Trusts can be categorized in several different ways:
- Living vs. testamentary
- Revocable vs. irrevocable
- Funded vs. unfunded
- Self-trusteed vs. third-party trusteed
There are several types of trusts within each of these categories.
TIP: in many estate plans the use of a revocable, self-trusteed trust as your basic estate planning document is a good option.
Living vs. Testamentary Trusts
Trusts can be created by a person either during life or after death. A trust created by a person during his or her lifetime is commonly called a "living trust". A trust can also be created after death through provisions in a decedent's last will and testament. This is called a "testamentary trust". Both living trusts and testamentary trusts can be used to implement estate tax planning techniques that shelter assets from the federal estate tax with a "credit shelter trust."
Revocable vs. Irrevocable Trusts
A revocable trust can be modified or even completely revoked by the person creating the document. This makes it a flexible tool for use in estate planning, since the settlor can change the terms of the revocable trust to meet the needs of the evolving family. One of the common advantages of a revocable trust is that the assets in the trust avoid probate, while the settlor retains control over the property.
An irrevocable trust cannot be changed after it is created. For that reason, it is critical that the language of the trust does what you want it to do before it is signed and funded. Normally, the creation and funding of an irrevocable trust is a taxable event/ irrevocable trusts are used to remove assets from a settlor's estate through transfers of insurance or other property for the ultimate beneficiaries, who are usually younger generation family members. In some circumstances, an irrevocable trust may also be used to insulate assets from creditor liability.
NOTE: Every revocable trust becomes irrevocable upon the death of the settlor
Funded vs. Unfunded Trusts
Trusts can be characterized as either funded or unfunded.
A funded trust has assets (other than the nominal $1.00) titled in the name of the trust. Revocable trusts can be funded with assets any time and there are varying reasons to fund a trust during life, rather than waiting to fund the trust through provisions in your Will. For example, some individuals fund a trust if they want the trustee to begin managing the assets placed into the trust. Self-trusted trusts are funded if the settlor (who is also the trustee) wants to avoid the probate process to transfer those assets at the death of the settlor.
An unfunded trust is a trust with just some nominal property (typically $1.00) as its assets (since some sort of corpus is typically required to have a valid trust). With proper planning, an unfunded trust can be just as effective as a funded trust to reduce estate tax liability. Unfunded trusts become funded when a decedent dies and the property passes to the trust through the Will. However, the property that is ultimately transferred into the trust must first pass through the probate process to get into the trust.
Self-Trusteed vs. Third-Party Trusteed Trusts
A self-trusteed trust is a trust with the settlor also serving as the initial trustee. This permits a person to create a trust and fund it with assets, while not having to give up control over the assets. A self-trusteed trust document typically provides that upon the death, resignation, or incapacity of the settlor/initial trustee, a successor trustee takes over.
A third-party trusteed trust is a trust created with someone other than the settlor (another individual or a corporate entity, such as a bank trust department), as the trustee. This independent, third-party trustee is charged with the fiduciary responsibility of managing the trust for the benefit of the beneficiaries.