A (First Principles) Guide to Understanding Trust Objectives

The Deeply Confusing World of Trusts

Throughout the financial planning and Trust & Estate (or "T&E") industries, there's a lot of confusion around trusts: what they are, how they should be used, what trusts are appropriate and when, etc.

I've seen many overviews of the space that focus on the popular acronyms and end result products. But, as is often the case, I find it's more productive instead to work from first principles.

Specifically: what are we trying to accomplish here?

Trusts are made up of their parts in interaction with the laws of the jurisdictions they're formed in. The "law" part of that is basically as complicated as you might imagine, probably even more so. For that reason, it always makes sense to speak to the correct lawyer for your needs when implementing and planning complex trust structures. That said, understanding the T&E-specific principles & related terms, combined with underlying objectives in using trusts, can actually get us pretty far in understanding where to go from here.

*None of the following (and nothing in a blog) should ever be interpreted as tax or legal advice.*

Let's start with the basic objectives people often try to accomplish by using trust and estate planning techniques. While one may look at the list and say "yes, that's right, I want all of those" the key point is here that it's very difficult and sometimes impossible to make them all work together. As is so often the case, tradeoffs need to be made, which calls for prioritization.

When you start to think of what you want to do, don't pick a target at random and try to optimize for it in isolation. Rank all of your objectives in order of importance to you, so that you can be sure you're not taking an "easy win" at the expense of a much bigger win that would have benefited you more in the end.

With that in mind, let's take a look at a usefully simple list of reasons people can cite for wanting to form and utilize a trust.

Why Do People Use Trusts?

• Access to Liquidity & Full Control of Assets (principal, income, asset management, business control, etc.)
  • Ok. We're off to a bad start, because this one is kind of a trick. If this is the most important to you, you need to slow down before trying to get too cute with trusts to accomplish any of the goals below. Pretty much by design, the function of a trust is to in some way remove your assets from you. There are reasons to do that, but if this is your top priority, then please keep that in mind as you continue down the list.
  • There are exceptions. Revocable Living Trusts (more below), for example, are a way of leaving your assets more or less in your own hands. That said, they won't accomplish many other goals on this list, especially when it comes to changing tax treatment.
    
    
• Lowering Future Estate Tax Bills
  • Ah, here we go. This is a big reason for a lot of people. Estate taxes federally don't kick in until fairly high asset values (some state thresholds are much lower, though), so if you are underneath these thresholds even after accounting for potentially decades of asset growth ahead of you, you may not think much of this one.
  • That said, when you do account for decades of growth plus the potential impact of federal and state law changes to lower the thresholds to very different levels, you might still care. Estate tax rates are high and apply to the asset total, so they are very noticeable, and they can quickly erode wealth over one or more generational changes.
    
    
• Living off of income from the trust while still alive
  • This is completely possible, if your trust structure allows it to be. It will just come with tradeoffs in how well it accomplishes other objectives on the list.
    
    
• Lowering Federal Tax Bills
  • ...especially on a large gain like the sale of a business or other investment.
  • Since there aren't a whole lot of available provisions that make it so that anyone doesn't owe taxes on a large chunk of income, there's no special trust that just doesn't owe any taxes by default.
  • Thus, this objective requires a significant amount of creativity to achieve on even a partial level.
  • Lowering ongoing payment of federal income taxes on income is also hard to achieve, for similar reasons.
    
    
• Lowering State Tax Bills 
  • ...especially on a large gain like the sale of a business or other investment asset.
  • There's a little more flexibility here than above, because especially with time and planning, state tax nexus can change with the location of the taxpayer (and that taxpayer can be a trust).
  • Just as you might be subject to lower state taxes by moving from New York to Florida, this is workable.
  • That said, the impact here might be limited. Some states highest marginal rates exceed 10%, which certainly isn't nothing. But it isn't 37% (the highest marginal federal income tax rate, at time of writing) or 40% (estate tax) either.
  • Further, as with everything tax and law, it may not be as simple as it sounds. Determining what state you owe taxes too isn't entirely in your control, and forming a trust out of state is nowhere near a complete and simple solution to accomplishing this goal without substantial detail and care. Depending on the assets and income sources in question, it's possible that almost no amount of physical and paperwork geographical shifting will move all of the state tax liability.
    
    
• Step-up in Basis
  
  • Cost basis for an asset gets "stepped up" upon your death only when inherited, not when gifted or sold.
  • If a successor plans to or needs to sell an asset, it might make a difference whether it was passed on to them or gifted (directly or into a trust for their benefit).
  • For some family situations and some assets, achieving the step-up in basis (and more to the point, not jeopardizing it by changing ownership structures) might be the most important objective, trumping the others on this list.
    
    
• Flexibility - Changing Estate/Distribution Plans and Usage of Assets & Income
  • Some strategies to effect the objectives on this list necessarily involve cutting off your ability to (unilaterally) change important aspects of the plan, like who the beneficiaries are and how funds can be used.
  • Dictating the future uses and beneficiaries of your wealth is one of the most universal purposes of trust and estate work. While some of this can be accomplished simply, it can also get complicated quickly.
    • Consider what you want to happen while your spouse is still alive vs after. Then consider what happens if you, your spouse, or both are re-married and if you have children with different parents.
    • Then consider what could happen if your children divorce and re-marry and have their own children, and you'll quickly understand why not only documenting your intentions, but also retaining the right to change them, can really matter.
  • If you expect to have many years ahead of you, or even if you simply face a lot of unknowns right now, you may decide that it's not the right time to end your flexibility over assets, income, and beneficiaries of your estate, simply to accomplish, for example, a tax goal.

• Charitable Intent
  • A substantial subset of trust and gift planning involves getting funds to charitable causes, sooner or later, sometimes with tax advantages (which might be now or later).
  • While no general statement is always true, I generally consider it to be the case that if you don't actually want to get your money to charity, it's likely not the best strategy just to accomplish a side effect. To say it differently, you can do charitable planning efficiently, intelligently, and plan it to provide as much advantage as possible, but you should only be doing it if you really want money to get to charity in the end.
    
    
• Liability & Asset Protection
  
  • There are multiple forms of trusts that provide at least some level of benefit here, but it's definitely not the case that a trust protects assets from liability and creditors in all cases.
  • State laws matter quite a bit here. Different state laws treat even otherwise similar trusts very differently when it comes to the level of asset protection provided. This is always a question for your properly credentialed attorney. Sometimes assets are protected, but only after a specific amount of time, and that amount of time (like everything else) varies.
  • Interestingly, this element of trusts can turn out to be even more important than it initially sounds. For example, a trust that fails to protect trust assets from the creditors of the individual grantor might cause that trust to be treated differently by legal and tax authorities than intended (think: being treated as still your own assets instead of distinct assets of the trust), which might in turn subvert your intentions in forming and funding it.
    
    
• Generation Skipping Concerns ("Dynasty", "GST", "Rockefeller")
  • If your wealth is meant to survive and be passed on for multiple generations (congrats, by the way!), avoiding multiple layers of estate and generation skipping taxes might matter to you.
  • Again, this concern needs to be weighed against other concerns on the list, because the solution to this specific problem is not the solution to all problems.

The important thing to remember here is that the order of importance matters. The perfect trust to accomplish mitigating state income taxes on the sale of a business next year will not also accomplish your goal of minimizing estate taxes or even federal taxes on the proceeds of the same sale. And vice versa. If you have big plans for your principal funds, you may not be able to use the otherwise "ideal" trust structure for other purposes, because complete control and flexibility might matter more to you.

So, once you rank your goals, how do these goals get accomplished or not accomplished? What are the levers to pull? Because the legal aspect of this is so complex, I won't really try to oversimplify it here - BUT, all of those popular trust acronyms are made of words that tend to have generally accepted meaning and purpose, so we'll break some of that down here.

Key Trust Terminology, Features, and Distinctions:

• What is a trust?
  • A trust is an arrangement (document, legal entity) that allows one party to give control of assets (property, money) to a 2nd party (the trustee) to manage for the benefit of a 3rd party.
    
    
• Basic Terms:
  • Grantor / Settlor / Trustor
    • For the purposes of this conversation let's call this "you" - the person with the assets and who would still have them if not for the trust. The person setting up the trust and contributing the assets to it.
  • Trustee 
    • Broadly, who's in charge of managing and/or making decisions about (within the guidelines of the trust) and then actually distributing the trust assets or their income. Often, it's not you, but it could be. It definitely won't be you once you're not alive.
    • Co-Trustee - if there's more than one at a time
    • Successor Trustee - Trustee after the prior trustee can no longer fulfill that role.
  • Beneficiary - who the trust exists to benefit.
    • This is serious - beneficiaries don't just get the money when you die for the most part.
    • In many cases, the beneficiary(ies) dictate(s) what kind of uses the assets can have once they are in the trust. It's not impossible for this to be you while you're alive, in specific cases.
      
      
• Revocable vs Irrevocable
  • A revocable trust can be changed or canceled by the grantor during the grantor's lifetime.
  • An irrevocable trust can't be changed or canceled, at least not without the approval of a court or the beneficiaries.
    
    
• Non-Grantor vs Grantor 
  • Non-grantor - the trust is its own separate taxpayer - it pays income taxes at the rates for trusts and does not pass through to the grantor.
    • What is it good for?
      • Generally, avoiding tax treatment that applies to you but that may not apply to a trust located somewhere else.
      • Keep in mind that (at least at the time of this writing) tax rates for trust entities tend to be among the highest applied to anyone.
  • Grantor ("grantor-retained" or sometimes "intentionally defective") - the grantor retains certain rights and thus is the taxpayer for income / what happens in the trust.
    • What is it good for?
      • Retaining the power to control or direct the income or assets within the trust. Often the trade-off for that is tax advantages, but if done properly, assets may still be excluded from the taxable estate (as in an "Intentionally Defective Grantor Trust" or IDGT).
      • Paying taxes on the trust's income and gains at your own personal rate, when it's lower than the trust rate.
        
        
• In Estate vs Out of Estate | Gifts
  • Completed Gifts 
    • Completed gifts, generally, have left your possession and thus your estate. 
    • You must file a gift tax return (above applicable thresholds), the gift has left the estate and is counted toward your annual and/or lifetime exclusion.
    • The grantor gives up certain rights to accomplish this.
  • "Incomplete" Gifts 
    • Designed not to trigger the need for a gift tax return.
    • Trust assets remain in the estate and are thus intended not to be subject to gift tax.
    • Grantor must retain certain rights within the trust in order to accomplish this.
      
      
• "Split-Interest": Income/Lead vs Remainder
  • Sometimes a trust is split into two parts, the "income" interest and the "remainder" interest. Income and Remainder, then, are attributed to different beneficiaries.
  • Income beneficiaries benefit from the income produced by the assets. You might hear "Lead" in conjunction with this when charities are involved. The charity might receive the income "Lead" while the donor is alive, with the "remainder" upon the donor's death going elsewhere.
  • Remainder beneficiaries are entitled to the underlying assets that remain upon a set future event like the passing of the grantor / end of the trust.
    
    
• Annuity vs Unitrust:
  • Annuity income payout structures pay out a fixed percentage of the trust’s initial value each year.
  • Unitrust income has more varieties. For example, it might be calculated as a percentage of assets, actual net income, or net income with a make-up to account for variable returns.
    
    
• Dynasty (Generation Skipping, "GST", "Rockefeller")
  • The key issue here is duration.
  • The trust is built to last a very, very long time and to exist ongoing, benefiting future generations without changing owners (because the owner remains a single long-lasting trust).
  • The goal is to avoid layers upon layers of estate and GST taxes as the assets move from generation to generation.

Other Considerations:

• Funding the Trust
  • For the trust to "matter", assets need to be moved into it. The paperwork/entity alone don't accomplish much.
  • In the relatively simple case of the Revocable Living Trust that's designed to benefit and be controlled by oneself until they die, this involves retitling assets (eg, changing the deed on real estate, transferring stocks or cash into a "Trust" account in the appropriate name). 
  • For trusts with more restrictive attributes, you'll have to make big decisions about gifting, selling, and transferring assets to the trust.
    • Gifts, for tax purposes, have limits you'll want to be fully aware of and report properly.
    • Sales and transfers might be taxable events and will involve heavily regulated valuation rules.
    • All of this needs to be constructed very carefully by you and your financial, tax, and legal experts.
      
      
• Tax Deductibility
  • Again, to be intentionally general and non-exhaustive, the most common means of tax deductibility in this context will involve charitable contributions.
  • The world of charitable contributions is full of acronyms, BUT, since you've read this far, they are no longer confusing to you!
    • CLAT, CLUT, CRAT, CRUT, CLT, CRT all refer to means of getting money to charity via trust, and they primarily vary by which part gets paid to who (Lead Income, Remainder) and how income gets paid (Annuity, Unitrust).
  • Some other charity-related acronyms don't refer directly to trusts, like the DAF (Donor Advised Fund) and PIF (Pooled Income Fund) - those generally refer to destinations for charitable funds/vehicles with certain special and specific timing and payout characteristics that may or may not be a fit for your goals.
    
    
• Permissible Beneficiaries:
  • Is the grantor a permissible beneficiary while still alive?
  • Is the grantor's spouse?
    
    
•  Spousal
  • A Type - "Marital Trust"- takes advantage of unlimited marital deduction for estate tax, and leaves the remaining estate in the spouse's estate upon their death.
  • B Type - "Bypass", "Family", or "Credit Shelter" Trust - designed to maximize use of the gift and estate tax exemption threshold by limiting the surviving spouse's benefit to an extent that allows the assets not to be taxed as part of the surviving spouse's estate.
  • SLAT - "Spousal Lifetime Access Trust" - designed to benefit the spouse while the grantor is still alive. Generally, a way of removing assets from the taxable estate without the immediate family/household losing access in the meantime. Both spouses can sort of do this with each other, BUT those trusts must not be "reciprocal" or the whole thing doesn't work as intended.
  • QTIP - Under a QTIP ("qualified terminable interest property") trust, income is paid to a surviving spouse until that spouse's death. At that point, the balance of the funds is paid to the beneficiaries specified by the original grantor. These might come in handy if you have children from multiple marriages, and don't consider leaving all of your money to your current spouse to be the cleanest solution to achieve your wishes.
    
    
• Location
  • State and country matter a lot, since most of what works or doesn't work in trusts is a matter of law, and different states have different laws.
  • State income tax is just one consideration.
  • Some trust features simply can't exist in certain states.
    • An important example of this is the DAPT - A domestic asset protection trust, aka a self-settled spendthrift trust, is an irrevocable asset protection trust created by the grantor for the grantor’s benefit, and it can only exist in 19 states.
    • Very few states allow for the duration to create an effective Dynasty Trust.
    • Only a few states don't have their own income taxes.
  • As noted above, different states have different treatment of protection from creditors and who's considered exempt from that.
  • Further complicating matters, where you live as a resident at the time of forming a trust or at the time of making it irrevocable may have a lasting impact on the trust's treatment, income, etc.
    
    
• Distribution Committee (Control Considerations)
  • Above, I referred to the powers of the Trustee.
  • It's not always the trustee. If it makes sense for a trust structure, it could also be a committee that replaces to some extent the powers of the trustee for some set of circumstances or time period.
    
    
• ILIT - The Irrevocable Life Insurance Trust
  • This isn't exactly a distinct concept, but it's a use case that's different enough to warrant its own mention.
  • As I've mentioned repeatedly throughout this article, often achieving one goal comes at the expense of another. One example includes balancing gift and estate taxability against ongoing income taxability.
  • The interesting thing happening here is that you contribute relatively lower initial dollar amounts (insurance premiums, which must be contributed in a specific way) that later become income and estate tax free life insurance death benefits (generally larger amounts, relative to the premium paid) on your passing. As is often the case, to accomplish this, taxes are owed on growth within the trust in the interim. Taken alone, this isn't unique, and it can be accomplished with different savings and investment vehicles.
  • That said, cash value life insurance is one of few such vehicles with special tax treatment in the US, such growth within the policy and the subsequent death benefit payout may not turn out to be taxable to you or the trust, depending on your specific circumstances (always consult tax and legal experts when structuring and relying on such tools).
    
    
• Special Purpose: I'm going to consider the details of these to be out-of-scope for detailing in this article, but some (potentially important!) trusts have very specific use cases. Having a general awareness of special purpose trusts and vehicles can help to spark your awareness if the situation arises in your life where one could be a fit.
  
  • QPRT - Qualified Personal Residence Trust - a trust designed to allow someone to attempt to remove their residence from their taxable estate while still allowing them the legal right to live there while still alive.
  • Special Needs Trusts - an entire universe of trust planning that combines traditional trust planning concepts with the complex web of public benefit qualification rules as well as the potential challenges of beneficiaries with special needs, generally.
  • Real Estate: Real Estate in the US has a history of specialty legal and tax treatment, and trusts fall into that bucket.  
    • Delaware Statutory Trust (DST) - designed to split ownership of a property while allowing each owner to hold their share of ownership directly, unlike through a more typical partnership.
    • Land Trust - trusts designed to hold real property.
      
      

What To Do with This Information

As mentioned repeatedly above, law, tax, estate, and trusts are exceptionally complicated and still require the combined work of professionals to execute successfully. The purpose of the principles and thought starters above is to begin thinking in a structured way about (1) what it is you really want and (2) what is (at least sometimes) possible. The right experts can help you accomplish what I consider to be some pretty impressive goals - knowing where to look and how to think about it is a critical first step in making that a successful journey.

2024-7232564.1 Exp 11/2026