What is a grantor trust?

You make decisions every day, from what you’ll have for breakfast to how you’ll spend your evening. But it’s important to consider the choices that go beyond the present and look toward the future — including what happens to your property when you pass away. For many people, setting up a trust is a great option for distributing their assets after they’ve passed on.  

A trust is a legal arrangement that lets you decide who should receive your property after you die. As the creator of a trust — known as a grantor — you’re responsible for deciding the trust’s terms and determining what assets it holds. You also choose who should oversee the trust, both during your lifetime and after you pass away. This person is known as a trustee.

Many grantors choose to manage their trust themselves, which lets them maintain control over their assets and makes the trust a “grantor trust.”

What is a grantor trust?

“Grantor trust” is an umbrella term that refers to any trust in which the grantor is considered the owner of the assets in the trust for income tax purposes. This means, as the grantor, you’re responsible for paying income taxes on any income the trust assets generate. For example, this could include paying tax on income-producing assets, like bonds.

There are many types of trusts that can be considered a grantor trust. One of the most common is a revocable living trust.

Grantor trust status

“Grantor trust status” means a trust is considered a grantor trust for tax purposes. There are many types of trusts that can be considered a grantor trust. Whether a trust triggers “grantor trust status” will depend on the authority, or powers, that a grantor has. These powers can include:

• Serving as the trustee
• Adding or removing beneficiaries in a trust
• Maintaining the right to cancel the trust at any time and get the property back

Grantor trusts can be a complex topic. If you have questions, consider working with an estate planning attorney.

Are grantor trusts revocable or irrevocable?

All trusts fall into one of two categories: revocable trusts and irrevocable trusts.

A revocable living trust (RLT) is a trust you create during your lifetime. With an RLT, you have the flexibility to make changes to your trust at any time, including adding or removing beneficiaries, changing your trustee, or even canceling the trust altogether. Because of these features, all RLTs are grantor trusts while the grantor is alive.

Grantor trusts can also be irrevocable, but this is less common. Irrevocable trusts are commonly used to reduce estate tax exposure, which usually only apply to very large estates. Irrevocable trusts are also more rigid and don’t allow the grantor to hold on to as many powers, like acting as trustee or retaining control over the assets in the trust.

There are some exceptions to this. Intentionally defective grantor trusts (IDGTs) and irrevocable life insurance trusts (ILITs), for example, are types of irrevocable trusts where you keep certain powers, like paying life insurance premiums from trust income. IDGT and ILIT tax rules can be complex, so it’s best to work with an estate planning attorney to learn more about these types of trusts.

Benefits of a grantor trust

Trusts offer a variety of benefits, and grantor trusts are no exception. A grantor trust may be right for you if:

• You want to reduce the financial burden on your loved ones. When you’re responsible for the trust’s income tax, the assets in the trust grow tax-free. This means that, when you pass away, there will be more assets in the trust to pass to your beneficiaries. In addition, the value of your own estate decreases. This can mean a smaller estate tax bill for your estate after you pass away — and more assets passing to your loved ones.
• You want your assets to avoid probate. Probate is the court-supervised legal process of distributing your estate according to your last will and testament. Trust assets don’t have to go through the probate process, which can save your heirs time, money, and hassle.
• You want to retain important powers over the trust during your lifetime. A grantor trust provides you with more flexibility than other trust options. Depending on the type of grantor trust you choose, you can add or remove beneficiaries, change your trustee, or cancel the trust.

A grantor trust does have potential drawbacks. By claiming trust income as part of your taxable income, you run the risk of being pushed into a higher tax bracket — which can increase the taxes and fees you owe while you’re still alive.

What happens to a grantor trust when the grantor dies?

When you die, your grantor trust will become a non-grantor trust. Your chosen successor trustee will assume responsibility for managing and distributing the trust. Once this happens, the trust will then become responsible for paying any income taxes generated by its assets.

Unlike grantor trusts — which generally use the grantor’s Social Security number — non-grantor trusts need their own tax identification number. When you pass away, your successor trustee will need to apply to the Internal Revenue Service for a taxpayer ID specifically for the trust.

Creating a grantor trust

A grantor trust is a type of trust where the grantor retains ownership of trust’s assets for income tax purposes. This means that the grantor — not the trust — is responsible for paying income taxes on trust earnings.

Trusts can offer several advantages, like allowing your property to avoid probate. Grantor trusts can help you pass more money to your loved ones, while allowing you to hold on to important powers during your lifetime.

If you're interested in a trust, you can take advantage of FreeWill’s revocable living trust tool to create your trust documents in as little as 20 minutes.