What Are the Most Common Types of Trusts?

A trust is a legal arrangement that allows an individual to transfer assets to be managed by another party. The arrangement is governed by a legal document, frequently called a trust agreement, which outlines the rules for managing the assets. This document establishes a framework for privacy, asset protection, and flexible wealth transfer.

Three distinct parties are central to any trust’s operation. The first is the Grantor, also known as a settlor or trustor, who is the individual that establishes the trust and transfers their assets into it. These assets, which can include property, investments, and cash, are then legally owned by the trust. The Grantor is responsible for defining the terms of the trust.

The second party is the Trustee, who can be an individual or an institution like a bank. The Trustee has a fiduciary duty, meaning they are legally required to manage the trust’s assets in the best interests of the beneficiaries. Their responsibilities include investing its assets and distributing funds according to the Grantor’s instructions.

Finally, the Beneficiaries are the individuals or organizations designated to receive the income or assets from the trust. A Grantor can name family members, friends, or charitable organizations as beneficiaries. Beneficiaries receive distributions as dictated by the trust document.

The Foundational Classifications of Trusts

Trusts are broadly categorized based on two characteristics: whether they can be altered and when they become effective. The first distinction is between a revocable and an irrevocable trust. A revocable trust offers the Grantor control, allowing them to modify the terms, add or remove assets, or terminate the arrangement during their lifetime.

Conversely, an irrevocable trust generally cannot be changed or revoked once established, as the Grantor permanently relinquishes control over the assets. This is often done to achieve financial goals, such as reducing the value of an estate for tax purposes.

The second classification relates to when the trust is created. A living trust, also known as an inter vivos trust, is established and becomes operative during the Grantor’s lifetime and can be either revocable or irrevocable. In contrast, a testamentary trust is created through the provisions of a will and only comes into existence after the Grantor has died and the will is validated by the court in a process known as probate.

Revocable Living Trusts

A Revocable Living Trust is an estate planning instrument used for the management and transfer of assets outside of the court system. A primary function is to avoid probate, the legal process of validating a will. By transferring title of assets—such as real estate, bank accounts, and investments—into the trust, those assets are no longer part of the probate estate, leading to a faster and more private distribution.

Another purpose of a revocable living trust is the management of assets if the Grantor becomes incapacitated. The trust document can name a successor Trustee to manage the trust’s assets if the Grantor is unable to do so. This ensures financial affairs can be handled seamlessly without the need for a court-appointed conservatorship, providing a clear plan for managing property according to the Grantor’s wishes.

In a revocable living trust, the Grantor initially acts as the Grantor, Trustee, and Beneficiary, maintaining complete control over their property. For tax purposes, all income generated by the trust’s assets is reported on the Grantor’s personal income tax return. The trust does not require a separate tax identification number while the Grantor serves as Trustee.

The Grantor designates a successor Trustee in the trust document, who can be a trusted individual or a corporate entity like a bank’s trust department. Upon the Grantor’s death, the successor Trustee takes over management of the trust assets without court intervention. Their role is to pay any final debts and taxes and then distribute the remaining assets to the beneficiaries.

Common Irrevocable Trusts for Specific Goals

Irrevocable trusts are used to achieve specific financial objectives related to tax reduction, asset protection, or charitable giving. Once assets are transferred into these trusts, the Grantor cannot reclaim them, a feature central to their specialized functions.

• A Special Needs Trust (SNT), also known as a Supplemental Needs Trust, is established to hold assets for a beneficiary with a disability. The purpose is to provide for supplemental needs not covered by public assistance without disqualifying them from government benefits like Supplemental Security Income (SSI) and Medicaid. The trustee makes distributions directly to vendors for goods and services rather than giving cash to the beneficiary.
• An Irrevocable Life Insurance Trust (ILIT) is a tool designed to own a life insurance policy. By having the trust purchase or receive a life insurance policy, the death benefit proceeds are not included in the Grantor’s taxable estate upon death. The proceeds can provide immediate, tax-free liquidity to the beneficiaries or the estate to pay taxes or other expenses.
• A Charitable Remainder Trust (CRT) allows a Grantor to transfer assets into a trust that provides an income stream to a non-charitable beneficiary for a set term or for life, after which the remaining assets pass to a charity. A Charitable Lead Trust (CLT) makes payments to a charity for a specified period, after which the remaining assets are distributed to non-charitable beneficiaries, potentially with reduced tax consequences.
• A Spendthrift Trust is created to protect a beneficiary’s inheritance from their own potential mismanagement or from the claims of their creditors. The Grantor names a trustee who has discretion over how and when distributions are made. Because the beneficiary does not have direct control over the trust assets, they are generally shielded from creditors, divorce proceedings, or lawsuits.

Testamentary Trusts

A testamentary trust is established under the terms of an individual’s last will and testament. Unlike a living trust, a testamentary trust does not legally exist until after the Grantor’s death, as the will acts as the trust instrument.

The creation of a testamentary trust is linked to the probate process. After the Grantor dies, their will must be filed with the court, which oversees the validation of the will before assets from the estate can be transferred into the trust. This court oversight continues throughout the life of the trust, making the arrangement less private than a living trust.

One of the most frequent applications is to provide for the care and financial needs of minor children. A will can specify that assets be placed in a trust for the children’s benefit, appointing a trustee to manage the funds for their health, education, and support until they reach a certain age, such as 25 or 30.

This type of trust allows a Grantor to exert control over their assets after death, ensuring that inheritances are managed responsibly for beneficiaries who may not be equipped to handle a large sum of money. While it does not avoid the initial probate of the estate, it provides a structured and legally enforceable mechanism for long-term asset management.