The language of trustsAs you read about trusts, you’ve probably encountered legal terms and specialized language. The definitions below will aid in your understanding of the estate planning process.
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Elements of a trust
Think of a trust as a container, a place to hold assets such as cash or securities. A trust is an arrangement in which the ownership of assets is given to someone else, the trustee — usually a financial institution such as Bremer, but sometimes an individual. The trustee keeps possession of and control over the assets in the trust and has legal title of these assets, which allows the trustee to exercise most property rights. The trustee's responsibilities and duties are outlined in the trust agreement.
The trustee manages the assets in the trust for the trust beneficiaries, the recipients of the trust's income and principal (sometimes referred to as the corpus of the trust). The beneficiaries are considered to have equitable title to the trust's assets, meaning that they have the right to benefit from the assets managed by the trustee.
Who establishes and benefits from trusts
The person who establishes a trust is usually referred to as a grantor; other terms include settlor or creator. The persons who benefit from the trust are referred to as beneficiaries.
An income beneficiary is someone who is entitled to receive only the income generated from the trust's assets. A remainder beneficiary is someone who has been named to receive the assets in the trust after the interest of a prior beneficiary has been terminated (for example, through death).
Beneficiaries also may be described as either primary or secondary. A primary beneficiary is someone who is entitled to receive immediate benefits from the trust's assets. A secondary beneficiary's interest in a trust is postponed or subordinated to that of the primary beneficiary.
Descriptions of trusts
Trusts can be described based on when they are established and how they operate.
For example, trusts are referred to as either inter vivos or testamentary. An inter vivos trust — more commonly described as a living trust — is established during the grantor's lifetime. A trust is testamentary when it becomes active after the grantor's death, through his or her will.
Trusts may be revocable or irrevocable. A revocable trust is the more flexible of the two. The grantor can make any changes to the trust at any time, and he or she can cancel the trust altogether if necessary. An irrevocable trust may not be changed or cancelled. However, irrevocable trusts have tax advantages that living trusts do not.
Sometimes a trust is referred to as a grantor or nongrantor trust. These terms refer to tax attributes of a trust. In a grantor trust, the grantor controls the trust's assets and is considered the owner of the assets for both income and estate tax purposes. Most revocable living trusts are taxed as a grantor trust. When the trust creator has relinquished benefits from and control over a trust, it becomes a nongrantor trust. A non grantor trust is taxed as a separate entity. Trust earnings that are distributed to a beneficiary are often taxed to that beneficiary, while the income taxes on earnings that stay inside the trust are paid by the trust itself. In some non grantor trusts, trust assets are excluded from being taxed in the creator's estate, and perhaps a beneficiary's estate as well. Certain types of trusts have a combination of both grantor and nongrantor attributes.
Special kinds of trusts
Sometimes a trust is defined by its purpose or by its assets. Here are a few of the most common kinds of trusts:
A charitable remainder trust allows the grantor or a designate to receive income from the trust for the beneficiary's lifetime or for a period of years. When the income beneficiary's interest ends, the trust's assets pass to the designated beneficiary.
A charitable lead trust mirrors the charitable remainder trust. The charity receives the income from the trust and the trust assets later pass to the beneficiaries named by the grantor.
A life insurance trust is an irrevocable trust in which a life insurance policy is the chief asset. At the grantor's death, the policy proceeds pass to the trust for distribution to the beneficiaries according to the directions outlined in the trust agreement. Usually, the proceeds are not considered part of the estate for federal tax purposes.
A qualified principal residence trust (QPRT) is an irrevocable trust in which the grantor's residence or vacation home is the chief asset. The grantor retains the right to live in the residence for a fixed number of years.
Grantor retained annuity trusts (GRATs) and grantor retained unitrusts (GRUTs) provide special tax benefits. The grantor transfers highly appreciating assets to a trust at less than their full value, removing the threat of estate tax on the assets (as well as any tax on their future appreciation). With a GRAT, the grantor establishes a set amount of income to be paid each year. With a GRUT, payments are equal to a fixed percentage of the value each year of the assets in the trust.