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What kinds of trusts are there?

There are two basic types of trusts: living trusts and testamentary trusts. A living trust or an "inter-vivos" trust is set up during the person's lifetime. A Testamentary trust is set up in a will and established only after the person's death when the will goes into effect.

Living trusts can be either "revocable" or "irrevocable."

Revocable trusts allow you to retain control of all the assets in the trust, and you are free to revoke or change the terms of the trust at any time.

With irrevocable trusts, the assets in it are no longer yours, and typically you can't make changes without the beneficiary's consent. But the appreciated assets in the trust aren't subject to estate taxes.

There are many more complicated types of trusts, too, that apply to specific situations. Some include:

Credit shelter trusts: With a credit-shelter trust (also called a bypass or family trust), you write a will bequeathing an amount to the trust up to but not exceeding the estate-tax exemption. Then you pass the rest of your estate to your spouse tax-free. And there's an added bonus: Once money is placed in a bypass trust, it is forever free of estate tax, even if it grows.

Generation-skipping trusts: A generation-skipping trust (also called a dynasty trust) allows you to transfer a substantial amount of money tax-free to beneficiaries who are at least two generations your junior - typically your grandchildren.

Qualified personal residence trusts: A qualified personal residence trust can remove the value of your home or vacation dwelling from your estate and is particularly useful if your home is likely to appreciate in value.

Irrevocable life insurance trusts: An irrevocable life insurance trust can remove your life insurance from your taxable estate, help pay estate costs, and provide your heirs with cash for a variety of purposes. To remove the policy from your estate, you surrender ownership rights, which means you may no longer borrow against it or change beneficiaries. In return, the proceeds from the policy may be used to pay any estate costs after you die and provide your beneficiaries with tax-free income.

Qualified terminable interest property trusts: If you're part of a family in which there have been divorces, remarriages, and stepchildren, you may want to direct your assets to particular relatives through a qualified terminable interest property trust. Your surviving spouse will receive income from the trust, and the beneficiaries you specify (e.g., your children from a first marriage) will get the principal or remainder after your spouse dies.

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