A trust is a very useful legal arrangement which may save you, your heirs, and beneficiaries a great deal of money, time, and trouble, as well as help to keep important matters private.
A trust is what one might consider an “extra” document to a basic estate plan (but an “extra” that can be super helpful, for the reasons discussed below). Over the last several blog posts, I discussed the six basic documents that should be part of most everyone’s estate plan:
- Estate planning questionnaire
- Power of attorney for health care
- Power of attorney for financial matters
- Disposition of personal property
- Disposition of final remains
At the outset of this seven-part series of blog posts about estate planning, I explained the basics of a will. Then, I covered health care power of attorney, and also financial power of attorney. Most recently, I blogged about disposition of final remains.
When should you consider setting up a trust? You might consider a trust if you have:
- A blended family;
- More than $1 million in total assets;
- Unusual assets (such as one or more antique automobiles);
- Complex assets (for example, more than one piece of real estate, like a home and a vacation cabin); and/or
- Ownership of part or all of a business.
In such cases, as well as others (talk to your estate planning lawyer!), a trust may be helpful.
WHAT IS A TRUST? HOW DOES IT WORK?
A trust will ensure that your wishes are followed and your assets appropriately handled after your death. A trust is simply a legal agreement among three parties—settlor, trustee, and beneficiary—that provides instructions on how and when to pass assets to the trust’s beneficiaries. Let’s look at the role of each of these three parties, then delve more deeply into how trusts work.
A settlor—sometimes called the “donor, “grantor,” or “trustor”—is the person who creates the trust and has the legal authority to transfer assets into it.
The trustee is the person who agrees to accept, manage, and protect the assets delivered by the settlor. The trustee has a fiduciary duty to administer the assets according to the trust’s instructions, and distribute the trust income and principal according to the rules outlined in the trust document. Distribution is done in the best interests of the beneficiary.
A trustee can be one, two, or more people. A trustee can also be what is known as a “corporate trustee,” such as a financial institution (like a bank) or a law firm that performs trustee duties and charges fees for their services. There are no formal requirements for being a trustee, and nonprofessionals frequently serve as a trustee for family members and friends.
The beneficiary is the person or entity benefiting from the trust. The beneficiary can be one person or entity or multiple parties. Trust beneficiaries don’t even have to exist at the time the trust is created (such as in the case of a future grandchild or a charitable foundation that has not yet been established).
A trust can be either funded or unfunded. “Funded” means that the settlor’s assets—sometimes called the “principal” or the “corpus”—have been placed into the trust. A trust is “unfunded” until the assets are in it. Please note that failing to fund a trust is a common estate planning mistake!
Trusts can hold just about any kind of asset: real estate, intangible property, business interests, and personal property. Common trust properties include farms, buildings, vacation homes, stocks, bonds, savings and checking accounts, collections, personal possessions, and vehicles.
Think of a trust as an “imaginary container” that holds and protects your assets. After the trust is funded, the trust property will remain in the same place as before the trust was created—your land will remain where it always was, your artwork on the wall, your money in the bank, your comic book collection in the den. The only difference is the asset will have a different owner: “The Jane Jones Trust,” rather than Jane Jones.
TRANSFER OF OWNERSHIP
Putting property in a trust transfers it from personal ownership to the trustee, who holds the property for the beneficiary. The trustee has what is called “legal title” to the trust property and, in most instances, the law treats trust property as if it were now owned by the trustee. Each trust has its own taxpayer identification number, just like an individual.
Do not be mistaken, trustees are not the full owners of trust property. Trustees have a legal duty to use trust property as directed in the trust agreement and as allowed by law. However, the beneficiaries retain what is known as “equitable title”—the right to benefit from trust property as specified in the trust.
ASSETS TO BENEFICIARY
The settlor provides terms in a trust agreement directing how the fund’s assets are to be distributed to a beneficiary. The settlor can provide for the distribution of funds in any way, so long as it is not against the law or against public policy. The near-limitless flexibility of trusts is a primary advantage for setting one up.
TYPES OF TRUSTS
A joke among estate planners says that the only limit to trusts is the imagination of lawyers. It’s true, though, that the number and kind of trusts are virtually unlimited.
Let’s start by taking a look at the four primary categories of trusts:
INTER VIVOS AND TESTAMENTARY TRUSTS
Trusts that are set up during the settlor’s lifetime are called “inter vivos” trusts.
Those that arise upon the death of the settlor, generally by operation of a will, are called “testamentary” trusts. There are advantages and disadvantages to both types of trusts, and how one decides depends upon the goals and purposes of the settlor.
REVOCABLE AND IRREVOCABLE TRUSTS
Inter vivos and testamentary trusts can be broken down into two more categories: revocable trusts and irrevocable trusts. A revocable trust, just as you might infer from the name, can be changed at any time during the settlor’s lifetime. The settlor can alter parts of the trust or even revoke the entire document.
An irrevocable trust, again, is as it sounds – it’s a type of trust that can’t be changed by the settlor after the agreement has been signed and the trust has been formed and funded. The terms of an irrevocable trust can’t be modified, amended, or terminated without the permission of the settlor’s beneficiary or beneficiaries.
A revocable living trust becomes irrevocable when the settlor dies because he or she is no longer available to make changes to it. A revocable trust can be designed to break into separate irrevocable trusts at the time of the grantor’s death for the benefit of children or other beneficiaries.
You might wonder, “Why make a trust irrevocable? Wouldn’t you want to maintain the ability to change your mind about the trust or its terms?”
Irrevocable trusts, such as irrevocable life insurance trusts, are commonly used to remove assets from a person’s estate and thus avoids the assets being taxed. Transferring assets into an irrevocable trust gives those assets to the trustee and the trust beneficiaries forever. If a person no longer owns the assets, they don’t comprise or contribute to the value of his or her estate, therefore they are not subject to, say, estate taxes upon death.
REVOCABLE LIVING TRUSTS
There is no “one size fits all” trust—different kinds of trusts offer different benefits (and drawbacks) depending on a person’s circumstances. Age, number of children, health, and relative wealth are just a few of the factors to be considered.
The most common trust my clients use is a revocable living trust (sometimes referred to by its abbreviation, “RLT”).
A revocable living trust is created while you’re alive and can be revoked or amended by you. An RLT has huge advantages:
Establishing a revocable living trust helps avoid costly probate—the legal process required to determine that a will is valid. Probate generally eats up about two percent (2%) of an estate, which can add up to a chunk of change you’d probably rather see go to your beneficiaries.
Avoiding probate also means avoiding other fees, such as court costs, that go along with it.
A revocable living trust not only eliminates the costs of probate, but the time-consuming process of probate as well. Here in Iowa, probate can take several months to a year, or sometimes even longer, perhaps leaving beneficiaries without their inheritances until th end of the probate process. The transfer of assets through a trust is much faster.
Don’t want your sixteen-year-old niece to inherit a half-million dollars in one big lump sum? I agree, it’s probably not a good idea.
A revocable living trust offers flexibility for the payout of an inheritance because you set the ground rules for when and how distributions are made. For example, you might decide your beneficiaries can receive certain distributions at specific ages (21, 25, 30, etc.), or for reaching certain milestones, such as marriage, the birth of a child, or graduation from college.
Despite the significant advantages of establishing a revocable living trust, there are drawbacks people should be aware of. For starters, trusts are more expensive to prepare than basic estate plan documents such as a Will. However, the costs associated with sitting down with a lawyer and carefully creating a trust is, in my opinion, greatly outweighed by the money your estate will save in the end.
Creating a trust can also be an administrative bother because assets (farm land, business, stock funds, etc.) must be retitled in the name of the trust. All things considered, this is a small inconvenience that is greatly outweighed by the smooth operation of a trust when you pass away.
YOU CAN TRUST ME TO TALK ABOUT THE BEST TRUST(S) FOR YOU
Interested in learning more about trusts or questioning if you need one? Feel free to reach out at any time by email, firstname.lastname@example.org, or on my cell, 515-371-6077.
If you want to simply get started on an estate plan (everyone needs at least the basic documents in place!) check out my estate plan questionnaire, provided to you free, without any obligation.
*OK, not everything. But many things, let’s say, an excellent start.