Trusts can be useful for estate planning and financial planning purposes. Different trusts are available for different purposes. Two major types of trusts that are often used in estate planning are living trusts and generation-skipping trusts. Each of these trusts has unique features that should be carefully understood before you decide to create one.
Definition of Trust
A trust is a legal entity to which a person transfers his assets. A trust involves three parties. The person who forms the trust and transfers his property into it is called the grantor, trustor or settlor. The person who receives a benefit from trust property is called a beneficiary. The person who manages a trust is called the trustee. Trusts are governed by state law. Although there is much uniformity among the states, trust law will vary slightly from state to state.
A living trust is created during the grantor's lifetime -- as opposed to a testamentary trust, which is created after death through a will. A living trust is created by the grantor executing a legal instrument known as a declaration of trust. It is common for the grantor to be both the trustee and primary beneficiary of the trust during his life. After the grantor's death, a new trustee will be appointed according to the trust for the benefit of the living beneficiaries.
Revocable and Irrevocable Trusts
Living trusts can be revocable or irrevocable. A trust is revocable if the grantor has the right to terminate it at any time. A trust is irrevocable if the grantor cannot revoke the trust without the consent of the beneficiaries. Under an irrevocable trust, the grantor ceases to hold legal title to the trust assets; this provides some significant tax advantages to the grantor. On the other hand, if the trust is revocable, the grantor is considered the owner of the trust assets for tax purposes because the grantor has the power to terminate the trust.
A generation-skipping trust is a special type of irrevocable trust. In a generation-skipping trust, the grantor skips over her children and names her grandchildren as beneficiaries. A grantor may decide to skip over her children because they don't need the money, because of family disputes or for other reasons. A generation-skipping trust has the advantage of avoiding estate taxes two times -- when the grantor dies and when the children of the grantor dies. However, there is a special federal generation-skipping tax if the transfer is large enough.
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