9 Different Types of Trusts – A Financially Simple Overview

As business owners, so much of our time and effort is poured into making our businesses successful. You plan for every possibility and eventuality, mitigating risk while maximizing value. You pour so much of yourselves into the business side of your lives, but do you take as much care with your personal effects? Think about it, if you put so much thought into protecting your business, shouldn’t you put at least as much thought into your personal lives?

Over the last few weeks, I’ve discussed the importance of estate planning. As I continue digging into the topic, I’d like to take some time to understand nine different types of trusts. Trusts are a crucial part of managing your estate, so let’s take a few moments to get to know them.

Follow along with the Financially Simple podcast:

Podcast Time Index for “The 9 Basic Types of Trusts”

• 00:53 – The Nine Basic Types of Trusts
• 01:51 – What is a Trust?
• 03:08 – The Nine Types
• 03:41 – Revocable Trusts
• 05:00 – Irrevocable Trusts
• 06:08 – Asset Protection Trusts
• 08:45 – Charitable Trusts
• 09:50 – Constructive Trusts
• 11:34 – Special Needs Trusts
• 12:25 – Spendthrift Trusts
• 14:15 – Tax By-Pass Trusts
• 14:47 – Totten Trusts
• 16:02 – Summary
• 17:30 – Wrap Up

What is a Trust?

A trust is simply a legal document created during a person’s lifetime that often survives the person’s death. It can be created as a stand-alone document, or it can be created by a will. Once assets are placed into a trust it is considered “funded.” If no assets are placed into the trust it is considered “unfunded.” Typically, there is a trustee, whose job is to oversee the rules and instructions of the trust’s contract. It is usually created for a beneficiary and there is sometimes a relationship where the trustee has a responsibility to care for the assets of the beneficiary. It’s really a simple concept. We want to place assets somewhere that they can be utilized by someone else after our death.

Trusts come in a variety of shapes and sizes. If you aren’t familiar with the different types of trusts, and how each of them is designed, choosing the right one can be quite difficult. So follow me as I dig into nine different types of trusts and make them a little more financially simple before we delve into our exhaustive list of the most common types of trusts.

9 Different Types of Trusts

1. Revocable Trusts

This type of trust can be changed, adjusted, or terminated during the lifetime of the trust’s creator. The most popular form of a revocable trust is a living trust. The terms “revocable trust” and “living trust” are frequently used interchangeably. You can place the title of an asset in the trust, and it can be transferred to another person without going through probate. Once the trust’s creator passes away, the trustee must follow the rules of the trust as they are at that point.

2. Irrevocable Trusts

Basically the opposite of the revocable trust, the irrevocable trust cannot be altered, changed, or terminated once the creator places an asset in the trust. Perhaps the most common type of irrevocable trust is a life insurance trust. If something happens to you, the proceeds go to the trust just as if it were part of your estate, and the trustee must decide what to do with those funds based on the instructions of the trust’s contract. The simplest explanation of the difference between these first two trusts is that a revocable trust can be changed or terminated, and an irrevocable trust cannot.

3. Asset Protection Trusts

This does exactly what it sounds like. It is established to protect your assets. If your business were to fall on hard times and your assets were subjected to a creditor, an asset protection trust could provide a layer of division between your personal assets and the assets you have in the trust. Maybe the most common use of an asset protection trust is to replace a prenuptial agreement. Assets that you currently own could be placed into an asset protection trust where they would be safe from a potential ex-spouse.

4. Charitable Trusts

This is where you give money to a trust that will benefit a charity. It is a great planning tool to help minimize taxes. I spoke about this in a previous podcast about a real-life example where a client sold their business for 10 million dollars and gave 1 million dollars to a charity. By doing this, they ended up netting more money in sales proceeds than if they had not donated the money to the charity at all. Plus, I really believe that we should give.

5. Constructive Trusts

These are implied trusts that are typically created by the court. Based on certain facts or circumstances, the court may decide that, even though there is no trust document in place, the individual intended to place their assets in a trust. The court would then create the trust and place the assets in it. This is usually the result of poorly executed language or documentation in estate planning.

6. Special Needs Trusts

The idea here is that you are able to set up a trust for a person that receives a government benefit without disqualifying them from that government benefit. It also helps them be able to utilize the social security benefits that people with special needs or disabilities are often able to use.

7. Spendthrift Trusts

The spendthrift trust does not allow the beneficiary to sell or pledge the interest of the trust. This is sometimes used to set up funds for a beneficiary that either spends money irresponsibly or suffers from substance addiction. This type of trust is protected from the beneficiary’s creditors. Basically, if the creator of the trust is worried that unrestricted access to the funds and assets in the trust would be detrimental to the beneficiary, they may choose to go with this kind of trust.

8. Tax By-Pass Trusts

Typically, this is called an AB trust, and it allows one spouse to leave proceeds to the other, thus limiting estate taxes. Basically, this is put in place to minimize taxes on the assets that are shifting from spouse to spouse. It can also be used for couples that have children from previous marriages to pass assets to their individual beneficiaries in the same limited tax manner.

9. Totten Trusts

A Totten trust, also known as a “Payable on Death” account, is a revocable trust set up in another person’s name with the creator of the trust as the trustee. You place assets in the trust which can’t be transferred to the beneficiary until the trust’s creator passes away. We see this most often with very wealthy individuals who are trying to minimize their estate size.

Need more information about the MANY types of Trusts: Comprehensive list of Trusts

What Does This Mean to You?

As a business owner, minimizing taxes and ensuring the smooth transfer and proper handling of your assets could go a long way to making sure that your business continues to function if something happens to you. Setting up one of these basic trusts might be the perfect way to achieve that. Now, I’m not giving you legal advice or tax advice here. But, with this understanding of basic trusts, it should be easier to make decisions with your attorney and the rest of your planning team. If a good financial planner and business growth coach are not yet part of your team, reach out to us.

Don’t miss out on more areas of Trusts, Insurance, and other Risk Management topics in our series – Personal Finance for the Business Owner.