For some time, people set up living trusts almost exclusively to save on taxes. Today, they are used to avoid Probate and for other important purposes as well. Many articles have been written to explain living trusts. All of those I have seen are too technical, contain wrong information, or come to conclusions I disagree with. This article explains the living trust as I see it. It is not meant to be a comprehensive discussion of the subject, but it should help you to understand a typical living trust and its plan.
What is a living trust?
- It is imaginary, a "legal fiction." You will never meet a "trust" walking down the street. Trusts have been created and used by lawyers for several hundred years for a variety of purposes (most often to avoid taxes).
- It is created by a trust document, either a "trust agreement" or "declaration of trust."
- The trust document designates one or more individuals or corporations to act as "trustee."
- The trustee is directed to accept title to or ownership of property, either real property or personal property. The property in the trust is sometimes referred to as the trust "corpus" or "res."
- The trustee owns property "as trustee" only, not individually.
- The property is to be held and used for the benefit of one or more "beneficiaries."
- The trust document sets out in detail how the trust is to be administered. It contains the directions of the person who sets up the trust (the "grantor" or "settlor"). If it is properly drafted, that document will guide the trustee and the beneficiaries throughout the entire term of the trust.
- The trustee is a "fiduciary" towards the beneficiaries. That means that the trustee must act at all times in the interest of the beneficiaries, not the interest of the trustee. The document is called a "trust" for good reason. The trust beneficiaries place their "trust" in the "trustee" to follow the directions of the trust document.
- You might find it easier to think of a trust like a corporation, partnership, or other business. The business is kept separate from its owners and is governed by its own organization and documents. In many ways, a living trust is like a "business" for an individual's "personal" affairs.
A trust that cannot be changed is called "irrevocable." Irrevocable trusts are most often used in estate tax planning or where the grantor wants to lock in certain terms of the trust. Most people want to keep their trusts flexible and set up revocable trusts.
This article will deal with the revocable living trust. I will first describe the most common plan and then explain the advantages and disadvantages of that plan.
The most important document in the plan is the living trust itself. The trust document names the trust, names the trustee (usually the grantor) and one or more successor trustees, gives the trustee powers, and directs the administration of the trust for as long as it exists. Most of those provisions are fairly standard from one trust to another, except for names. The trust may specify the property to be transferred to the trust, but most trusts can and do accept any property transferred to them.
The trust then says how the trust is to be run during the grantor's lifetime. The grantor is usually paid from the trust whatever he or she wants, asks, or needs. The trust usually provides for support of the grantor's spouse and children, if any. The grantor can specify exactly what he or she wants done with the trust assets and income.
Finally, the trust specifies what to do with the property left in the trust after the grantor dies. At that point, the trust operates much like a will and serves a similar function. However, distribution can be made directly from the trust without the necessity of Probate and its additional requirements and expense.
The second document in the plan is called a "pour-over" will. Why do you need a will if you have a trust? The trust can only affect property that is specifically transferred to it. The will acts on any property that is not transferred to the trust. The will provides for collection of that property, payment of Probate expenses, and transfer of whatever is left to the trust. In effect, whatever is left in the Probate estate "pours over" into the trust and is then administered according to the terms of the trust. The will can also name guardians for minor children and can address other matters that do not relate only to "assets."
Once the pour-over will and the trust are executed, the job is not completed. It is vital to transfer assets to the trust! Real estate must be deeded from the grantor(s) to the trustee(s). Stock, bank accounts, and other assets which are registered in individual or joint names must be transferred to and re-registered in the name of the trust. Insurance policies and other assets payable on death should be changed so that the trust is beneficiary (and perhaps the owner). Personal property should be transferred to the trust. The goal of the plan is to funnel all of the assets into the trust either by transferring them directly to the trust, having them paid directly to the trust upon death, or passing them through the Probate estate via the will to the trust. Once everything is in the "pot," the trust can do its work.
Advantages of the Living Trust
- When the trust is done right, it works like magic and avoids all Probate! It even avoids multiple Probate proceedings in different states where real estate or other assets are located.
- Money and assets are distributed sooner.
- The trust is private, although not totally. Some financial institutions may require or request copies of the trust agreement before complying with its terms, but there are virtually no "public" aspects as with Probate.
- Save Lawyer's fees and costs. Assets are transferred to the trust while the grantor is alive and competent, and multiple sets of bank accounts are not necessary.
- A more orderly process. Without a trust, it is often more difficult to find asset information at death and to collect the assets.
- Flexible. So long as the grantor's intentions can be expressed in words, they can be embodied in a trust.
- Easy to amend. A trust can be amended by a document signed only by the grantor. No witnesses or other formalities are necessary as with a will or codicil. The reduced cost of amendments may ultimately save some of the additional up-front costs of a living trust.
- Less important if the original documents are lost. Copies of a trust document can substitute for a lost original. .
- A trust is more difficult to contest than a will or codicil, because the grantor not only signed the documents but acted on them.
- So long as all interested parties agree, it is easier to "change" the terms of a trust than a will, even after the grantor dies or becomes incompetent.
- Up-front costs are more than for a will.
- Assets must be properly transferred to the trust. Time must be spent by the grantor after the trust is set up to see that all of the transfers are made. If they are not, the trust may provide little or no savings, and Probate may still be necessary.
- Claims of creditors of an estate are cut off six months after appointment of the executor (with some exceptions). Claims against a trust can be pursued for two years from the date of death.
- Some assets may not be held in a trust without adverse income tax effects.
- A will is still necessary, although it is simpler, is less likely to need updating, and will probably never have to be "used."
- Based on the plan set out above, there is no savings of Federal Estate Taxes or attorneys' fees spent in preparing a Federal Estate Tax return. So long as the grantor has any power over the trust, a trust has no effect on death taxes.
I heartily recommend living trusts for most of my clients, but each situation must be separately evaluated. A living trust has many advantages, but it also has some disadvantages. Advantages for one individual or couple can be disadvantages for others. There is nothing wrong with a will, and it is much better to have a will than not to plan at all. Still, most individuals and couples will ultimately save by use of a living trust.
Why do I promote something that will avoid Probate when I earn significant fees each year from handling Probate matters in Court? Doesn't that ultimately hurt my practice? Maybe so, but I do it because it is right. Most Probate is truly "unnecessary." When the law requires Probate, it must be done. The end result, however, whether through Probate with a will or through a living trust is almost always the same. Bills and taxes are paid, and the assets are distributed to those who are supposed to receive them.
I hope this explanation has helped you to understand living trusts. Each person or couple should discuss with their attorney (hopefully, me) whether or not to set up a living trust and how to do it after reviewing the size and nature of the estate, the goals desired, and the fees and costs to be spent. While there are many do-it-yourself kits and computer programs available, you use them at your own risk. Even attorneys make mistakes that can destroy a client's objectives. Virtually every attorney who prepares living trusts can tell you horror stories about clients who committed malpractice on themselves. You are always safer with proper legal advice, and the least expensive is not always the best. A sign I saw in another lawyer's office said it well:
- "If you think hiring a professional is expensive, just wait until you hire an amateur