1. Qualified Personal Residence Trust A qualified personal residence trust removes your residence from your estate and gives it as an asset to your designated beneficiary. But you retain the right to live in the primary residence for a specified period of time, called the “retained income period.” A QPRT moves the value of your primary residence out of your estate, and can also help you avoid gift taxes. This is an irrevocable trust, so once it’s established, you will not be able to reverse it and regain ownership of the home.
Drawback: Your beneficiary may have to pay income tax on the value of the home after he or she receives it as an asset.
2. Intentionally Defective Grantor Trust With an IDGT, you’re the owner of the trust for income tax purposes, but the assets in the trust are no longer part of your estate. In addition, the funds in the trust grow tax-free, which makes it especially appropriate if you have an asset that you expect to appreciate substantially, such as a business that you own. One advantage of an IDGT is the swap power, which lets you pull assets out of the trust and substitute different assets of the same value. The assets in the trust are excluded from your taxable estate, and you also avoid gift tax limits when the assets pass to your beneficiaries.
Drawback: The defective trust doesn’t pay its own taxes, so it retains more of its assets for your heirs. But that means that you yourself have to pay the income taxes generated by the trust.
3. Charitable Remainder Trust A charitable remainder trust (CRT) can generate an income stream for its current beneficiaries, either a fixed amount each year or a percentage of the assets. After a certain term (of no more than 20 years) the remainder of the assets go to one or more charitable organizations. You can take a charitable deduction against either the income tax or gift tax for the present value of the trust’s assets that are expected to go to the qualified charity — in other words, the remainder.
Whatever you contribute to a CRT upon your passing is deducted from your estate tax, and it’s also exempt from tax on any investment income earned in the trust. Many people choose to sell appreciated assets to a CRT and then reinvest the proceeds elsewhere.
Drawback: The initial contribution to a CRT requires a sizable investment, enough to provide the income for a period of year and leave enough for the charity.
4. Charitable Lead Trust Charitable lead trusts (CLTs) are sort of the opposite of charitable remainder trusts: The payment to the charity comes first, over a fixed term of years or over the course of the life of the person setting it up. After that, the remaining assets go to the beneficiaries specified by the trust.
Drawback: Unlike charitable remainder trusts, CLTs are not tax-exempt so any assets transferred to heirs at the end of the trust are taxable. And they’re irrevocable, so once assets are transferred to the trust, they cannot be removed.
5. Generation-Skipping Trust As the name suggests, a generation-skipping trust can transfer assets to your grandchildren, but also to anyone else who is at least 37 1/2 years younger than you. The idea is that you want the money to end up with that generation anyway, and by bypassing your children, it goes directly to someone who is putatively in a lower tax bracket.
Drawback: You have to have great confidence in your grandchildren, because your children — their parents — have no control over anything in the trust. This is another trust that’s irrevocable, so you can never reclaim the assets in the trust.
6. Irrevocable Life Insurance Trust Life insurance proceeds generally aren’t taxable, but they could be included in your estate, which could make them subject to the estate tax. With an irrevocable life insurance trust, you transfer the ownership of your life insurance proceeds to a beneficiary to ensure they wouldn’t be part of your estate.
Drawbacks: If you’re interested in this type of trust, set it up soon; if you die within three years of making the transfer, your life insurance proceeds would still be considered part of your taxable estate. You also cannot make any changes to it without the consent of the beneficiary.
7. Crummey Trust Named after the 1968 U.S. Supreme Court case
Crummey v. Commissioner, the basic idea of a Crummey trust is that each year, you contribute money to the trust, but the recipient has a short window of time, such as 30 days, where they can take the money and treat it as an immediate gift. If the beneficiary does not withdraw the money during that time, the assets remain in the trust. If the recipient of the gift does not exercise their option to take control of the money, it becomes part of the trust. At that point, you regain control of it, and can disburse it as you see fit. But now that it is part of a trust, it no longer counts against your lifetime estate tax exemption.
Drawback: If your beneficiary accepts the money from the trust within the 30-day window, it will count as part of your annual gift limit, which means it counts against your lifetime estate tax exemption.
8. Grantor Retained Annuity Trusts and Unitrusts Grantor retained annuity trusts (GRATs) and grantor retained unitrust (GRUTs) are both used to shelter income-producing assets such as business interests or real estate. The income-producing asset is placed into a trust for a set amount of time, and you receive the asset’s income during that time. When the trust expires, the asset goes to your beneficiaries. The difference between the two is that GRATs are more appropriate for assets that produce consistent incomes, while GRUTs are better for assets whose income tends to vary.
Drawback: A GRAT or a GRUT won’t reduce your estate by the full value of the asset you put into it. On the other hand, it does reduce the taxable value of the asset by delaying the transfer to your heirs.