Family Estate planning document

The Mystique of Trusts

What’s a trust?  Do you need a trust?  There are so many misperceptions about trusts.  The answer is that there is no one size fits all.  There are revocable trusts and irrevocable trusts.  And trusts are used for a variety of purposes.  This article provides a general overview of trusts and takes the mystique out of them.

Generally speaking, a trust is a separate entity, like a corporation, limited liability company or partnership.  In some cases, it may even be a separate taxpayer, depending on the terms of the trust.  A trust consists of three distinct characters – (1) the settlor creates the trust, (2) the trustee has the legal title to the assets owned by the trust, similar to the President of a corporation, and (3) the beneficiary enjoys the benefits of the trust.  Depending on the terms, the same person can be the settlor, trustee and a beneficiary.

Revocable, or Living, Trusts

Let’s start with a revocable trust.  Just like the name suggests, a revocable trust can be amended or revoked at any time.  An individual would create a revocable trust for one of three reasons, which may overlap:  (1) to avoid the probate of assets owned by the trust upon death, (2) to avoid the guardianship of assets in the event of an incapacity, and (3) to maintain privacy.


Probate, Guardianship & Privacy

More specifically, probate and guardianship are legal processes.  Probate is the legal process that occurs upon death – it is the mechanism that allows assets to be transferred from an individual to his or her estate, and then to the beneficiaries named in his or her will.  Probate is perceived to be an expensive and burdensome process.  In some cases, depending on the State and the type of assets, it can be; in others, it is not as complicated as it is made out to be.  Nevertheless, most people want to avoid it.

Similar to probate, guardianship is the legal process that occurs when an individual becomes incapacitated.  It is the way the court takes control over an individual’s assets during life upon incapacity.  This process is costly and burdensome, as a guardian of the property is under strict court supervision.  And, needless to say, it is embarrassing to be declared incompetent. Thus, most want to avoid the guardianship process.

Finally, there is the privacy issue.  An individual’s will is generally a public document, and anybody can see it.  When an individual has a revocable trust, the individual’s wishes regarding the disposition of his or her assets upon his or her death remain probate, as a revocable trust is not filed with the court.

So how does the revocable trust avoid probate and guardianship of assets.  Very simply.  Upon creation, the trust is funded with assets that are in an individual’s name.  Thus, upon death, the assets do not go through the probate process and, in the event of an incapacity, the assets are not subject to the guardianship process.  Upon death, the successor trustee, who is named by the settlor, distributes the assets to the named beneficiaries without court intervention.  Similarly, in the event of an incapacity, the successor trustee administers the trust for the benefit of the settlor i.e., pays his or her bills and manages the assets in the trust.

It is important to note what a revocable trust does not do.  It does not avoid any taxes or creditors whatsoever.  Yes, a revocable trust may contain certain language that is designed to use an individual’s estate and generation-skipping transfer tax exemptions upon death but these provisions would also appear in a will.

Irrevocable Trusts

What about irrevocable trusts?  Again, as the name suggests, these trusts cannot be changed, although modern trust law does provide certain methods to move assets from one irrevocable trust to another and to even make changes by going to court under certain circumstances and even by not going to court, provided the necessary parties all consent.  The topic of changing an irrevocable trust is beyond the scope of this article and will be saved for another day.

There are tax and non-tax reasons to create an irrevocable trust.  Either way, the same parties exist – the settlor, trustee and the beneficiary.  However, to achieve the tax or non-tax objective, there are generally limitations on who can serve as a trustee and, in most cases, a settlor will not be a trustee or beneficiary of an irrevocable trust.

Let’s start with the tax reasons.  For high net worth individuals whose estate will be subject to estate tax upon death, there are sound, true and tried, ways to gift assets to irrevocable trusts.  The benefit of gifting assets during life is twofold.

First, under current law, “discounts” may be applied to the value of interests in family entities, such as family limited partnerships, because the asset may not be “marketable” and may represent a “minority interest” even though the donor retains control of the family entity and other family members are also members.  These types of discounts have been around for many, many years and have been on the IRS’ hit list for as long as they have been around. However, under existing law, they still work.

Second, estate tax is imposed upon death on the value of the assets at that time.  Thus, it behooves high net worth individuals to gift assets during life so that the appreciation over the rest of an individual’s life can occur estate tax free, as such appreciation escapes estate tax at death.

Now the non-tax reasons.  There are many.  Suffice it to say, nothing good can come from owning an asset in your individual name.  Assets held in trust are generally protected from creditors, treated as separate property in a divorce (and, thus, not subject to division), will pass to the individuals or charities chosen by the person who created the trust, meaning, in most cases, his or her bloodline), and are included in an individual’s estate for tax purposes so estate tax can be avoided at future generations (up to certain prescribed amounts).  Furthermore, there are many individuals who are incapable of handling their own assets – these range from physical and mental disabilities to drug and alcohol use to incarceration to plain old irresponsibility.

As should be evident by now, trusts are complicated.  There are lawyers who specialize in trust and estates.  For anybody who needs a trust, only competent and expert counsel should be retained.



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