Non-Grantor Trusts

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on July 27, 2023

Ask a Financial Professional Any Question

Definition of Non-Grantor Trusts

Non-grantor trusts are legal entities established to hold and manage assets for the benefit of designated beneficiaries.

Unlike grantor trusts, where the grantor retains control and is treated as the owner for income tax purposes, non-grantor trusts are considered separate taxable entities, with their own tax identification numbers and filing requirements.

Purpose and Benefits of Non-Grantor Trusts

Non-grantor trusts serve various purposes, including estate planning, asset protection, tax minimization, and charitable giving. They offer privacy, flexibility, and control over the distribution of assets while safeguarding them from creditors and potential legal liabilities.

Comparison With Grantor Trusts

Grantor trusts, in contrast, are designed to provide more control to the grantor, who retains certain rights and powers. This control comes at the cost of grantor trusts being treated as "owned" by the grantor for income tax purposes, potentially resulting in higher taxes.

Types of Non-Grantor Trusts

Types of Non Grantor Trusts

Irrevocable Trusts

Irrevocable trusts are trusts that cannot be altered or revoked by the grantor once established. They offer various tax benefits and asset protection features. Some common types of irrevocable trusts include:

Irrevocable Life Insurance Trust (ILIT)

An ILIT is designed to hold a life insurance policy, with the trust as the policy owner and beneficiary. It helps exclude the policy's proceeds from the grantor's taxable estate.

Charitable Remainder Trust (CRT)

A CRT provides an income stream to beneficiaries for a specified period, after which the remaining assets are transferred to a designated charity.

Qualified Personal Residence Trust (QPRT)

A QPRT allows a grantor to transfer a personal residence to beneficiaries at a reduced gift tax cost while retaining the right to live in the residence for a specified term.

Grantor Retained Annuity Trust (GRAT)

A GRAT provides the grantor with a fixed annuity income for a specified term, after which the remaining trust assets are transferred to the beneficiaries.

Special Needs Trusts

These trusts are designed to provide financial support to a beneficiary with special needs without jeopardizing the beneficiary's eligibility for government assistance programs.

Spendthrift Trusts

Spendthrift trusts protect trust assets from being seized by creditors and help ensure that beneficiaries use the assets in a fiscally responsible manner.

Generation-Skipping Trusts

These trusts enable the grantor to transfer assets directly to future generations while minimizing estate, gift, and generation-skipping transfer taxes.

Establishing a Non-Grantor Trust

Steps in Establishing a Non-Grantor Trust

Selection of Trustee(s)

The grantor must appoint a trustee or trustees who will be responsible for managing the trust assets, making distributions, and handling administrative tasks.

Drafting the Trust Agreement

A trust agreement is a legal document that outlines the terms and conditions governing the trust, including the rights and responsibilities of the trustee(s) and beneficiaries.

Funding the Trust

The grantor must transfer assets to the trust, which can include cash, real estate, securities, and other types of property.

Tax Identification Number and Filing Requirements

A non-grantor trust must obtain a tax identification number (EIN) from the IRS and file annual tax returns.

Tax Implications

Income Tax Consequences

Trust Income Taxation

Non-grantor trusts are subject to income tax on their undistributed income and may be subject to tax at higher rates than individuals.

Distribution Deductions

Non-grantor trusts can claim deductions for distributions made to beneficiaries, reducing the trust's taxable income.

Taxation of Trust Beneficiaries

Beneficiaries may be required to include trust distributions in their taxable income, potentially subjecting them to higher income tax rates. However, in some cases, trust distributions may carry tax benefits, such as reduced tax liability.

Estate and Gift Tax Considerations

Exclusions and Exemptions

Transferring assets to a non-grantor trust may be subject to federal gift tax. However, the grantor can utilize the annual exclusion and lifetime exemption to minimize or eliminate gift tax liability.

Generation-Skipping Transfer Tax

Generation-skipping trusts may be subject to the generation-skipping transfer (GST) tax. The grantor can allocate their GST tax exemption to help minimize or avoid this tax.

Valuation Discounts

By using certain non-grantor trust structures, such as GRATs and QPRTs, grantors can benefit from valuation discounts, which help to reduce gift tax liability.

Uses of Non-Grantor Trusts

Asset Protection

Non-grantor trusts help protect assets from creditors, lawsuits, and other legal liabilities by placing assets under the control of an independent trustee.

Tax Minimization

Non-grantor trusts can offer various tax benefits, such as the exclusion of assets from the grantor's taxable estate and reduced gift tax liability.

Charitable Giving

Charitable trusts, such as CRTs, allow grantors to combine philanthropy with tax and estate planning benefits.

Estate Planning

Non-grantor trusts can help grantors achieve their estate planning goals by providing for beneficiaries, minimizing taxes, and controlling the distribution of assets.

Special Needs Planning

Special needs trusts ensure that beneficiaries with special needs maintain their eligibility for government assistance programs while receiving financial support from the trust.

Generational Wealth Transfer

Generation-skipping trusts allow grantors to transfer assets directly to future generations, minimizing estate, gift, and generation-skipping transfer taxes.

Challenges and Potential Drawbacks

Loss of Control

Once a non-grantor trust is established, the grantor typically loses control over the trust assets and cannot alter or revoke the trust.

Trust Administration Complexity

Non-grantor trusts can be complex to administer, requiring professional advice and ongoing management by trustees.

Legal and Accounting Fees

Establishing and maintaining a non-grantor trust may involve significant legal and accounting fees, which should be weighed against the potential benefits.

Potential Conflicts Among Beneficiaries

Conflicts may arise among beneficiaries, particularly when the trust assets are not distributed equally or when beneficiaries have differing interests.

The Bottom Line

Non-grantor trusts play a crucial role in estate and tax planning, providing numerous benefits and helping individuals achieve their financial and personal goals.

Each non-grantor trust should be tailored to the grantor's specific needs and objectives, taking into account factors such as family dynamics, asset types, and tax considerations.

Professional advisors, such as attorneys, accountants, and financial planners, can provide valuable guidance and assistance in establishing and managing non-grantor trusts, ensuring that they are structured and administered effectively to achieve the grantor's goals.

Non-Grantor Trusts FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

Search Estate Planning Law Firms in Your Area

Find Advisor Near You