Types of Trusts: How to Choose for Your Estate Plan

Anna Burton is a lead planning excellence consultant at Northwestern Mutual.

If you’re in the process of estate planning, you might be wondering if it should include one or multiple trusts in your plan. After all, trusts can be a powerful tool for protecting your assets, avoiding probate, minimizing certain kinds of taxes and helping ensure that your final wishes are carried out after you’ve passed.

But it’s also important to understand that there are many types of trusts, each of which works differently and may be better suited to certain situations. Beyond deciding whether or not a trust in general is right for you, you will need to decide which type of trust best aligns with your estate planning goals.

Below, we discuss the two main categories that trusts fall into—revocable and irrevocable—and review additional types of trusts that might fit into your financial plan.

The two main categories of trusts: Revocable and irrevocable

Trusts fall into one of two main categories: revocable or irrevocable.

A revocable trust is any trust that can have its terms, like who its beneficiaries are or what assets it contains, revoked or changed. Revocable trusts are typically better suited for those who want to retain the flexibility to adjust their estate after establishing a trust—for example, if a new grandchild is born, you may want to reconsider how your assets are distributed between beneficiaries. While assets held in a revocable trust will avoid probate, they are not shielded from estate taxes after your death or creditors or lawsuits while you are alive.

An irrevocable trust, on the other hand, is any trust that cannot be changed or amended after it has been established, except for in very specific circumstances. Unlike assets held in a revocable trust, assets held in an irrevocable trust are protected from estate taxes after you die and lawsuits and creditors while you’re alive. But this protection comes at the cost of flexibility. If you want to maintain control over your assets while you are still alive, an irrevocable trust probably isn’t right for you.

Additional types of trusts

While trusts are either revocable or irrevocable, they can also be broken down into other categories based on the assets they hold, what they’re used for or how they are created. Some of the more common types of trusts to be aware of include the following:

Living trusts

A living trust, also called an inter vivos trust, is a type of trust that gives you control over your assets while you are still alive. When establishing a living trust, you would typically place all of your assets into the trust and appoint yourself as trustee. This setup allows you to manage the assets however you see fit while you are still alive. Following your passing or incapacitation, a successor trustee will take over administration of the trust, including the distribution of assets to your beneficiaries. Living trusts are usually revocable but can also be irrevocable in nature.

Testamentary trusts

A testamentary trust is a type of trust that is established by your final will and testament. While other types of trusts can be established during your lifetime, a testamentary trust is created at your passing. Testamentary trusts give you the power to specify how you want your assets distributed after you pass, including whether certain conditions must be met before a beneficiary is allowed to take ownership of an asset. For this reason, they are often established as a means of passing assets to minor children or beneficiaries with special needs. Because testamentary trusts are established by your will, they do not bypass probate (unlike most other types of trusts).

Pour-over wills

If you establish a living trust and transfer some—but not all—of your assets into it, the remaining assets may be subject to probate, gift and estate taxes after your death. A pour-over will is a type of will designed to help you protect these assets. It works like this: Upon your death, any assets you own that are not currently in the living trust would be transferred into it. While not a trust in and of itself, these wills can be a powerful tool and act as something like a “catch all” to cover your bases.

Special-needs trusts

If you have a child, grandchild or other beneficiary with special needs, a special-needs trust allows you to set money aside for their care without jeopardizing their ability to qualify for government benefits like Supplemental Security Income (SSI) or Medicaid. That’s because assets in a special-needs trust do not count toward the asset caps that typically apply to these benefits. These trusts can be either revocable or irrevocable in nature and can be established as a living trust or testamentary trust.

Irrevocable life insurance trusts

An irrevocable life insurance trust is a trust that is generally funded with one or more life insurance policies. This can be an effective estate planning strategy because it removes life insurance proceeds from the taxable estate, and it can provide liquidity for the payment of estate or inheritance taxes. However, in order to avoid the additional inclusion, the trust must purchase illiquid assets from the estate.

Charitable lead trusts and charitable remainder trusts

Charitable lead trusts and charitable remainder trusts are both ways that you can leave assets to charity as a part of your legacy planning. While both are irrevocable trusts, they do work differently.

With a charitable remainder trust, you would place assets in the trust, which would then be used to generate an income for your beneficiaries. When the terms of the trust expire, any remaining assets (the remainder) would go to the charity you’ve named in the trust. With a charitable lead trust, it’s sort of the opposite: You place assets in the trust, and those assets are used to make periodic payments to the charity you named in the trust. After the terms of the trust expire, any remaining assets transfer to your beneficiaries.

Marital trusts

The unlimited marital deduction allows a surviving spouse to inherit an unlimited amount of assets from a deceased spouse without triggering estate taxes. Marital trusts, also called A-trusts, empower spouses to take full advantage of this provision. The trust essentially acts as a vehicle for transferring assets from the deceased spouse’s estate to the surviving spouse. When the surviving spouse dies and the remaining assets are transferred to other beneficiaries, they will then typically be subject to estate tax rules.

Credit shelter trusts

A credit shelter trust (CST) or B-trust is a type of irrevocable trust designed to help couples avoid estate taxes when passing assets onto their heirs. They work like this: Upon one spouse’s death, the assets in the trust are transferred to the surviving spouse, much like a marital trust. But because the CST is irrevocable, the surviving spouse never has control over the assets, and those assets are never added to the surviving spouse’s estate. When the surviving spouse passes, the assets move to the remaining beneficiaries without triggering estate taxes. Credit shelter trusts are often used in conjunction with marital trusts to minimize estate taxes as much as possible.

Qualified terminable interest property trusts

A qualified terminable interest property trust (QTIP) is another way that you can leave assets to your spouse after you’ve passed. With a QTIP, you place assets into an irrevocable trust, which are then used to generate a lifelong income for your spouse after your death. The surviving spouse does not take control over the assets, however. After the surviving spouse’s death, any remaining assets are transferred to the beneficiaries you named in the trust when you established it.

Spendthrift trusts

A spendthrift trust is a type of trust that contains a disbursement schedule. Instead of gaining access to the trust’s assets all at once, your beneficiaries would receive distributions according to this schedule. This could include payments on a monthly, quarterly or annual basis or some other cadence that you decide. Spendthrift trusts are typically used when you are worried your beneficiary might struggle to make appropriate decisions with a large sum of money. They can be revocable or irrevocable in nature.

Education trusts

An education trust allows you to leave assets to beneficiaries while also specifying that those assets can be used only to cover educational expenses, such as high school or college tuition, textbooks, etc. You can establish the terms of the trust as you see fit, including what expenses the trust can be used to cover—giving you greater control over how your assets are spent after your death and offering additional flexibility over other types of college savings plans like 529 accounts. An education trust can be revocable or irrevocable in nature.

Pet trusts

If you have a pet, a pet trust will allow you to provide for that pet after your passing. With this type of trust, your pet is the beneficiary, and the terms indicate how the pet is to be cared for. Funds from the trust are then paid to your pet’s designated caregiver according to the terms of the trust. A pet trust can be established as either revocable or irrevocable.

Generation-skipping trusts

As the name suggests, a generation-skipping trust is a trust that you can use to leave assets to your grandchildren instead of your children, effectively skipping a generation—and with it, some of the estate taxes that the assets may otherwise have been subject to. (The trust may, however, be subject to the generation-skipping tax.) For this reason, generation-skipping trusts are particularly well-suited to high-net-worth families. More of a blanket term than a specific “type” of trust, many different types of trusts can be established to be generation-skipping in nature.

Dynasty trusts

A dynasty trust is a type of long-term, irrevocable trust designed to help you pass wealth from generation to generation. Because a dynasty trust is irrevocable, it can avoid estate taxes, generation-skipping taxes and gift taxes that the assets might otherwise be subject to each time they are passed from one generation to the next. How long these trusts can last will vary depending on the laws in the state where you live, but it is often possible to create a dynasty trust capable of surviving for a number of generations.

Totten trusts

A Totten trust is essentially a bank account that allows you to name a beneficiary. While alive, you can use the account as you would any other bank account. When you pass away, the money held in your account would be transferred to your beneficiary—avoiding probate. For this reason, Totten trusts are also called payable-on-death accounts.

Grantor-retained annuity trusts

A grantor-retained annuity trust (GRAT) is a type of irrevocable trust that can help you limit the effect of both gift and estate taxes when you give or leave assets to your beneficiaries. It works like this: You establish a GRAT to last for a specific length of time, typically a number of years. You then fund the trust with assets that you expect to significantly appreciate in value. In exchange, you receive annuity payments equal to the original value of the assets, plus a rate of return set by the IRS. Once the trust expires, the remaining appreciation of the asset is transferred to the beneficiary, with little to no gift and estate tax impact. The downside? If you pass away before the trust expires, the assets in the trust revert to your estate, at which point they could be subject to estate taxes.

Qualified personal residence trust

A qualified personal residence trust (QPRT) is a type of irrevocable trust that makes it possible to remove your home from your estate—even while you are still living in it. When you establish a QPRT, you will retain interest in your home for the duration of the trust; once the trust expires, your interest in the property transfers to your beneficiaries. Because this interest is typically a fraction of what the property is worth, it is possible to transfer the property to your beneficiaries with a lower gift tax burden than might otherwise be possible. Importantly, if you pass away before the trust expires, the property becomes a part of your estate and may be subject to estate taxes.

Deciding Which Type of Trust is Right for You

Before you pursue any specific type of trust as a part of legacy and estate planning, it’s important to understand how each different type is used and how different trusts may empower you to work toward different goals. A financial advisor can help you weigh your options and select the trust structure that makes most sense for your financial situation.

This article is not intended as legal or tax advice. Financial Representatives do not render tax or legal advice. Consult with a tax professional for tax advice that is specific to your situation.