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Understanding Finances: 3 Common Types of Trusts

Trusts are a valuable estate planning tool. They can help you ensure that your children retain the bulk of your assets after your death. They are also particularly helpful when it comes to avoiding estate taxes.

If you’re not sure what type of trust is right for your family, don’t fret. Keep reading for the 3 most common types of trusts.

Types of Trusts: The Basics

Depending on how new you are to the world of estate planning, you may need a quick primer on more than the most common types of trusts. In simple terms, a trust is a legal agreement that lays out the rules for a particular asset.

That asset could be a piece of real estate or anything else of high value that you want to protect for your children’s benefit.

A trust generally involves three roles: the trustmaker, the trustee, and the beneficiary. Depending on your situation, one person could fill each one of these functions.

The Trustmaker

This dramatic-sounding position is simply the person who creates the trust agreement. They may also go by the title of settlor, grantor, or trustor.

The Trustee

A trustee is in charge of following the stipulations in the trust. A trustmaker grants the trustee management rights over the asset.

The Beneficiary

The beneficiary is anyone who stands to receive the benefits of the asset in the trust. That most likely describes your family.

Top 3 Types of Trusts

1. The Living Trust

A living trust goes into effect during the trustmaker’s lifetime. These trusts will protect your assets from probate court after your death.

Living trusts come in two forms: revocable or irrevocable.

Revocable living trusts allow the trustmaker to keep control of the asset and change the terms of the trust at any time. These trusts still protect the asset if the trustmaker dies or becomes otherwise incapacitated.

Irrevocable living trusts cannot be changed or removed after they’re created. Many trustmakers use these to move assets from their estate to their beneficiary’s. As an added bonus, this reduces the trustmaker’s estate tax obligation.

You may be wondering, “how much does a living trust cost?” The answer will vary depending on your state, but it is usually more expensive than creating a will. When you consider how valuable skipping the probate process is, that cost may be well worth it.

2. The Testamentary Trust

As opposed to a living trust, testamentary trusts do not take effect until the trustmaker has died. These are usually set up per the guidelines in the deceased’s will.

These trusts are particularly useful for guaranteeing the inheritance of children from another marriage or a surviving spouse. Many trustmakers also use them to keep beneficiaries from accessing their inheritance until they come of age, usually at age 18.

3. The Irrevocable Life Insurance Trust (ILIT)

This type of trust lets the trustmaker avoid hefty taxes by excluding their life insurance policy from their estate. A trustmaker can put the proceeds from their life insurance policy into an ILIT and avoid surpassing the national limit on estate tax exemption.

In 2017, that exemption hit $5.49 million. That means that any inheritance over that amount will face heavy taxes. If you want to protect a particularly large estate and have a substantial life insurance policy, an ILIT may be the way to go.

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