effectively avoid probate, assets must be formally transferred and titled in the trust’s name during the Grantor’s lifetime.

Testamentary Trust

Conversely, a “Testamentary Trust” is not established during the Grantor’s lifetime but is created through their will and only comes into existence upon their death. Unlike living trusts, a testamentary trust must go through the probate process, as the will dictates its formation and funding. Assets are transferred into the testamentary trust after the will has been probated and the estate settled. Testamentary trusts are commonly used to manage inheritances for beneficiaries who may not be ready to manage large sums of money independently, such as minor children or individuals requiring long-term financial oversight. The trust document, embedded within the will, provides instructions for the trustee on how to manage and distribute the inherited assets over time. While they do not avoid probate, testamentary trusts offer a structured way to control asset distribution posthumously.

Other Common Trust Types

Beyond the fundamental categories, numerous specialized trust types serve particular purposes in estate planning. These trusts often fall under broader classifications but are distinguished by their specific objectives and unique features, addressing distinct financial, charitable, or personal circumstances.

Special Needs Trust (SNT)

A “Special Needs Trust” (SNT) is designed to provide for individuals with disabilities without jeopardizing their eligibility for government benefits, such as Supplemental Security Income (SSI) and Medicaid. The assets held within an SNT are not counted toward the beneficiary’s resource limits for these needs-based programs. Funds from an SNT supplement government assistance, covering expenses like education, transportation, or personal care that public benefits do not.

Charitable Trusts

“Charitable Trusts” facilitate philanthropic giving while offering potential tax advantages.
A “Charitable Remainder Trust” (CRT) is an irrevocable trust where assets are transferred to the trust, which then pays an income stream to the Grantor or other non-charitable beneficiaries for a specified term or their lifetime. Upon the term’s end, the remaining trust assets are distributed to a designated charity. CRTs can provide an income tax deduction at the time of funding and allow for the sale of appreciated assets within the trust without immediate capital gains tax.
A “Charitable Lead Trust” (CLT) is an irrevocable trust that first makes payments to a charity for a set period, with the remaining assets passing to non-charitable beneficiaries, such as family members, after the charitable term concludes. CLTs can be used for estate or gift tax planning, as the Grantor may receive an income tax deduction or reduce the taxable value of assets transferred to heirs.

Spendthrift Trust

A “Spendthrift Trust” is created to protect beneficiaries from their own poor spending habits or from creditors. This trust limits a beneficiary’s access to the trust principal, often by releasing funds incrementally or under specific conditions. The assets within a spendthrift trust are generally protected from the beneficiary’s creditors, as the beneficiary does not directly own the assets until they are distributed. This feature ensures that the inheritance is preserved for the beneficiary’s long-term well-being and cannot be attached to satisfy their debts.

Irrevocable Life Insurance Trust (ILIT)

An “Irrevocable Life Insurance Trust” (ILIT) is specifically designed to own a life insurance policy, removing the death benefit proceeds from the Grantor’s taxable estate. By doing so, the ILIT can help avoid estate taxes on the life insurance payout, maximizing the inheritance for beneficiaries. The trust is both irrevocable and unfunded, meaning it holds no assets other than the life insurance policy itself, and the Grantor typically makes gifts to the trust for premium payments.

Blind Trust

A “Blind Trust” is typically established by public officials or others in positions where conflicts of interest could arise. Assets are placed under the management of an independent trustee who has full discretionary control over investment decisions without the Grantor’s knowledge or influence. This arrangement aims to prevent potential conflicts of interest by ensuring the Grantor is unaware of the specific holdings or transactions within the trust.

Asset Protection Trust (APT)

Lastly, an “Asset Protection Trust” (APT) is designed to shield assets from future creditors or legal judgments. These trusts are generally irrevocable and are established in jurisdictions that offer robust asset protection laws. While APTs can provide significant protection, their effectiveness can vary considerably depending on the specific state laws governing the trust and the timing of the asset transfer relative to any potential creditor claims.