Which Trust is Right For You?

| October 26, 2015
Planning for the Future

It’s important to have a basic estate plan to ensure things are taken care of after you die. While an estate plan has several elements, including a will, assignment of power of attorney and a living will or healthcare proxy, it may also be beneficial to set up a trust. Not just for high-net-worth individuals, trusts legally control how your assets will be distributed when you die, potentially reduce your tax burden and don’t have to go through probate court. Some trusts may even protect your assets from creditors and lawsuits. Everyone needs a will, but how do you know which trust is right for you? Here are 5 of the most common types of trusts explained:

1. Credit-shelter trust. Also called a bypass or family trust, the credit-shelter trust allows you to bypass estate taxes by setting up a trust in an amount not in excess of the estate-tax exemption. When you die, the trust is passed along to your spouse. When your spouse dies, the trust principal goes to your children. And everything is exempt from estate taxes. By using a credit-shelter trust and not passing down inheritance directly to your children, you create income in the form of interest for your spouse, and you ensure the money is used as you intend while your spouse is still alive.

2. Generation-skipping trust. This type of trust, also called a dynasty trust, allows the distribution of funds tax free, typically to your grandchildren. They can receive income from the trust, and you can specify how the principal should be used, like for college tuition. Just be sure not to leave money in excess of the exemption amount, or your grandchildren may have to pay a separate transfer tax.

3. Qualified personal residence trust. If you are invested in real estate, the qualified personal residence trust allows you to subtract the value of your home from your estate. If you give your house as a gift, you can maintain control of it for a period of time that you stipulate. During that time, the IRS values the house less than its present-day value, since the person you gave it to won’t take possession right away. However, you have to outlive the trust for it to be valid. If not, the full value of your house will be counted in your estate when you die.

4. Irrevocable life insurance trust. This type of trust allows you to subtract your life insurance from your taxable estate. To do this, you have to give up ownership, as well as the ability to borrow against it or change beneficiaries. The proceeds from the policy help pay for estate costs when you die, and it helps provide tax-free income to your heirs.

5. Qualified terminable interest property trust. This trust allows you to specify which relatives will receive assets after you die. The idea is simple. When you die, your spouse receives income from the trust. When your spouse dies, your beneficiaries receive the principal of the trust. This can be particularly helpful if you have gone through a divorce and gotten remarried with stepchildren. This type of trust ensures your money will go exactly to those family members that you choose. Note that this type of trust is subject to estate tax, so it may be beneficial to set up a bypass trust first.

Estate planning can be confusing, but don’t let that stop you from setting up a trust that could save you and your family time and money. If you hold your assets in property or other tangibles, you want to stipulate who receives assets after you die and how, you want to create income for your spouse after you die or you want to lessen your estate tax burden, setting up one of these trusts may be right for you. If you want to set up a trust as part of your overall estate plan, contact a financial advisor to get started.