Do You Need a Grantor or a Non-Grantor Trust?
Setting up an irrevocable or a revocable trust can be a great way to protect your assets and plan for the future. But did you know that aside from irrevocable and revocable, there are other factors that indicate what type of trust you have? All of these types of trusts offer different benefits and may impact trust administration.
In this quick guide, you’ll learn the difference between a grantor trust and a non-grantor trust. We’ll also cover some potential benefits of each, what implications each type has for taxes, and how you can decide what type of trust is right for you.
What Is a Grantor Trust?
The Internal Revenue Code notes that a grantor trust is created when the grantor retains controlling power over the assets or income of the trust. The grantor is the person who establishes the trust and often the person who funds it. Other terms for grantor include creator, trustor, and settlor.
For example, imagine that Mike creates a trust and funds it with $500,000. Mike maintains control over the assets. He might make decisions about how the funds are invested and when income or funds can be dispersed and to whom. This makes the trust a grantor trust.
If the trust is a revocable trust, Mike also retains the benefits of the assets and income. In short, he acts as the beneficiary of the trust. At any point, though, Mike can change the beneficiary of the trust to someone else.
Benefits of a Grantor Trust
Grantor trusts are popular because they come with a variety of benefits. Most of the benefits are related to the control that the grantor retains over the trust and the assets within it. Some potential benefits of a revocable grantor trust include:
- The grantor can change the beneficiary. The grantor can make changes to the beneficiaries of the trust when desired. In the hypothetical example above, Mike set up a trust with himself as the beneficiary. Imagine that Mike gets married and wants to add his wife as a beneficiary; with a revocable grantor trust, this is possible.
- The grantor can revoke the trust. A revocable trust is one that can be altered or undone in the future. If a grantor creates such a trust, they can undo it later, providing ample flexibility for the future.
- The grantor can manage the assets. As the grantor of a grantor trust, you retain control over how the assets are managed. That can be important if you want to grow the wealth in the trust a certain way or ensure the assets are used for specific things during your lifetime.
According to the IRS, all revocable trusts are grantor trusts. You can, however, have an irrevocable trust that is treated as a grantor trust in certain cases.
What Is a Non-Grantor Trust
If a trust doesn’t meet the definition of a grantor trust, it is considered a non-grantor trust. The person who established the trust doesn’t retain any rights to control the assets within the trust. Instead, they create trust parameters that govern how the trust is administered.
For example, imagine that Mike gets divorced. He wants to provide for the children from his marriage and his ex-wife in a way that allows him to retain tax savings while also protecting the assets from any future person his wife might marry. Mike could set up a non-grantor trust with his ex-wife and children as beneficiaries.
One of the main benefits of a non-grantor trust is the tax implications for the grantor.
The Tax Differences Between Grantor and Non-grantor Trusts
It’s important to work with a legal or tax professional when considering the exact details of taxes and trusts. These matters can be complex, and it’s obviously important to ensure you have all the details right before you commit to legal structures or other estate-planning or trust-creation decisions.
That being said, there is one major tax difference between grantor and non-grantor trusts that is fairly straightforward. A non-grantor trust is a different taxpayer than the grantor. It must have its own Tax ID Number, and the income of the assets within the trust is taxed to the trust.
However, a grantor trust is taxed to the grantor. That means the grantor continues to be responsible for the taxes on the income of the assets in the trust. This is generally a good thing because the grantor’s tax bracket is almost certainly much more favorable than trust tax brackets.
The Internal Revenue Code has a lot to say about what factors make a grantor trust and when grantors are responsible for the taxes on the income of assets in a trust. You can’t, for example, establish what you call a non-grantor trust to avoid income tax issues and then attempt to maintain a certain level of control over the assets.
How Do You Know What’s Right for You?
Understanding what type of trust is right for you is only the first decision in a line of decisions you’ll need to make when setting up trusts. Because these decisions require considering fairly complex legal, financial, and tax matters, it’s typically a good idea to work with an experienced estate planning and trust attorney.
Your attorney can consider your needs and goals and help you understand what types of trust are right for you. Get started today by calling the Stone Arch Law Office at 612-502-5746 to make an appointment.