11 Common Types of Trusts and How They Work

Curious about different kinds of trusts and how they work? Whether you’re hoping to leave a legacy or simply wanting to be as strategic as possible, you’ve probably thought about how your wealth will be managed and passed on. 

For high-earning professionals in Seattle, trusts can be one of the most powerful, flexible tools in estate planning. They can provide control, protect assets, and minimize taxes. And, they can even help care for loved ones (two- or four-legged) after you’re gone. 

Below, we explore some of the most common types of trusts and what you should know about them.

1. Revocable and Irrevocable Trusts

A revocable trust, sometimes called a revocable living trust, gives someone the legal power to make decisions about another person’s money or property that’s held in the trust. (The term revocable means you can change or revoke it during your lifetime.) These trusts are flexible and often used to avoid probate. 

An irrevocable trust, on the other hand, is a legal arrangement that cannot be changed or terminated after it’s created, making it a permanent transfer of assets to a trustee for the benefit of designated beneficiaries. It provides more protection from estate taxes and creditors, but you give up control.

In short, revocable trusts serve as flexible planning tools, whereas irrevocable trusts focus on tax efficiency and asset protection.

2. Charitable and Family Trusts

Charitable trusts, like CRATs and CRUTs, are designed to support a cause while also giving you tax benefits. These trusts can provide income for you or your heirs before the remainder goes to charity. Family trusts focus on passing wealth to your children or other heirs in a structured way.

• Charitable Remainder Annuity Trust (CRAT): An irrevocable trust that provides you or another beneficiary with a fixed annual payment, then directs the remaining assets to charity at the end of its term. It’s often funded with highly appreciated assets like stocks.

   

• Charitable remainder unitrust (CRUT): Pays a set percentage of the trust’s assets each year, so your income rises or falls with the trust’s value. Like a CRAT, the remaining assets go to charity when the trust ends.

Both serve long-term goals, but charitable trusts also let you leave a legacy beyond your family. 

In general, remainder trusts pay income to one beneficiary (like you or your spouse) for a set time, then transfer the remaining assets to another beneficiary. This is a way to provide for two different parties with one pool of assets.

3. Control and Tax Planning Trusts

Some trusts are all about control. For example, spendthrift trusts include what’s called a spendthrift clause or spendthrift provision, which permanently designates the trust itself as the sole owner of the assets held within it, rather than transferring ownership to your beneficiary upon your passing. Basically, it restricts how and when a beneficiary can access funds, which is helpful if you worry about overspending or creditors. 

Inside scoop: This type of trust helps protect beneficiaries from their own bad financial decisions — or outside creditors. It sets limits on distributions, ensuring funds last longer.

Others, like credit shelter trusts — also called bypass or AB trusts — are designed to help married couples reduce or avoid estate taxes. They work by using both spouses’ estate tax exemptions. When the first spouse dies, assets are split into two trusts, allowing the surviving spouse to benefit while ultimately lowering the overall estate tax liability. They can be set up through each spouse’s will or through a living trust.

4. Special Needs Trusts

It’s no secret that there are special considerations for parents of a child with special needs. For those who have a loved one with a disability, a special needs trust ensures they’re provided for once you’re gone without jeopardizing their eligibility for government benefits. 

The Special Needs Alliance breaks down three types of special needs trusts:

• Special needs trust (SNT): Preserves the beneficiary’s eligibility for needs-based government benefits such as Medicaid and Supplemental Security Income (SSI). Because the beneficiary does not own the assets in the trust, they can remain eligible for benefit programs that have an asset limit.

   

• First-party SNT: Also referred to as a “self-settled” or “(d)(4)(A) trust,” these are funded with assets or income that belong to an individual with a disability and who is the beneficiary of the trust. Typically, the funding comes from a personal injury settlement or inheritance that the beneficiary receives directly.

   

• Third-party SNT: Frequently referred to as a supplemental needs trust, these are funded with assets belonging to a person other than the beneficiary. In fact, no funds belonging to the beneficiary may be used to fund the trust. Typical funding comes from gifts, an inheritance from parents or grandparents, and proceeds of life insurance policies.

Special needs trusts require careful drafting but can make a big difference in long-term quality of life.

5. Life Insurance Trusts

A life insurance trust allows a third party to manage the death benefit from a life insurance policy to ensure that your policy’s death benefit is distributed to your beneficiaries according to your wishes. These trusts hold your policy outside of your taxable estate. The payout can provide liquidity for estate taxes or other needs without inflating the taxable value of your estate.

6. Testamentary Trusts

A testamentary trust is a trust that is established with the instructions contained in a last will and testament. These only take effect after death. They’re common for parents who want to control how assets are distributed to minor children. Testamentary trusts can help reduce estate tax liabilities and ensure professional management of the assets. Keep in mind, one disadvantage of a testamentary trust is that it does not avoid probate.

7. Asset Protection Trusts

As the name suggests, these trusts are built to shield assets from future creditors or lawsuits. Asset protection trusts are typically established by individuals in high-risk occupations (i.e., doctors and real estate developers) and very wealthy individuals who may be targets for creditors due to their net worth. Asset protection trusts can also be used instead of a prenuptial agreement. They’re not bulletproof, but they can provide a meaningful layer of protection.

8. Pet Trusts

Yes, even your golden retriever or tabby cat can be covered. A pet trust provides for the care of one or more animals should the owner die or become disabled. Pet trusts ensure funds are set aside for their care and designate a caregiver. For many families, pets are loved ones too.

9. Generation-Skipping Trusts

Want to pass assets directly to your grandchildren and avoid one layer of estate tax? A generation-skipping trust (GST) passes assets down to the grantor’s grandchildren or anyone who’s at least 37½ years younger, bypassing the next generation of the grantor’s children. The children of the grantor avoid the estate taxes that would otherwise be due by skipping the opportunity to receive the assets. It’s often used by families thinking long-term about preserving wealth across multiple generations.

10. Dynasty Trusts

Do you desire a trust designed to last for multiple generations, or even indefinitely, depending on state law? Dynasty trusts allow wealth to pass from one generation to the next without the trust being subject to estate and generation-skipping taxes. And depending on where it’s located and structured correctly, one can last in perpetuity — a way to build a lasting family legacy.

11. QTIP Trusts

A qualified terminable interest property (QTIP) trust protects an individual’s assets on behalf of the surviving spouse while maintaining control over how the assets are distributed once the surviving spouse dies. QTIP trusts can be helpful for international or blended families — AKA children from multiple marriages or when a surviving spouse isn’t a U.S. citizen. 

Talk to Your Financial Advisor About Trusts

Trusts can feel overwhelming due to the numerous types and rules involved. But with the right advisor, they become a powerful way to protect your wealth, care for your loved ones, and leave the legacy you want.

At Northern Lights Advisors, our team understands the complexities involved with estate planning, whether it’s for individuals without heirs or multi-generational families. If you’d like to learn more about how trusts can fit into your overall financial goals and planning, feel free to put some time on our calendar for a short consultation. 

Northern Lights Advisors is a fiduciary, fee-only Registered Investment Advisor (RIA) firm based in Seattle, Washington. The information in this article is not intended as tax, accounting, or legal advice. Read the full disclosure here.