JANUARY 17, 2011 VOLUME 18 NUMBER 2
We frequently are asked to explain the differences between different types of trusts, or to analyze a trust with no more information than its type. Confusion about the differences is widespread, and we hope to provide a little clarity to consideration of trust types.
Before we embark, we have three caveats:
- We are not trying to list every possible type of trust here, but just those our clients most often encounter. We may expand this list over time.
- Just because you believe your trust is, for example, a “spendthrift” trust does not necessarily make it so. Even if the name of the trust includes one of these categories, it might be inaccurate. The type of trust is determined by the language of the trust itself, and it may take some close reading to identify a trust’s correct categorization.
- Most of these categories are neither magical nor exclusive. Just because we can categorize a given trust as a “spendthrift” trust, for example, it does not necessarily mean that it will be protected against all of the beneficiary’s creditors. And just because a trust is a “spendthrift” trust does not mean it could not also be a “special needs” trust, a “bypass” trust or some other category.
With that out of the way, let’s get started on a partial list of common types of trusts you might encounter (or create):
Spendthrift trust. This trust is protected against the creditors of a beneficiary. The trustee can not be compelled to make distributions to a beneficiary, or to the beneficiary’s creditors. This does not necessarily mean that the trustee is not permitted to make such distributions (after all, it might be in the beneficiary’s best interests to pay his or her debts). Even very strong spendthrift language might not be effective against some types of creditors in some states. Common exceptions adopted by state law include child support and alimony obligations or governmental debts. State laws vary widely on these lists.
“Third-Party” Special Needs trust. These trusts are usually specialized spendthrift trusts created for a beneficiary who suffers from a disability. The language of the trust will usually include a clear expression of the intent that the trust’s monies should not interfere (or not interfere too much) with the beneficiary’s public benefits, like Supplemental Security Income or Medicaid. The variation here from state to state, and from beneficiary to beneficiary, can be tremendous, so be very careful about generalizing when discussing third-party special needs trusts.
“Self-Settled” Special Needs trusts. Just to keep the confusion level high, there are also special needs trusts created by the beneficiary himself or herself. Of course, a beneficiary with a disability may have to act through a court proceeding, a guardianship or conservatorship, or a parent or grandparent. But whoever signs the actual documents, if the money in a special needs trust comes from the beneficiary’s own resources (like a personal injury settlement, or an unrestricted inheritance) then the special needs trust will be treated as a self-settled trust. That means the rules will be more difficult, both as to creation and administration of the trust. Can a self-settled special needs trust also be a spendthrift trust? What an interesting question you ask.
Bypass trust. Sometimes these trusts are called “credit shelter,” “exemption,” “decedent’s,” or just “B” trusts, but all of those names are pretty much interchangeable. The basic premise of a bypass trust is that a married couple arranges to take full advantage of the federal estate tax exemption amount, so that they can pass up to twice that amount to their heirs on the second death. That means that on the first spouse’s death a portion of the couple’s assets transfers to the bypass trust irrevocably, with some limitations on the use of the money during the surviving spouse’s life.
Bypass trusts are a special breed just now. Because the new federal estate tax law allows a married couple to retain both estate tax exemption amounts without having to create a bypass trust, there are a lot of trusts out there that may not still be needed. If both spouses are still alive it may be time to change the documents. If one spouse has already died the problems are more complicated. About the time we all figure this out (in two years) the estate tax provisions are scheduled to end automatically. We will have to wait most of those two years to find out if bypass trusts will fade out of existence.
Revocable trusts. Any trust that can be revoked — by anyone, but usually by the person who established the trust — is “revocable.” You may sometimes see the phrase “revocable living trust,” which means the same thing. If the only person who can revoke the trust has died (or become permanently incapacitated) then the trust has become irrevocable. Even if the name of the trust includes the word “revocable” (as, for instance, “The Smith Family Revocable Trust”) it may now be irrevocable.
Irrevocable trusts. The flip side of a revocable trust is, obviously, an irrevocable trust. The category just means that no one has the power to revoke the trust. That does not mean it will go on forever — if the assets held by the trust are spent or distributed, it ceases to exist even though it was irrevocable.
Grantor trusts. This term is most important in considering federal income tax liabilities, but it is often used more broadly. In a nutshell, a grantor trust is one in which the person who established the trust has retained one or more of the elements of control listed in the federal income tax code. Most important (but not the only ones) are: the power to revoke the trust, the right to receive the trust’s income and/or principal, and the role of trustee. Grantor trust rules are actually quite complicated, and are sometimes subject to some interpretation — fortunately, the shades of meaning don’t show up very often. Most trusts are either quite obviously grantor trusts or quite clearly not.
Those are some of the most common terms you might see to describe trusts. In a future Elder Law Issues we will tackle some of the less common ones, like “Crummey” trusts and ILITs, QTIP and QDoT trusts, and — well, feel free to ask us to try to describe/define your favorite trust category.