What is
a trust?
A trust is the
legal relationship that is created
when a person transfers property to a trustee
with the understanding that the trustee will manage the property for the
benefit of one or more beneficiaries. We use the term “property” here in its
broadest sense; it includes both real
property—such as land and buildings—and personal
property—such as bank accounts, stocks and bonds, and personal effects. The person who transfers the property to the
trustee is called a trustmaker. This person is also known as a settlor, grantor, or trustor. Usually, the trustmaker is also the trustee (or
perhaps co-trustee) and the initial beneficiary of the trust. For a variety of tax and asset preservation reasons, a married
couple will usually want to create two revocable living trusts instead of just
one. It is not uncommon for husbands and
wives to be the co-trustees of both of their trusts during their joint
lifetimes, and then, after the death of one spouse, to have the survivor serve
either as sole trustee or co-trustee with one or more other individuals or a
trust company.
A trust is controlled by a document called the trust instrument. If the trust instrument says that the
trustmaker can revoke the trust or change the trust instrument, the trust is
what we call a revocable trust. If the trust instrument does not allow the
trustmaker to change the trust instrument or revoke the trust, we have what is
called an irrevocable trust. Irrevocable trusts are also used in many
estate plans. They allow trustmakers to
make gifts but keep the recipients from having complete control over the gifted
assets.
One more quick explanation before we move on. A living
trust is one that you create during your lifetime by making a trust agreement
with a trustee and transferring assets into the trustee’s name. A testamentary
trust, on the other hand, is one that goes into effect and is funded (i.e., assets are transferred to the trustee)
following your death. Thus, a revocable living trust is one that you
create and fund during your lifetime, and over which you have virtually
complete control.
Will I
lose control of my assets when they are transferred to the trustee?
NO. The trustee is bound by the trust
instrument. You have final say over what
the trust instrument says, and failure to abide by the trust instrument can
make the trustee personally liable to the beneficiaries, including
yourself. This means that if the trustee
messes up, that person may have to pay for the mess out of his or her own
pocket. Most often, the trustmaker is
the initial trustee. In that situation,
the trustmaker does not have to worry about anyone questioning his or her
management of the trust for two reasons.
First, the trustee is usually granted very broad discretion to favor the
trustmaker as the initial beneficiary. Second,
the trustmaker of a revocable living trust has the power to amend the trust
instrument or to revoke the trust and get the trust assets transferred back
into the trustmaker’s name. Thus, no one
else is in a very good position to challenge what the trustmaker/trustee does
with the trust. In fact, potential
beneficiaries have a vested interest in not
doing anything that might cause the trustmaker to revoke the trust or change
the trust instrument in order to exclude a troublemaker. This is a simple demonstration of the “golden
rule” of estate planning:
If
your kids are good kids, they won’t stick their noses into what you do with
your trust. If they are bad kids, they
will at least act like good kids as long as you’re alive because they won’t
want to be disinherited. If you do not
have any children—or don’t have any that you like—don’t assume that revocable
living trusts are not a good idea for you.
There are many good reasons for creating trusts, and some of them may
apply to your situation.
How
does a revocable living trust avoid probate?
Once assets are transferred to the trustee, the
trustmaker no longer holds legal title to them—even if the trustmaker and the
trustee are the same person. Thus, if
the trustmaker dies, the trust continues, and the successor trustee (who is
named in the trust instrument) takes over administering the trust. Since a trust can’t die the same way a person
can, the trust assets will not be
subject to probate upon the trustmaker’s death. Title to the trust assets
simply remains in the trust, and the trust instrument tells the successor
trustee (i.e., whoever the trust
instrument identifies as next in line to serve as trustee) exactly what to do
with them. Any assets not transferred to
the trustee, however, will be subject to probate upon the trustmaker’s death.
What is
probate, anyway?
Probate is
the court proceeding to transfer a dead person’s assets to the people who are supposed to get them. Simple in concept, but humbug in
practice. Probate can easily take a year
or more to complete, and the attorneys’ fees and other costs associated with
probate could easily eat up 5% or more of a decedent’s gross estate. (“Decedent” is
lawyer talk for someone who has assumed room temperature—i.e., a “dead person.”) If a
decedent owned assets located in more than one state or country, it may be
necessary to have a probate in each jurisdiction where the assets are
located. If one probate is bad, you can
bet that more than one probate is worse.
In almost every case, probate is an awfully good thing to avoid.
In addition to the money and time that probate can
consume, another reason people try to avoid probate is that the court’s probate
files are public records. Nosy people
can go through the court’s probate files and gather all kinds of information
that may be profitable to them—and detrimental to decedents’ families. This is a growing concern, especially as we
see more and more cases of identity theft.
What
other benefits do revocable living trusts provide?
A revocable living trust can avoid a conservatorship
proceeding (sometimes called a “living probate”) in the event the trustmaker loses
the ability to handle assets.
Ordinarily, if a person becomes incompetent, a court must appoint a conservator
to administer the person’s assets on his or her behalf. The conservator must then account to the
court every year or so, and the whole conservatorship process can end up being extremely
costly and time consuming. Not only
that, but the documents in the court’s file are a matter of public record. Anybody who so chooses could go down to the
courthouse and find out personal information about you (such as the specific
diagnosis of your incapacity). Even
worse, that person can find out information about your assets and your family
members that would best be kept private.
On the other hand, if your assets had been held in trust, if you became
incompetent, the successor trustee could have stepped in—without court
action—and picked up the administration of the trust where you left off.
Trusts also allow you to have control over your estate even after
your death. If one of the
beneficiaries of your trust after your death is a minor, you will want your
trust to hold on to that beneficiary’s share of your estate until the
beneficiary reaches the age when you believe he or she will be mature enough to
handle it. Think back to when you turned
18. What would you have done if all of a
sudden you had more money than you knew what to do with? Would your little munchkins do any
differently? If you don’t plan for that
possibility, you could be setting up one of your loved ones to blow his or her
inheritance. If this does not appeal to
you, your trust document could provide, for example, that the share of any
beneficiary under the age of 25 will stay in trust until the beneficiary turns
25. In the meantime, the trustee could
make distributions to or for the beneficiary, but the beneficiary could not
demand that any distributions be made until he or she turns 25.
There is no magic to the age of 25; you could postpone
a beneficiary’s control over his or her inheritance to any age you wish. You could also use an event besides a
birthday to trigger a distribution from your trust. For example, your trust instrument could call
for a distribution when a child either turns 25 or graduates from an accredited
college or university, whichever happens first.
You could also have the trust assets distributed to a beneficiary in
increments—say a third of the trust principal at age 25, half of the remaining
assets at 30, and the rest at 35. You
could even set out different terms for each beneficiary. One beneficiary might be quite capable of
handling an inheritance at the age of 21, whereas another might never have that
ability. You can tailor your trust instrument to include appropriate
provisions for each situation.
Many clients choose to leave children’s inheritances
in trust during the children’s entire lifetimes to provide them with creditor protection and to avoid estate taxation upon their
deaths. The trust assets are available
to the children, who can pick the trustees of their individual inheritance
trusts, and the children can say where their remaining trust assets go when
they die. Thus, they get virtually all
of the control of outright ownership, while at the same time being spared two important disadvantages of outright
ownership: vulnerability to creditors
and susceptibility to predators. If
the trusts are set up and administered correctly, most creditors (including
ex-spouses) and questionable characters can be prevented from walking away with
your children’s inheritance. If that
wasn’t good enough, consider this: the
trust assets will not, at your children’s deaths, be counted as part of their
estates and subjected to estate tax.
Even the IRS goes away disappointed.
The technical term for this kind of trust is a “generation-skipping
trust.” Children are understandably
suspicious of the name, but they are not actually skipped—unless you want them
to be.
Revocable living trusts can be used to provide incentives for beneficiaries. As hinted at above, another thing you can do
through your revocable living trust is provide incentives for beneficiaries. For example, you could say in your trust
document that the Trustee will make distributions to a beneficiary only if he
or she earns a college degree. Another
type of incentive provision might be that the Trustee will match the income
earned by the beneficiary, as evidenced by the W-2 forms provided by the
beneficiary’s employer for income tax purposes.
The point is that your trust can cover a vast array of different
situations. You are limited only by your
own creativity and that of the professionals who help you design your trust.