Probate and Planning
What Is a Trust?
A trust manages the distribution of your assets. A trust is created by the transfer of property by the owner (sometimes called the “grantor,” “donor,” or “settlor”) to another person (the “trustee”). A trustee can be a professional with financial knowledge, a relative or friend, or a professional trust company. The trustee holds the title to the property and manages the property for the benefit of the beneficiaries who may be a specific person, a group of people, or an organization.
What Are the Basic Types of Trusts?
There are two basic types of trusts. A “testamentary” or “after-death trust” is created by the settlor’s will which transfers property to the trust. A “living” or “intervivos” trust is created during the lifetime of the grantor when all or part of the grantor’s property is transferred into the trust.
Testamentary or After-Death Trusts
An after-death trust will be created by a will after a person’s death. The assets to fund these trusts must usually go through the probate process and may be supervised by the court even after the estate is closed. An example of an after-death trust would be one created by a parent leaving land to a trust to benefit a minor child in his or her will. The will establishes the trust to which the land is transferred, to be administered by a trustee until the child reaches a stated age, at which point title to the land is transferred to the child outright.
A living trust is a trust made while the person establishing the trust is still alive. In this case, a parent could establish a trust for a child during his or her lifetime, designating himself or herself as trustee and the child as beneficiary. As the beneficiary, the child does not own the property, but instead receives income derived from it. Living trusts can be revocable or irrevocable.
The most popular type of trust is the revocable living trust, which allows the settlor to make changes to the trust during his or her lifetime. A revocable trust usually directs the trustee to pay all income to the settlor for life and to pay the trust assets to named persons after the settlor’s death. Revocable living trusts avoid the often lengthy probate process but, by themselves, don’t provide shelter for assets from federal or state taxes. These trusts are often considered tax-neutral as the tax consequences for the grantor are usually the same whether or not the property is placed in a trust.
An irrevocable living trust is usually set up to reduce estate or income taxes. For tax purposes, the trust becomes a separate entity; the assets cannot be removed nor can changes be made by the settlor. In most cases, the settlor cannot be sole trustee of an irrevocable trust without losing the intended tax benefits.
Trusts can be tailored to fit your goals. An attorney can help you evaluate your particular needs in light of your overall estate planning objectives. Here are a few special uses for trusts:
- A charitable trust is used to make donations and realize tax savings for an estate. Typically, you transfer property, such as art or real estate, to a trust. The trust holds the asset until it is transferred to a charity, usually after your death. The donor may continue to enjoy the use of the property and also realize estate tax savings by donating it to a charity.
- A bypass trust allows a married couple, in certain cases, to shelter more of their estate from estate taxes. The first spouse to die can leave assets in a trust which provide income to the surviving spouse. Upon the death of the second spouse, the assets in the trust belong to the children or other beneficiaries, without being taxed at the second spouse’s death.
- A spendthrift trust can be a good idea if the beneficiary is too young or does not have the mental capacity to handle money. The trust can be established so that the beneficiary receives small amounts of money at specified intervals. It is designed to prevent the young person from squandering money or losing the principal in a bad investment. Further, creditors will not be able to take a beneficiary’s income from this trust.
- A life insurance trust is often used to give an estate liquidity. In this case, the trustee of the trust is named as the beneficiary of the life insurance policy. The trust then receives the life insurance proceeds upon the death of the insured.
What Are the Pros and Cons of a Revocable Living Trust?
Revocable trusts offer some advantages. First, a revocable living trust enables you to have a trustee with financial expertise manage your assets during your lifetime. The trustee with financial experience might charge a fee of around one percent of the total amount of the property in the trust. This arrangement is particularly useful if you are having difficulty managing your financial affairs. A trustee could invest your assets, arrange for payment of bills and debts, and file your tax returns. If you wish, you can establish yourself as a co-trustee.
Second, a revocable living trust can protect your privacy regarding the distribution of your assets. With a will, the probate laws require that an inventory of the estate’s assets be filed with the court. The will and the inventory are public information. With a revocable living trust, generally only the beneficiaries of the trust will be informed of the nature and the value of the assets. The important thing is to make sure that all of your property is in the trust.
Third, by placing your assets in a revocable living trust instead of a will, you can avoid the time delays that are typical of probating a will. Trust assets, in most situations, can be distributed to beneficiaries almost immediately after the death of the grantor.
Fourth, if you own land in another state, a revocable living trust might help you avoid a probate proceeding in the other state for that property. For example, if you have a cabin in Wisconsin and place it in a revocable living trust, you may be able to avoid a Wisconsin probate proceeding.
There are some potential drawbacks to a revocable living trust. First, transferring property into a revocable living trust may make you ineligible for Medical Assistance. Second, when the grantor is also the trustee, the grantor has a fiduciary obligation to the beneficiaries for both present and future income. A fiduciary duty is a high standard that requires the trustee to follow the terms of the trust and the law in good faith and with loyalty, confidence, and candor to the beneficiaries.
How Do I Establish a Trust?
Establishing a trust requires a document that specifies your wishes, lists beneficiaries, names a trustee or trustees to manage the assets, and describes what the trustee or trustees may do. For a living trust, you can name yourself as trustee but, if you do, you should also name a successor trustee to take over if you should become disabled or die. Once the document is completed, you must transfer the assets to the trust. Keep in mind that, in the case of certain assets, such as real estate, you may incur fees and transfer taxes.
If the living trust contains all of your property, a will may be unnecessary and you can avoid probate. If the trust contains only part of your property, you need a will for the rest of it. If you want your property to go into the trust after your death, your will should include a “pour-over” provision to put the remaining property into the trust upon your death. Also, a will can be used to distribute personal belongings, identify guardians for your children, and provide for a personal representative to handle any unfinished business. If assets are not put into a trust and are disposed of by a will, they will have to be probated, which negates the advantage of the living trust.
Prepared forms or kits used to establish living trusts are currently marketed through magazines, brochures, and door-to-door salespeople. Review these forms carefully; they may be too generic to suit you and your situation.
Watch out for investment scams advocating unrealistic benefits of a trust. Also beware of workshops conducted by people with the intent to sell you something rather than to provide objective information. If you want to set up a trust, be sure to talk with people who are credible and trustworthy.
You may want to consider contacting an attorney if you would like to set up a trust. An attorney can help you evaluate the need and uses of a trust in light of your overall estate planning objectives.
What Is the Role of the Trustee?
The trustee is considered a fiduciary and therefore must adhere to a high standard of care with respect to the trust. Included in this standard is the duty to protect trust property, to manage trust investments prudently, to refrain from engaging in self-dealing or receiving improper benefits from the trust, and to not mingle trust assets with the trustee’s own assets. The trustee has a duty to manage the trust’s assets in the best interests of the beneficiary or beneficiaries. This might include managing rental properties, investing funds, or paying income to the beneficiary.
Trusts differ in how a trustee can distribute trust income. A simple or mandatory trust requires the trustee to distribute income to the beneficiary. A complex or discretionary trust may afford the trustee discretion over the principal and income to be distributed. The requirements imposed on the trustee should be specified in the trust.
If you want to name someone as a trustee, talk with that individual or entity about the trust. Be sure the person not only agrees to serve as trustee but can comply with the terms of the trust. Because the fiduciary standard imposes such a high standard of duty and corresponding potential liability, the trustee cannot be forced into becoming a trustee just because he or she is named in a trust document or will. If your designated trustee is unable or unwilling to perform, the court will appoint a trustee for you, unless a successor trustee, such as a corporate trustee, is designated, or the beneficiaries of the trust unanimously agree to appoint a new trustee.