There are many types of trusts and frequently a trust will include multiple characteristics. For example, one of the most frequent classifications of trusts is by when they become effective, i.e., living trusts and testamentary trusts. A living trust or an “inter-vivos” trust is set up during the person’s lifetime. A testamentary trust is set up in a will and established only after the person’s death when the will goes into effect.
Trusts can also be classified by whether they can be revoked. Living trusts can be either “revocable” or “irrevocable.” Testamentary trusts, since the creator of the trust is dead when it becomes effective, are irrevocable. Revocable trusts can be revoked or the terms of the trust changed at any time. Irrevocable trusts cannot be revoked and are very difficult to make changes to.
There is still one other form of classification that is used to distinguish one type of trust from another – that is, by the purpose of the trust. Every trust is established for a specific purpose, and that purpose will dictate the form and the basic provisions of the trust. Frequently the purpose is included within the name of the trust to help convey to others information about the trust. Just about every trust has certain income tax and/or estate tax consequences associated with it. In fact, many trusts are established primarily to take advantage of certain income or estate tax benefits that are provided under the tax laws. Frequently the name of the trust includes language identifying which tax provision the trust is targeting.
There are many more complicated types of trusts, too, that apply to specific situations. Some include:
Credit shelter trusts: With a credit-shelter trust (also called a bypass or family trust), you write a will bequeathing an amount to the trust up to but not exceeding the estate-tax exemption. Then you pass the rest of your estate to your spouse tax-free. The assets in the credit-shelter trust may be available for the surviving spouse if needed for specified needs and then upon the subsequent death of the surviving spouse the assets pass to the beneficiaries listed in the trust free of estate tax – regardless of how much they have grown in the meantime.
Generation-skipping trusts: A generation-skipping trust (also called a dynasty trust) allows you to transfer a substantial (but limited) amount of money tax-free to beneficiaries who are at least two generations your junior – typically your grandchildren.
Special needs trusts: A “special needs trust” (also called a “supplemental needs trust” or “SNT”) is a trust that is established for a person who is receiving or is likely to receive need-based government benefits. The intent of a special needs rust is to provide a source of funds for such person without disqualifying such person from such government benefits. Ordinarily when a person is receiving government benefits, an inheritance or a gift or even the receipt of a sum of money for damages in a personal injury law suit could reduce or eliminate the person’s eligibility for such benefits. With a special needs trust, a beneficiary can obtain certain luxuries and other benefits without defeating his or her eligibility for government benefits. Often a special needs trust will include a provision that terminates the trust if it makes the beneficiary ineligible for government benefits. A special needs trust may be created under a living trust or a testamentary trust.
Irrevocable life insurance trusts: An irrevocable life insurance trust can remove your life insurance from your taxable estate, help pay estate costs, and provide your heirs with cash for a variety of purposes. To remove the policy from your estate, you surrender ownership rights, which means you may no longer borrow against it or change beneficiaries. In return, the proceeds from the policy may be used to pay any estate costs after you die and provide your beneficiaries with tax-free income.