Simona Ondrejkova, CFP

Feb 15, 2024

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Grantor Trust vs Non-Grantor Trust: What’s the Difference?

If you or your clients are considering an estate planning strategy that includes a trust, you may be wondering about the difference between the many types of trusts out there. Specifically, if you hear a trust referred to as a grantor trust, what does that mean? And how is this different from a non-grantor trust? 

Today, we’ll explain the difference between a grantor trust and a non-grantor trust and help you understand when to use each one to achieve your estate planning goals.

What is a grantor trust?

A grantor trust is a type of trust in which the person who creates the trust (known as the “grantor” or “settlor”) is treated as the owner of the trust property for income tax purposes. This means that the income generated by the trust is generally attributed to the grantor rather than the trust itself.

The key feature of a grantor trust is that the grantor retains certain powers or control over the trust that cause them to be considered the “substantial owner” for tax purposes under the Internal Revenue Code.

The individual who creates a grantor trust typically has one or more of the following powers:

• Power to revoke or terminate the trust
• Power to make changes or amendments to the trust document
• Power to manage and control the investments within the trust
• Power to direct how and when trust distributions are made
• Power to change the trust beneficiaries
• Power to substitute assets within the trust with other assets of equivalent value
• Power to borrow from the trust or use trust assets as collateral

Within a grantor trust, the grantor can also be the trustee of the trust. 

How is a grantor trust taxed?

For the purposes of income taxes, a grantor trust is a disregarded entity and does not have its own tax identification number. Instead, any income or earnings generated within the trust are passed along to the grantor. Because trust tax rates can be much higher than individual tax rates, this can be of benefit to the grantor. 

For estate tax purposes, because the grantor does not relinquish full control over the trust assets, these assets are still part of that individual’s estate upon death. Since the trust assets are not removed from the grantor’s estate, placing them into a grantor trust does not typically trigger the gift tax.

One strategy that allows individuals to reduce estate taxes while still retaining the grantor powers mentioned above is the use of the Intentionally Defective Grantor Trust (IDGT). The IDGT is an irrevocable trust created during the grantor’s lifetime that is defective for income tax purposes which means that the trust income is taxable to the grantor even while the assets are removed from their estate.

If the grantor’s objectives or tax situation changes enough to justify doing so, it is possible to convert a grantor trust into a non-grantor trust.

When should you use a grantor trust and how do you set it up?

If you want to retain control over your assets while you’re alive and don’t mind paying the income taxes on the trust earnings, a grantor trust can be a great tool. Since taxes don’t have to be paid directly out of the trust, this might allow the trust assets to grow faster.

You can also use a grantor trust as part of a larger estate planning strategy to reduce taxes or pass your assets in a structured way to achieve certain outcomes. 

Some common types of grantor trusts you can use include:

• Grantor retained annuity trust (GRAT)
• Spousal Lifetime Access Trust (SLAT)
• Irrevocable Life Insurance Trust (ILIT) 
• and most revocable living trusts.

To set up a grantor trust, you can visit an estate planning attorney or use an estate planning software to craft the trust document. As the grantor of the trust, you can then specify the trust’s beneficiaries, trustees, and terms of the trust. 

What is a non-grantor trust?

A non-grantor trust is a trust where the grantor relinquishes control over the trust property after the trust is established. Unlike a grantor trust, where the grantor is considered the owner of the trust property for tax purposes, a non-grantor trust is a separate legal and taxable entity. It has its own tax identification number (TIN) and files its own income tax return.

In a non-grantor trust, the grantor typically does not retain the power to revoke the trust or make significant changes to its terms. The benefit of this feature is that it provides asset protection from creditors. It also removes the assets from the grantor’s estate which can be useful in certain estate planning strategies used to reduce estate taxes.

So who controls a non-grantor trust, if not the grantor? The trustee is the one who gets the power to manage and distribute the trust assets in accordance with the trust terms. When setting up the trust, the grantor of a non-grantor trust gets to specify the trustee and the successor trustee of the trust.

How is a non-grantor trust taxed?

The income generated by a non-grantor trust is generally taxed at the trust level rather than being passed through to the grantor’s individual income tax return. If the trust earnings are distributed, however, they are then taxed directly to the beneficiaries. This can be beneficial if the beneficiaries are in a lower tax bracket than the trust.

Because the assets are effectively transferred out of the estate of the individual creating the trust, they may be subject to gift tax. For purposes of the estate tax, however, the upside of this is that the assets will now be “frozen” in value as any future growth will occur inside the trust and therefore will not be part of the grantor’s taxable estate upon their death.

When it comes to estate and gift taxes, the assets transferred into a non-grantor irrevocable trust are removed from the estate of the grantor. This could potentially trigger the gift tax, depending on whether the transfer to the trust is considered a present interest gift (i.e. the trust beneficiaries have crummey powers) such that the gift can be offset with the annual exclusion ($18,000 per beneficiary in 2024) and whether the grantor has used up his estate and gift tax exemption ($13.61 million per individual in 2024).

When should you use a non-grantor trust and how do you set it up?

If you’re concerned about asset protection or want to move certain fast-growing assets out of your estate to save on income taxes while you’re alive, consider using a non-grantor trust. Keep in mind, however, that you will no longer have control over the assets as you would in the case of a grantor trust.

As with setting up a grantor trust, setting up a non-grantor trust can be achieved by meeting with an estate planning attorney or using an estate planning software. As the grantor of the trust, you can specify the trust’s beneficiaries, trustees, and terms of the trust. Once you form and fund the trust, however, you will no longer have the ability to make changes to the trust.

Some common types of non-grantor trusts you can use include:

• Bypass trust
• Charitable remainder trust (CRT)
• Charitable lead trust (CLT)(can be set up as grantor or non-grantor)
• Qualified personal residence trust (QPRT)
• Qualified domestic trust (QDOT).

For a more complete list of trusts, download our Guide to Trusts for Estate Planning.

What is the main difference between a grantor and non-grantor trust?

The main difference between a grantor and a non-grantor trust is in the tax treatment and the grantor’s control over the assets once the trust is established.

A non-grantor trust definition implies that the trust is the opposite of a grantor trust in that the individual creating the trust does not retain power over the trust assets. On the other hand, depending on the powers the grantor retains over the trust, a grantor trusts may allow the grantor to make changes to the trust terms, investments, or beneficiaries. non-grantor trusts, on the other hand, offer asset protection from creditors.

While any earnings within a grantor trust are taxed to the grantor, any earnings within a non-grantor trust are taxed to the trust which is established as its own tax entity.

If you’re a financial advisor looking to help your clients decide between a grantor vs a non-grantor trust, you can use our estate planning checklist for financial advisors to get started. This checklist will help you put together the essential documents needed to create or update a solid plan to achieve your legacy goals.

The information provided here does not constitute legal, financial, or tax advice. It is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with an estate attorney, financial advisor, or tax professional who can advise as to your particular situation.