A trust is a legal agreement that has 3 parties to it:

  1. The Trustor is the person who creates the trust. Also may be known as a Settlor or Grantor.
  2. The Trustee is the person or entity responsible for managing the property owned by the trust.
  3. The Beneficiary is the person or entity that receives the benefits of the property owned by the trust.

Under a trust agreement, the trustor transfers ownership of certain assets to the trust, to be managed by the trustee for the benefit of the beneficiaries. When a trust is created during someone’s lifetime, it is called an inter vivos trust. When it is created in someone’s will after death, it is called a testamentary trust. Trusts can be revocable, meaning that the Trustor retains the right to modify the trust agreement or terminate the trust, or irrevocable meaning the Trustor permanently gives up any rights he/she may have had to the Trust property and effectively removes all trust property from his/her name. Irrevocable trusts are usually utilized by individuals who have large enough estates to warrant estate planning to avoid estate taxes, or by individuals who practice in professions of high liability and need to protect their assets.

Here are some common trusts you should know about:

The Revocable Living Trust

A revocable living trust is created primarily to avoid probate. A trustor creates a trust, often also acting as the trustee for the benefit of his heirs. All of the trustor’s assets are transferred into the trust, and after the trustor’s death the assets can be transferred to the beneficiaries without the need for probate. However, keep in mind that if the trustor still owns property outside of the trust, that probate may still have to be undertaken for the assets outside of the trust.

Living trusts also have successor trustee language in case the original trustee is incapacitated because of a mental or physical reason. In these instances, the successor trustee would be free to transact business involving the trust property without the need for a power of attorney.

This is a revocable trust meaning that the trustor can revoke it at any time. However, as a result of being revocable, the trust does not provide any tax savings or asset protection.

The Crummey Trust

Currently, gift taxes may be due if someone gives a gift of more than $13,000 annually to their child. Also, many children may not be mature enough to handle these amounts of money once they are given to them outright. A solution may be a Crummey trust.

The Crummey trust is named after the Crummey family, which were the first ones to set up such a trust and successfully challenge the IRS. It allows people to make annual gifts of $13,000 (or whatever the annual exclusion is in a particular year) to the trust for the benefit of their children. The trustors may also act as trustees. The assets contributed to the trust can be controlled by the trustor/trustee, multiply over time, and the trust can terminate at, say, when the child reaches the age of 30 or at another age when the trustee feels like the child is mature enough to handle the large dollar amount.

One catch is that the Crummey trust must give the child the right to withdraw the amount of each gift for up to 30 days after each gift is made. If the child does not withdraw the gift within the 30 days, the withdrawal right lapses and the money remains in the trust until the child reaches the designated distribution age.

The Crummey trust is irrevocable and it provides the added benefit of removing the contributed assets from the trustors’ estates and protecting them from potential creditors.

The Irrevocable Life Insurance Trust

Many people don’t realize that the payouts from life insurance policies are included in the size of their estates after they pass away. For people with large estates and/or large life insurance policies, this may increase the amount of estate taxes that are paid upon death.

A way to avoid this is to transfer the life insurance policy into an Irrevocable Life Insurance Trust, or ILIT. An irrevocable trust is created, naming someone other than the trustor as trustee. Then the life insurance policy is transferred into the trust and the trust becomes owner of the policy. The trustor no longer has any control over the policy, but through the terms of the trust the trustor can determine who will have control, how premiums will be paid, who will benefit from the trust, and how payments should be made to the beneficiary or beneficiaries.

Some important things to consider:

  1. The trust must be irrevocable.

  2. Trustor cannot act as trustee of the trust

  3. Trustor cannot change the beneficiaries of the life insurance policy

  4. Trustor cannot borrow from the life insurance policy

  5. An existing policy cannot be transferred to the trust unless Trustor lives for at least 3 more years. This is the IRS’s way for avoiding last minute transfers to avoid estate taxes. However, if the life insurance trust takes out a new policy on your life, Trustor will never be deemed to own the policy and you do not have to wait 3 years.

Despite these drawbacks, many people find that the tax saving potential of a life insurance trust is worth the cost and hassle. It allows trustors to remove a significant asset from their estate that they are unlikely to want access to during their life. It ensures that the life insurance proceeds go 100% to the beneficiaries, not the federal government.

Trusts are usually part of comprehensive estate plans that are created for specific individuals. If done properly, they can be invaluable tools to allow individuals to leave more of their estate to their heirs, give them added protection from creditors and limit hassle for their heirs after death.