Trusts serve a variety of tax, asset protection and estate planning purposes for families, and over the years different types of trusts have evolved to best serve families’ planning needs and objectives. Each type of trust provides specific benefits and has specific rules to follow. By using multiple types of trusts in your estate plan, your attorney is trying to capture the variety of benefits available to you while meeting your wealth transfer and protection goals.
Helping your family’s next generations understand the different types of trusts you have created can be challenging, and the alphabet soup of trust acronyms can be bewildering. Below, we offer families a “cheat sheet” with high-level overviews of popular trust types.
Trusts for Married Couples
Some trusts are created for spouses to provide for each other. Examples include:
“A” Trust – This is the marital trust, created by one spouse for the benefit of the surviving spouse. While the trust creator (known as the “settlor”) could have left the trust assets to the surviving spouse outright, the “A” Trust is designed to benefit the surviving spouse for the rest of their life while also being eligible for the unlimited marital deduction from the estate tax. The “A” Trust will be includible in the surviving spouse’s estate upon the surviving spouse’s death.
“B” Trust – Also known as a bypass trust, family trust or credit shelter trust, this is created by one spouse primarily to maximize the use of their unified credit ($13.61 million for 2024) against estate tax. Most commonly, the “B” Trust is designed to benefit the surviving spouse to the greatest extent possible without causing the trust assets to be includible in the surviving spouse’s gross estate for federal estate tax purposes. Like the “A” Trust, any assets left over upon the death of the surviving spouse go to someone else – usually, the couple’s children. However, unlike the “A” Trust, the assets of the “B” Trust are not taxed in the estate of the surviving spouse.
“A/B” Trust – In an estate plan using “A/B” Trusts, a combination of marital and bypass trusts is used. This allows the trust settlor to take maximum advantage of their unified credit against estate tax while leaving any excess to the surviving spouse in the other trust in a form that is eligible for the marital deduction from the estate tax, thereby ensuring that no estate taxes are owed on the death of the first spouse.
SLAT – The “Spousal Lifetime Access Trust” is an irrevocable trust designed primarily to “freeze” the value of trust assets for wealth transfer tax purposes, ensuring all future appreciation escapes wealth transfer taxation. The trust benefits the settlor’s spouse to the greatest extent possible without causing the trust assets to be includible in either spouse’s gross estate for federal estate tax purposes.
QTIP Trust – A “Qualified Terminable Interest Property” trust is a special type of marital trust that allows a settlor to control what happens to the trust assets upon the death of the surviving spouse without disqualifying the trust for the marital deduction. This trust allows the surviving spouse to receive lifetime payments of the income from the trust assets but not any of the principal. Once the second spouse dies, the trust assets pass to the beneficiaries that were chosen by the trust settlor. This can be particularly useful for blended families where the settlor wants to ensure that his or her children (usually from a prior marriage) and his or her current spouse are all provided for.
Trusts for Charitable Giving
Over the years, several types of trusts have been created to facilitate philanthropy. To encourage charitable giving, Congress created many tax advantages for charitable trusts. Examples of these trusts include:
CRT – A “Charitable Remainder Trust” allows the beneficiary to receive payments from the trust for a fixed number of years (or the rest of their life), and upon the end of the term (or their death), the remaining assets go to charity. The payments can be designed as an annuity, which is a fixed amount (making the trust a “CRAT”), or a “unitrust” interest, which is a payment that is a percentage of the trust assets (making the trust a “CRUT”). As a result, unitrust payment amounts fluctuate with the value of the trust assets.
CLT – A “Charitable Lead Trust” is the reverse of a CRT – the charitable beneficiary receives payments from the trust for a term, and when the term ends, the remaining assets go to a non-charitable beneficiary. Like with the CRT, the CLT payments can be structured as an annuity (a “CLAT”) or unitrust interest (a “CLUT”).
Trusts to Hold Life Insurance
ILIT – An “Irrevocable Life Insurance Trust” is created specifically to own a life insurance policy, collect the proceeds from the insurance after the settlor’s death and administer them for the benefit of the trust beneficiaries. Although less commonly used today because of the large estate tax exemption amount, ILITs have been a foundational tool in the estate planner’s toolbox for many years because a properly structured ILIT permits the proceeds from the policy’s death benefit to pass to the beneficiary free of wealth transfer taxes. And since life insurance proceeds paid to the beneficiary are not subject to income tax, ILITs can be an extraordinarily tax-efficient tool to transfer wealth.
Trusts for Beneficiaries with Special Needs
SNT – A “Special Needs Trust” holds assets for the benefit of a person with a disability who qualifies for government health and/or financial benefits. A special needs trust will hold assets, such as an inheritance or funds received from a personal injury settlement, that are managed by a trustee and used to serve needs that cannot be met with the person’s government benefits. Designed correctly, it will not disqualify the person from receiving their necessary government benefits.
Trusts for Grandchildren and More Distant Descendants
Dynasty Trust or GST – A “Dynasty Trust,” also known as a “Generation-Skipping Trust” or simply a “Generation Trust,” is often used for families with significant wealth who want to preserve and transfer wealth to grandchildren and more distant descendants. There are two principal benefits of a Dynasty Trust.
- The first benefit is that the wealth transferred in trust will be subject to wealth transfer tax just one time: when the trust is settled. Without implementing a Dynasty Trust, the wealth might be subject to wealth transfer tax each time it is transferred to another generation – 40% when you transfer it to your beneficiary, 40% when they transfer it to their beneficiary, so on and so forth. And after four generations of estate and gift tax, $1,000,000 could potentially be whittled down to less than $130,000.
- The second benefit is that the wealth transferred in trust will escape generation-skipping transfer (“GST”) taxes, which are an additional 40% layered over the top of estate and gift taxes. Put simply, without a Dynasty Trust, wealth might be subject to a 40% estate or gift tax plus an additional 40% GST tax.
Trusts to Hold S Corporation Stock
Complicated rules apply to businesses electing to be treated as S corporations for tax purposes. In particular, trusts (other than “grantor” trusts) are generally not allowed to own S corporation stock. This presents a significant problem for small business owners engaging in estate planning. Fortunately, there are two exceptions to this general rule.
QSST – A “Qualified Subchapter S Trust” is a trust eligible to own S corporation stock. Among other requirements, a QSST may only have one income beneficiary, all income must be distributed to that beneficiary at least annually, and distributions of principal can only be made to that beneficiary while they are living. The income of this trust is reported and taxed on the beneficiary’s tax return.
ESBT – An “Electing Small Business Trust” is also eligible to own S corporation stock. An ESBT is more flexible than a QSST – income does not need to be distributed at least annually (it can be retained in the trust instead) and distributions can be made to beneficiaries other than the income beneficiary. The downside of an ESBT is that the trust will pay taxes on the Subchapter S portion of the ESBT’s income at the highest tax rate applicable to trusts, regardless of what tax bracket would otherwise apply.
Other Popular Trust Types
GRAT – A “Grantor Retained Annuity Trust” is a popular technique for shifting wealth to beneficiaries with minimal or zero wealth transfer taxes. The trust settlor, also known as the grantor, receives payments at least annually for a fixed period of time, and the assets remaining at the end of the term go to the beneficiaries (or continue to be held in trust for their benefit). If the trust assets appreciate at a rate exceeding what is known as the “Section 7520” rate, the excess appreciation represents a tax-free transfer of wealth. When a GRAT is structured to achieve a gift tax close to $0, it is often referred to as a “Zeroed-out GRAT,” and when a series of short-term GRATs is coordinated, the series is often referred to as “Rolling GRATs.”
QPRT – A “Qualified Personal Residence Trust” is an irrevocable trust designed to hold a personal residence (or vacation home) for the benefit of the settlor for a fixed period of time and, after the term expires, for some other beneficiary. A QPRT permits the transfer of the residence at highly reduced wealth transfer tax rates while allowing the settlor to continue to live in the home rent-free for a period of time.
IDGT – An “Intentionally Defective Grantor Trust” (aka “Grantor Trust”) is designed so that the settlor is deemed to own the trust assets for income tax purposes. The trust income is taxed to the settlor instead of to the trust under the compressed trust income tax brackets, which in turn allows the trust assets to grow tax-free. The payment of income tax by the settlor can be thought of as an additional tax-free gift to the beneficiaries. The term “intentionally defective” arose because the grantor trust rules originally were designed to deter people from creating trusts as tax shelters, and to cause trust income to be taxed at the then very high rates applicable to individuals for tax purposes. However, individual income tax rates were drastically reduced in the 1980s, and trust income tax brackets were compressed causing trust income to be taxed at a much higher effective rate. Taxpayers and their attorneys learned they could avoid the harsh tax treatment now imposed on trust income and take advantage of the reduced individual income tax rates by intentionally causing trusts to be “defective” for income tax purposes. The term “intentionally defective grantor trust” became a popular way to describe this kind of trust and planning.
Help Your Beneficiaries Understand the Family Trusts
Your estate plan may include some of these trust types. Even if your beneficiaries don’t know the amount contained in each trust, it is important to ensure they understand the trusts included in your estate plan, their advantages and disadvantages, and the intentions behind your planning. To create a plan to educate your family members about your trusts and how they work, contact your Warner attorney or Scott DeWeerd.
See the other blog posts in this series:
Trusts 101, Part 1 – What is a Trust and How is it Created? Trusts 101, Part 2 – Living or Testamentary; Revocable or Irrevocable; Grantor and Non-Grantor – What Does All of this Mean?
