A Trust is a legal entity that has a Trustor (who creates the Trust), Beneficiaries (who will benefit from the Trust), and a Trustee (who manages and administers the Trust for the benefit of the Beneficiaries). By placing property in a Trust, you can control how your assets, including income, are used and for what purposes during your life and at your death. With a Trust you can also control when your assets will be distributed, to whom, and on what conditions.
A Trust is often used as an alternative to the outright distribution of assets to children. A Trust can be structured to provide flexible management for Beneficiaries who are either too young or incapable of managing property. By giving the Trustee broad discretionary powers, the needs, as well as the financial maturity, of the Beneficiaries can be taken into account when making distributions of Trust income and principal. Property placed into a Trust created and funded while you are living will not be subject to probate and thus the privacy of your personal affairs is maintained. During your life you can move your property in and out of your Trust and, generally, you can revoke or amend your Trust so long as you are alive and competent. Proper estate planning can make your life and the lives of your loved ones much easier.
Objectives of Revocable Trusts
Trusts can be used to reduce or eliminate transfer taxes including federal estate, gift, and generation-skipping taxes. The property taxed essentially includes all forms of property owned or controlled by a person, including life insurance, investments, retirement funds, real estate, etc. Some trusts are useful because they can cut off the types of ownership and control of property which will otherwise cause the property to be taxed to the person or estate. For example, a life insurance policy can be given away at low value during life but restricted under the terms of the trust. Another example would be using a trust to retain certain benefits during life but have the contributed property pass to charity on death. These uses are not appropriate for revocable trusts, however. A trust would need to be irrevocable and without any retained control “strings” to cut off taxable ownership and control. This leads us to the key reason trusts are so useful–they are very flexible. They can coordinate a plan designed to take advantage of the available credits, exclusions, and deductions to minimize taxes yet still accomplish the goals of the family. This flexibility can be of great benefit for tax planning even in a revocable trust, the kind most often used in estate planning. Such trusts often contain formula provisions to maximize the tax savings from the use of the unified credit and the marital deduction. The property held in such a trust will be included in the person’s taxable estate but will be covered by credits and deductions to the family’s best advantage. Thus, although trusts alone do not save taxes, they are such useful tools that just about any tax-saving plan will at some point likely use one or more trusts. The tax results will be substantially the same whether the trusts are revocable or are testamentary. But if a trust is needed in any event, a revocable trust may provide some additional benefits and will often be used in plans for larger taxable estates.
Clients usually want to avoid probate and its costs, delays, and invasion of privacy. Properly funded trusts avoid probate, including ancillary probate when there is real property in more than one state.
Trusts protect the privacy of family affairs from the prying eyes of the public because trusts are not filed as public documents, while Wills are probated in the public courts.
Revocable trusts are managed by a trustee who is often the original trustor or creator of the trust. If the trustee becomes incapacitated, a successor trustee can step in to manage the trust at very little cost and without a conservatorship or guardianship proceeding. A Durable Power of Attorney is recommended, even where a trust is used, in case there is a need to transfer assets into the trust for a disabled trustor. Trusts put legal title in the name of the trustee and are more widely respected and recognized than Durable Powers of Attorney. When a family has a member for whom long-term management will be needed, it may be most advisable to use a revocable trust.
Not all clients have the self-discipline to use a trust as a vehicle to organize their affairs, but for those who do, trusts are a good organizational tool. Funding the trust requires going through assets and making transfers at a time when the trustor is still alive. Not all assets are amenable to being held in trust, however, so some problem assets such as business interests or other property with transfer restrictions, qualified retirement plans, tangible items, etc., may need to be handled separately. A trust may not be the first choice to have named as a qualified plan beneficiary, but it may be good as a backup. Tangible personal property may be transferred easily by a written statement if there is a will which refers to such a statement. A trustee can be granted under the trust the discretion to follow such a statement without the need to probate the will.
Some clients are under the mistaken belief that a revocable trust will somehow provide protection against creditors. Revocable trusts generally will be subject to claims against the trustor of the trust and for estate administration and funeral expenses and for statutory allowances to the surviving spouse and children to the extent the trustor’s probate estate is inadequate to cover these things. However, property which passes to the trust as the result of the trustor's death, which property was otherwise exempt from creditors’ claims, does not become subject to such claims but remains exempt.
Using Trusts for Personal & Business Privacy
Trusts have been used for hundreds of years for tax savings and estate planning, but few people realize the enormous potential for using trusts for privacy. In this information age where records of your assets can be accessed via computer, fax and even telephone, you have to take active steps to protect your privacy.
What is a Trust?
A trust is a private contractual arrangement between several parties for holding, managing and investing assets. The parties to the trust are the grantor (the person creating the trust, also known the “settlor” or “trustor”), the trustee (the person or entity holding title to the assets), and the beneficiaries (for whose benefit the trust is established). A trust created during the life of the grantor is called an “intervivos” or “living” trust.
Benefits of a “Living Trust”
A typical living trust is created by an individual for his own benefit, and then for the benefit of others. He usually names himself as trustee. Upon his death, a successor trustee is named to hold and manage the trust property. One of the main reasons why living trusts are used is to avoid probate. Upon death, if there is no Trust, the assets remaining in the estate are distributed according to the instructions of a Will, or, if there is no Will, according to the rules set forth by state law. The probate court is involved throughout the process, adding time, cost and aggravation. The Will becomes public record for all the world to see. If an individual own assets in multiple states, an “ancillary” proceeding must be commenced in each state. When someone's assets are owned in trust they are not subject to probate, nor are they on display for the world to see. The trustee, according to the instructions of the trust agreement, either distributes the assets outright to the heirs (the alternate beneficiaries), or holds them in trust until the heirs reach a certain age. A Trust can hold assets (such as real estate) in multiple states without the need for ancillary probate.
The Land Trust
In every county in the United States, copies of deeds to real estate are recorded in the public records. Anyone can go down to the courthouse or recorder’s office and look up the owner of any property in the county. A land trust will hide the owner's name from the public records. A land trust (also known as a “Title Holding Trust” and “Nominee Trust”) differs slightly from a regular living trust in that the trustee is a mere nominee. The beneficiaries have the right to direct the trustee as to the acquisition, management and disposition of trust property. The main purpose for using land trusts is privacy of ownership. No one will know who owns the property but the owner, his attorney and the trustee. If the trustee resides in a different state than where the property is located, it will be difficult, if not impossible, for anyone to discover the actual owner of the property. If a judgement is entered against the owner of the property, the lien will not automatically attach to the property, since the title is not in the owners name.
The Personal Property Trust
A personal property trust, like a land trust, is a simple, revocable trust used to hold title to assets. Cars, boats, bank accounts, leases, mortgages, mobile homes, and corporate stock can all be held in the name of a nominee. Using a nominee trust to hold title to assets will help keep financial matters private and discreet in the information age. A trust, unlike a corporation, is not registered with the state. There are no public records of officers, directors or shareholders. There are no minutes of directors’ and shareholders’ meetings. The trustee keeps control of the trust records and the identity of the beneficiaries, and will not reveal this information without a court order.
Revocable living trusts are “tax neutral.” There is no tax consequence of transferring property into trust. The property is treated as still being owned by the grantor. The logic is that since the grantor can still revoke the trust, it still belongs to him for tax purposes. For example, if someone owned rental property in his name and reported on schedule “E” of his federal income tax return, a transfer into a revocable living trust of which he is the beneficiary, would not change his income tax reporting. Trusts are simple yet effective devices for holding title to assets and preserving privacy.
Preserving Wealth With Trusts
A well-known story is the tale of the goose that laid the golden eggs, in which the goose’s owner is at first pleased with the magical goose’s steady output, but eventually becomes impatient and seeks to obtain all the eggs at once by killing the goose, only to find nothing inside. At that moment, he realizes too late that his once reliable income stream has vanished. In the real world, where the goose represents substantial assets accumulated over time or received by inheritance, a wise owner will seek to preserve the goose, both for themselves and for their families. Common concerns of clients in this situation include:
▸ Will my children act responsibly or foolishly in using their inheritance?
▸ Could my children lose their inheritance to a divorcing spouse or to creditors?
▸ During my lifetime, is there a way to shield my assets from unexpected lawsuits and catastrophic financial losses?
If you share any of these concerns, you might consider using a trust to preserve and protect your assets. Although trusts are ordinarily used as an estate-planning tool, the right type of trust, if properly designed, will also provide significant asset protection. How does a trust protect assets? This is best understood by first examining a trust’s basic structure. This person who sets up the trust (called the trustor) transfers assets for the benefit of the trust's beneficiaries. In a typical family, the parents are the trustors, they choose the trustee, and they or their children (or both) are the beneficiaries. Because the trust assets are owned solely by the trustee, a creditor of the trustor or the beneficiaries must go through the trustee to get to the trust assets. With the right type of trust, this structure acts as a roadblock that prevents the creditor from reaching trust assets until they are distributed to the beneficiaries.
Protecting a Child’s Inheritance
A common concern of parents with substantial assets is that a child might waste his or her inheritance instead of investing and using it wisely. Leaving the child’s inheritance in a trust is a good way to protect the child from himself because the child’s access to the trust funds is limited by the trust. For example, the trust may restrict distributions to basic living or educational expenses until the child reaches a certain age, thus preventing the child from withdrawing all of the funds at once until the child is mature enough to use them responsibly. What if a child tries to mortgage his or her inheritance by pledging it as collateral for a loan? Most trusts have a spendthrift clause which prevents this and which also prevents a child’s creditors (with a few exceptions) from reaching the trust assets before they are distributed to the child. A creditor could try to get around a spendthrift clause by seeking a court order compelling the trustee to distribute trust funds. A well-designed trust, however, will also prevent this because the trustee will not have to distribute funds unless the trustee chooses to do so.
Protection In Case of Divorce
Divorce is so common today that many parents worry about their child’s inheritance being taken by a divorcing spouse. This risk is real, because if a child mixes his or her inheritance money with the rest of the couple’s funds, the inheritance could be considered part of the couple’s marital property and, therefore, divided between the divorcing spouses as part of their property settlement. For example, if a wife has a $1,000,000 inheritance and combines it with her husband’s funds to purchase jointly owned investments, in a divorce her husband could get $500,000 of the inheritance as his one-half share of the couple’s property. A trust would keep the wife's inheritance separate from the couple’s marital property and protect her from having to divide her inheritance with her husband. A divorce court may, however, consider the wife’s income from the trust in determining the appropriate level of alimony and child support. If the tables were turned and the husband had the inheritance, under most state laws the wife could reach the trust assets for unpaid child support or could compel trust distributions for unpaid alimony.
Lifetime Protection Using a Self-Settled Trust
Until recently, a trust set up by a settlor for his or her own benefit (called a self-settled trust) provided no protection from a settlor’s creditors. Within the past few years, however, several states, including Alaska, Delaware, Nevada and Utah, have passed laws that provide creditor protection for a self-settled trust created under that state’s laws. The protection provided is not unlimited. For example, in each of those states a self-settled trust does not stop existing creditors from reaching the trust assets. Other limitations on creditor protection vary from state to state. To qualify for creditor protection, a self-settled trust must meet the state’s requirements. In all the states, the trust must be irrevocable, meaning that the settlor, acting alone, cannot modify or terminate the trust. Other common requirements include having at least one trustee and some trust assets in that state.
Comparison With Other Asset Protection Methods
The trusts described above are not, of course, the only way to protect assets. Other methods include family limited partnerships, limited liability companies, and conversion of non-exempt assets to exempt assets. Because of their simple structure, trusts avoid many of the administrative burdens imposed by family limited partnerships and limited liability companies. With a trust, no ownership interests are issued, no minute books are kept, and no annual report is due. Irrevocable trusts do have some administrative requirements, which include filing annual trust income tax returns if the trust has sufficient income and filing gift tax returns if gifts to the trust are taxable. An ongoing cost is an annual trustee’s fee if the trustee is a bank or trust company. Wealth preservation is a legitimate goal of every prudent person. With proper planning, a trust can not only be a central part of a person’s estate plan, but it can provide significant asset protection as well.