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One of the most underappreciated and misunderstood tools for passing wealth to the next generation is the subject of trusts. Many fail to ever foresee the costs that can so easily be avoided through use of proper planning right at their fingertips; but take heart! Here we will review this marvelous toolset that can spur a multi-generational legacy.

Do you want to avoid probate for your beneficiaries? Would you like to reduce, or avoid altogether, estate taxes on the wealth you eventually leave behind? How about maintaining some control over how, or how often, the money is spent or invested? These things and more can be accomplished through the use of various types of trusts.

Here we will address the most common types of trusts available to you today.

What Is A Trust?

It sounds a bit vague, doesn’t it? After all, a trust in some ways is simply a set of ideas. It’s not a physical business which you can point to and say, “Look, there it is!”

But think of it this way. A trust is a legal entity, much like an individual, with its own rights to own assets and define the rules of engagement between parties. A big reason this is important is that trusts, unlike individuals, do not pass away. On the contrary, trusts outlast the ones who write them, and anything under their ownership is not subject to the expensive process of probate.

The trust agreement involves the following parties:

Grantor | Settlor | Trustor

• This describes the individual(s) that establishes the trust, defining the terms of the agreement. He or she is referred to by one of these three interchangeable titles, and places the property or other assets into the name of the trust.

Trustee

• This person has a fiduciary responsibility to prudently make asset management decisions that are line with the Grantor’s stated wishes in the trust.
• He or she must take actions that are in the best interest of the beneficiaries, within the limitations granted them by the Grantor.
• Usually the Grantor is also the Trustee until passing away, but they name the individual who will take over as Trustee when that time comes.
• The Trustee’s job comes to an end once all assets have been distributed from the trust. Depending on the specifications of the trust, this may happen within a matter of months or after many years.

Grantee | Beneficiary

• Known as either the Grantee or the Beneficiary, this person inherits the assets according to the stated intentions of the trust. Depending on the trust’s specifications, this person may receive full control over the assets or may be subject to limited access.

Most Popular Trusts

There are many different types of trusts for unique circumstances. Do any of these apply to your situation? Here we will break down the most commonly used trusts and describe the particular strengths of each. For a longer list, check out 39 Types of Trusts: A Comprehensive Guide • Financially Simple.

Bypass Trust

Purpose: To reduce or avoid estate taxes, protect assets from creditors, provide income to the spouse and avoid changes to beneficiaries while leaving them available to the surviving spouse.

The details of how this trust can save on estate taxes is a bit complicated and deserves its own article. To read more about this trust type, check out 4 Massive Benefits of a Bypass Trust.

QTIP Trust

Purpose: To provide for a spouse and direct remaining assets to specific beneficiaries after the death of the surviving spouse, reducing or avoiding estate and capital gains taxes in the process.

This is most often used in mixed family situations, when one spouse has children by a former marriage and wants to ensure that the kids receive the inheritance after both spouses pass away.

It’s very similar to a bypass trust with some exceptions. Assets in a Qualified Terminable Interest Property (QTIP) Trust receive a double step up in cost basis: once at the death of the first spouse, and again at the death of the second. A bypass trust steps up the cost basis only at the death of the first spouse.

So doesn’t that make the QTIP trust better than a bypass trust? Not necessarily. Here’s why.

The assets placed in a bypass trust are not reassessed for estate taxes after the death of the surviving spouse. That means that these assets could grow well beyond the estate tax threshold within a bypass trust and still remain estate tax-free, even if they are subject to capital gains tax.

In a QTIP Trust, even though assets receive a stepped-up cost basis, the asset value will be reassessed at the death of the surviving spouse and potentially subject to estate tax if it is over the threshold.

If you’re concerned about estate taxes, the bypass trust may be the ideal choice. If you’re concerned more about capital gains taxes, then the QTIP trust may be the better option.

Charitable Remainder Trust

Purpose: To donate to charity while also providing income to oneself (the trustor) or other noncharitable beneficiaries over the course of up to 20 years or a beneficiary’s lifetime.

After the income-receiver passes away, the remainder is donated to the charity outlined in the trust. This trust is irrevocably outside the trustor’s estate, creating a tax deduction in the present and saving on potential estate taxes in the future. Distributions of 5%-50% per year are allowed to the noncharitable beneficiary or trustor, subject to income and/or capital gains taxes.

To read more about this trust type, check out Charitable Remainder Trusts | Internal Revenue Service (irs.gov).

Spendthrift Trust

Purpose: To limit access to the funds while controlling the circumstances, quantities and timing of the funds coming available to the beneficiary.

You are the grantor, you appoint a trustee (which can be yourself while alive, and a successor trustee after that), and you designate one or more beneficiaries. This is particularly useful when the beneficiaries are minors or otherwise unlikely to know how to make wise decisions with a large sum of money.

A spendthrift trust can either be revocable (changeable during your lifetime) or irrevocable (outside your estate for tax purposes).

Asset-Protection Trust

Purpose: To protect assets from creditors and lawsuits, while also increasing the likelihood of qualifying for government benefits like Medicaid if a long-term care stay is needed.

This is an irrevocable trust, so it cannot be undone once it is created. It is important to note that each state has its own rules about whether these trusts can be established, and how they must be structured in order to be valid. If you’re comfortable housing the assets offshore, you can establish an offshore asset protection trust which usually offers much more flexibility.

Living Trust / Revocable Trust

Purpose: Avoids the probate process after the grantor passes away. It also allows the trustee, usually the same as the grantor while alive, to continue management and control of the assets.

This is the most popular trust that I encountered during my days as a financial advisor. It saves time and money by avoiding probate, and it is very flexible. It can be changed at any time if you so choose.

It also allows for a successor trustee to take over control of the assets in the event of the primary trustee’s incapacity, which can be helpful in the absence of a power-of-attorney.

Note that, because it is revocable, it still counts as part of your net worth in the eyes of the government, particularly with regard to estate taxes and qualifications for Medicaid.

Irrevocable Trust

Purpose: Avoid estate taxes, protect from creditors, and qualify more easily for government benefits like Medicaid in case of a long-term care stay.

Because this is irrevocable, its terms cannot be changed except with the express agreement of the beneficiaries.

It’s important to note that anything placed into an irrevocable trust will still count toward estate tax for the first three years. Only after three years pass will the assets receive the benefit of being estate-tax-free when the grantor passes away. If the grantor passes away within three years, the assets are still subject to estate tax; in other words, this is not a strategy that can be set up effectively at the last minute of one’s life. It is best to set these trusts up earlier rather than later, assuming you have the excess net worth to do so.

Joint Trust

Purpose: To simplify trust ownership by making both spouses the grantors and trustees of one trust, thus avoiding the complications of dealing with two separate trusts after death or needing to keep both trusts up to date as the situation evolves.

The rare exception would be a circumstance where two individuals want to keep assets entirely separate and make their own rules surrounding specific assets (such as a business or inheritance). But even still, this type of segmentation can usually be accomplished by a joint trust anyway.

A joint trust can either be revocable or irrevocable.

Testamentary Trust

Purpose: To appoint a trustee who will manage the funds in the best interest of the beneficiaries.

This type of trust is created after the grantor passes away, and its creation is directed within the last will and testament. This can be helpful when the beneficiaries may not be able to make responsible decisions on their own. This is often used for minors or those with special needs.

Because this is created by direction of the will, it does not avoid the probate process. This is a big drawback, because assets cannot be distributed until after the probate process has been completed.

Special Needs Trust

Purpose: To ensure the continued provision for someone with special needs or disabilities while not disrupting any qualifications for government benefits like Medicaid or Supplemental Social Security (SSI).

These can either be first-party (funded by the individual with special needs) or third-party (funded by parents, grandparents, or someone else).

For a first-party trust, Medicaid will typically require a repayment of its benefits that it provided once the individual passes away. Only after Medicaid is repaid will any remaining assets go to a beneficiary.

The benefit here is that the individual with special needs can receive the combination of assistance from Medicaid as well as the special needs trust during their lifetime. After death, Medicaid can only request repayment using whatever funds remain in the trust. If there is not enough to repay them entirely, then they will not require more than remains in the trust.

In a third-party trust, Medicaid does not require repayment after the individual’s death.

Generation-Skipping Trust

Purpose: To immediately pass an inheritance to non-spouse beneficiaries who are at least 37.5 years younger than the grantor, typically used in the case of grandchildren.

This helps avoid double taxation if the estate is subject to estate tax: once when your children inherit, and again when the grandchildren inherit.

Keep in mind that if the grantor gifts assets into the GST that are presently valued above the estate tax threshold, that excess is taxed twice in that same year: once for gift taxes (same threshold and rate as estate taxes) and again for a special GST tax.

But it still may make sense to do so, as there is this benefit. Let’s say someone gifts an amount into the GST which is valued $200k above the estate tax threshold. When that amount is moved into the trust, it is subject to both the gift and GST tax. It will not be subjected again to estate or GST taxes when the grantor passes away. In this way, assets within the trust can continue to grow without being subject to future GST taxes when the value is potentially greater. This can save significantly on future taxes.

Dynasty Trust

Purpose: To pass assets through several generations while avoiding estate taxes or generation skipping taxes until the trust is terminated.

A dynasty trust can be funded up to the estate tax threshold, which is $13.61 million as of 2024. It is usually an irrevocable trust, meaning it is its own entity and will pay capital gains taxes when applicable as well as income taxes. If the beneficiaries receive income from the trust, they will be the ones to pay the income taxes.

A long-term trustee, usually a financial institution who will likely be around for a long time, is appointed to manage the assets and apply the rules of the trust.

Once assets are gifted into the dynasty trust, any gift tax thresholds are applied, and anything above the threshold is subject to the gift tax and the GST tax. But this is the only time such taxes (including estate taxes) will apply. This means that whatever growth takes place within the trust, it will still avoid any future estate or GST taxes when passed to each successive generation.

Conclusion

When you set your sights on leaving a legacy that perpetuates your influence beyond your own lifetime, establishing a trust is among the most important things you can do. With the variety of options available, a wide array of customization is available to benefit your personal situation.

Unfortunately, the government finds a way to tax almost everything, including death. Using a trust is one way to limit, and in some cases outright avoid, writing a paycheck to Uncle Sam. A proverb emerged in the early 20^th century which said, “from shirtsleeves to shirtsleeves in three generations.” The meaning is that regardless of the wealth developed by one generation, it is usually lost by the third.

A trust is one way to push back against this statistic, increasing the likelihood that your hard work will continue to pay off for generations to come. By this simple but profound strategy, the sky is the limit for how far your personal life will continue to benefit future generations well beyond this present era.