A trust is an agreement under which money or other assets are held and managed by a trustee for the benefit of the beneficiary(s). Different types of trusts may be created to accomplish specific goals. Each kind may vary in the degree of flexibility and control it offers.
The common benefits that trust arrangements offer include:
- Providing personal and financial safeguards for family and other beneficiaries;
- Postponing or avoiding unnecessary taxes;
- Establishing a means of controlling or administering property; and
- Meeting other social or commercial goals.
Creating a Trust
Certain elements are necessary to create a legal trust. The basic elements include a trustor, a trustee, one or more beneficiaries, trust property, and generally a written trust agreement.
The person who creates a trust is called a trustor. This person may also be referred to as the “grantor” or “settlor”.
The trustee is the individual, institution, or organization that holds legal title to the trust property and is responsible for managing and administering those assets. If not designated by name, a trustee will be appointed by the court. In some cases, a trustor can serve as the trustee. It is also possible for two or more trustees to serve together, or for both an individual and an organization to act as co-trustees. Separate trustees may also be named to manage different parts of a trust estate.
The beneficiary is the person or entity who is to receive the benefits (such as income) of a trust. In general, any person or entity may be a beneficiary, including individuals, corporations, associations, charities, units of government, or animals.
A trust must hold property to be administered. The trust property may be any asset such as stocks, real estate, cash, a business or insurance. In other words, either “real” or “personal” property may constitute trust property. Trust property may also include some future interest or right to future ownership, such as the right to receive proceeds under a life-insurance policy when the insured dies. Property is made subject to the trust by transfer to the trustee.
The trust agreement is a contract that formally expresses the understanding between the trustor and trustee. It typically contains instructions to describe the manner in which the trust property is to be held and invested, the purposes for which its benefits (such as income or principal) are to be used, and the duration of the trust.
Trust agreements may be expressed in writing, by oral agreement or may be implied, and the trustor usually has considerable latitude in setting the terms of the trust. A trust involving an interest in land must be in writing in order to be enforceable.
Living Trusts vs. Testamentary Trusts
There are many kinds of trusts. Trusts may be classified by their purposes, by the ways in which they are created, by the nature of the property they contain, and by their duration. One common way to describe trusts is by their relationship to the trustor’s life. In this regard, trusts are generally classified as either living trusts (“inter vivos” trusts) or testamentary trusts.
Living Trusts. Living Trusts are created during the lifetime of the trustor. Property held in a living trust is not normally subject to probate (the court-supervised process to validate a Will and transfer property on the death of the trustor). In Washington, because such property is not subject to probate, it need not be disclosed in the court record and confidentiality may be maintained. Such trusts are widely used because they allow the trustor to designate a trustee to provide professional management.
Under some circumstances, Living Trusts will allow income to be taxed to a beneficiary and result in income tax savings to the trustor. However, it should be noted that income earned by a trust established for a beneficiary under the age of 14 may be taxed at the beneficiary’s parent’s tax rate. The transfer of property to a living trust may also be subject to a gift tax.
Testamentary Trusts. Testamentary Trusts are created as part of a Will. This type of trust becomes effective upon the death of the person making the Will (the “decedent”) and is commonly used to protect, conserve or transfer wealth. The Will provides that part or all of the decedent’s estate will go to a trustee who is charged with administering the trust property and making distributions to designated beneficiaries according to the provisions of the trust.
Before the trust property transfers to the Testamentary Trust, it will normally pass through the decedent’s estate. When the estate is probated, those trust assets will be subject to probate. The assets, which will form the corpus of a Testamentary Trust, also are potentially subject to creditor claims and to an estate and generation-skipping transfer tax at the time of the decedent’s death.
A Testamentary Trust gives the trustor substantial control over his or her estate distribution. It also may be used to achieve significant savings in the future. For example, by using a Testamentary Trust, a trustor can provide for a child’s education or can delay the receipt of property by a child until the child gains financial maturity. Moreover, given the proper form of trust, property may be exempted from death taxation on the later death of a trust beneficiary. However, a generation-skipping transfer tax may still apply.
Living Trusts can be “revocable” or “irrevocable.” The trustor may change the terms or cancel a Revocable Living Trust. Upon revocation, the trustor resumes ownership of the trust property.
In general, a Revocable Living Trust is used when the trustor does not want to lose permanent control of the trust property, is unsure of how well the trust will be administered, or is uncertain of the proper duration for the trust. With a properly drafted revocable trust, you may:
- Add or withdraw some assets from the trust during your lifetime;
- Change the terms and the manner of administration of the trust; and
- Retain the right to make the trust irrevocable at some future time.
The assets in this type of trust will generally be includable in the trustor’s taxable estate, but may not be subject to probate. An Irrevocable Living Trust may not be altered or terminated by the trustor once the agreement is signed. There are two distinct advantages of irrevocable trusts:
- The income may not be taxable to the trustor; and
- The trust assets may not be subject to death taxes in the trustor’s estate.
However, these benefits will be lost if the trustor is entitled to (1) receive any income; (2) use the trust assets; or (3) otherwise control the administration of the trust in a manner that is inconsistent with the requirements of the Internal Revenue Code.
Just as a Will may be revoked or amended at any time prior to death, a Testamentary Trust may be changed or canceled. Revisions can be made by drafting a new Will or by using a simple document called a “codicil” to make changes or additions to your Will or Testamentary Trust. To be effective, however, any such modifications must be executed in the same manner required for Wills, i.e., witnessed and preferably notarized.
Establishing a Trust
In creating a trust, you should consider several factors and obligations, including:
- Your personal situation, including age, health and financial status;
- Your family relationships and your family’s financial circumstances;
- Personal financial data: personal property, real estate holdings, securities, and other property - as well as your tax situation and any debts or obligations;
- The purpose of the trust: your goals, or what you hope to accomplish by the arrangement;
- The type of trust, and how versatile or flexible your plans are;
- The amount and type of property it will contain;
- The duration, or how long the trust will last;
- The beneficiaries and their specific needs;
- Any conditions that must be met by a beneficiary to receive benefits (such as attaining a certain age);
- Alternatives for disposing of assets in case the trust conditions are not met or circumstances change; and
- The trustee, and the conditions or guidelines under which he or she will function.
Dependency exemptions, capital gains and losses, income, gift, estate and generation-skipping transfer taxes also should be considered when planning certain types of trusts. Likewise, you may want to think about naming alternative or contingent beneficiaries and trustees. Once a trust has been established, a periodic review of the status of the trust is advisable; you may want to obtain professional assistance appropriate to the requirements of the trust.
Longevity of a Trust
There is no specified time during which a trust must remain in effect. Each situation must be evaluated separately. In general, however, Washington State law will not allow a private trust to continue longer than 21 years after the death of the last identifiable individual living who has an interest in the trust at the time the trust was established. Charitable trusts, on the other hand, may continue indefinitely. Dynasty trusts can remain in existence for 150 years, benefiting multiple generations.
Duties and Obligations of a Trustee
A trustee - whether an individual or institution - holds legal title to the trust property and is given broad powers over maintenance and investment. To ensure that these duties are properly carried out, the law requires that the trustee act in a certain manner. In general, a trustee must:
- Act in accord with the express terms of the trust instrument;
- Act impartially, administering the trust for the benefit of all trust beneficiaries;
- Administer the trust property with reasonable care and skill, considering both its safety and the amount of income it produces;
- Maintain complete accounts and records; and
- Perform taxpayer duties, such as filing tax returns for the trust and paying required taxes.
The trustee must administer the trust property only for the designated beneficiaries and may not use trust principal or income for his or her own benefit. In other words, a trustee is usually prohibited from borrowing or buying from the trust, from selling his or her own property to it, and from using the trust assets as collateral for a personal debt.
In selecting a trustee you should consider the potential trustee’s competence and experience in managing business or financial matters and the potential trustee’s availability and willingness to serve.
Individuals and certain corporations (or a combination of both) may serve as trustee. Each selection offers distinct advantages and drawbacks that should be considered. For example, an institution, such as a bank, usually offers specially trained managers to provide administrative, counseling and tax services. Other typical advantages include the institution’s continuity and reliability of service, and its ready availability. Most banks charge a fee for trust services, and some may not want to manage small trusts, so you may want to compare options.
As an alternative, an individual, such as a relative, family friend or business associate, may serve as trustee. An individual, unlike an institution, may be willing to serve for little or no fee. Furthermore, this person could add a more personal touch for special understanding to the needs of the beneficiaries. However, you will want to be certain that any nominated individual has the skill and experience necessary to properly manage the trust property.
What are some of the different types of Trusts?
Trusts come in a variety of forms and can be established in many different situations. Some common forms of Trusts include:
- Asset Protection Trust - A type of Trust that is designed to protect a person’s assets from claims of future creditors, frequently established in foreign countries.
- Charitable Trust - Trust established to benefit a particular charity or the public. Typically Charitable Trusts are established as part of an estate plan to lower or avoid imposition of Federal (and some states’) estate and gift taxes.
- Constructive Trust - An Implied Trust establish by operation of law. While a person may take legal title to property, equitable considerations require that the equitable title of such property remain with others. Typically fraud (or accident or misunderstanding) is a requirement for the establishment of a Constructive Trust, when the person who took legal title to the property did so as a result of a fraud brought upon the prior legal title holder.
- Express Trusts - Those specifically created by the Grantor under a Trust Agreement or Declaration of Trust.
- Implied Trusts - Trusts arising from particular facts and circumstances in which courts determine that although there was not any formal declaration of a Trust, there was an intention on the part of the property owner that the property be used for a particular purpose or go to a particular person. For example, if a neighbor asks you to take care of her car for her when she is on vacation, and never returns, there was an Implied Trust, as she was not making you a gift of the car.
- Inter Vivos Trust - A Trust that is created during the lifetime of the Grantor. A common type is a Revocable Living Trust in which the Grantor transfers during his or her life property to a Trust, serves as the initial Trustee, and has the ability to remove the property from the Trust during his or her lifetime.
- Irrevocable Trust - A Trust that cannot be altered, changed, modified or revoked after its creation (absent extenuating circumstances). Once a Grantor transfers property to an Irrevocable Trust, the Grantor can no longer take the property back from the Trust.
- Living Trust - A Trust created during the lifetime of a Grantor which can be altered, changed, modified, or revoked. Typically the Grantor is the initial Trustee as well as the initial Beneficiary of the Trust, with his or her spouse and children as the ultimate Beneficiaries of the Trust.
- Marital Trust - A trust created to allow one spouse to transfer, during life or upon death, an unlimited amount of property to his/her spouse without incurring gift or estate tax. The surviving spouse has the full power to use the assets of the trust as well as to transfer assets to any heirs. Upon the death of the surviving spouse, any assets in the trust are subject to Federal Estate Tax.
- Resulting Trust - A Trust that arises from, or is created by operation of law, when the legal title to property is transferred, but the beneficial interest is to be enjoyed by someone other than the person who got the legal title. Under this type of Trust, the person who holds title to or has possession of property is considered a Trustee for the proper owner, who is considered the Beneficiary. The resulting Trust is a legal fiction that forces a property holder to honor the Beneficiary’s property rights.
- Special Needs Trust - A Trust that is established for a person who receives government benefits so as not to disqualify the Beneficiary from such government benefits. Ordinarily when a person is receiving government benefits, an inheritance or receipt of a gift could reduce or eliminate the person’s eligibility for such benefits. By establishing a Trust which provides for luxuries or other benefits which otherwise could not be obtained by the Beneficiary, the Beneficiary can obtain the benefits from the Trust without defeating his or her eligibility for government benefits. Often a Special Needs Trust includes a trigger that terminates the Trust in the event that it could be used to make the beneficiary ineligible for government benefits.
- Spendthrift Trust - A Trust that is established for a Beneficiary which does not allow the Beneficiary to sell or pledge away his or her interests in the Trust. A Spendthrift Trust is beyond the reach of the Beneficiary’s creditors, until such time as the Trust property is distributed out of the Trust and placed in the hands of the Beneficiary.
- Credit Shelter Trust - A type of Trust that is created to allow one spouse to leave money to the other, while limiting the amount of the Federal Estate Tax bite that would be payable on the death of the second spouse.
- Testamentary Trust - A Trust that is included under the terms and conditions established in a Will. Such Trusts take effect after the death of the person making the Will.
- Totten Trust - A Trust that is created during the lifetime of the Grantor by depositing money into an account at a financial institution in his or her name as the Trustee for another. This is a type of Revocable Trust in which the gift is not completed until the Grantor’s death, or an unequivocal act reflecting the gift during the Grantor’s lifetime.
Who should have a Trust?
There are many different reasons why you might want to have a Trust:
- Avoid probate;
- Provide for minor children;
- Provide for someone too young or who lacks the ability to manage money;
- Avoid paying federal estate taxes;
- Contribute to charity;
- Distribute real property, particularly if it is located in another state;
- Keep property separate;
- Provide for yourself and your care if you become incapacitated and avoid a conservatorship proceeding (which maintains privacy); and/or
- Decrease the possibility of a legal challenge to the way you want your property distributed.
If any of the above situations apply to you, you should consider using a Trust as part of your estate planning.
Probate is the legal process where a court oversees the payment of debts and distribution of property under a Will or by the laws of intestate succession (decedent dies without a Will). This can be a slow and costly process if the estate is even moderately large and complicated, and certain details of the estate are made public as part of the court proceedings. Several states have summary procedures for small estates, but if your estate doesn’t qualify for a summary procedure, your estate typically goes through probate. If you transfer assets to a Trust while you are alive, then when you die, the assets belong to the Trust, not to you (or your estate), so they are not included in probate, but will be distributed in the way you direct in the Trust documents. The process of distribution will be private and confidential.
Minor children cannot inherit property, but require an adult to manage property for them until they reach the legal age of majority in the state where they live. A parent can nominate a guardian for the child’s financial matters in a Will, but the probate court will have the final say on whether to approve the appointment. If you transfer assets to a Trust that is for the benefit of your children while you are alive, you can name the Trustee(s) and alternate Trustee(s) who will control the Trust when you die. It’s possible for a court to remove a Trustee you have appointed, but generally only for a breach of the trustee’s fiduciary duties, so you have more control over who will control your children’s assets.
If you leave assets to children in a Will, the children receive full control of the assets when they come of legal age. In most states this is 18, and if the assets are large, an 18 year old may not be ready to manage that amount of money. If you set up a Trust, you can control when the young person will receive full control of the assets, such as at age 25 or 30. Some older adults are also unable to manage money well. This may be the result of a developmental disability or just because the person lacks appropriate financial judgment. If you want to leave assets to a Beneficiary in that situation, you might want to set up a Trust that will control the assets throughout the life of the Beneficiary. People also want to leave money for the care of pets that survive them, and a Trust is a good way to do that.
If your estate is over the minimum amount for paying Federal Estate Tax, Trusts can be used to exempt some of your assets from your taxable estate. This can reduce your total estate to an amount below the estate tax minimum. You can also receive tax benefits during your lifetime by setting up a Trust that makes a donation to charity when you die but keeps the income for you while you are alive.
Probate laws differ from state to state, so to avoid unforeseen results under different laws, if you own real property in different states you can put that property in a Trust while you are alive so there will be no change when you die. The Trust will continue to own the property, and there will be no reason for the various states to be involved in how the property is distributed. If you want to make sure that certain property is not divided between beneficiaries, which might result in the property being sold, you can put property in separate Trusts and give separate instructions for distribution. That way, it won’t be possible for a court to decide that the property can be divided and/or sold.
If you become incapacitated from old age or some accident or illness, someone will need to take care of your financial affairs for you. By setting up a Trust where another Trustee will take control of your assets if you become incapacitated, you can prevent someone from filing a petition to be named your Guardian or Conservator. A court will only appoint a Guardian or Conservator if no other arrangements have been made, so the court is not likely to grant a guardianship/conservatorship to someone else if you have already made adequate arrangements for your own care. This allows you to choose who you want managing your affairs and allows you to exercise future control in the way you set up the Trust.
In a guardianship/conservatorship hearing, all of your affairs are made public, including details of your alleged incapacity. Most of us would not want the details of our private lives to be discussed by others in a public courtroom, so a Trust that avoids this is useful. Trusts can also provide privacy regarding your assets. If you don’t want all the details of your assets and the assets you are passing to others to be made public, you can use a Trust to preserve privacy.
How is a Trust helpful in estate planning?
A Trust, if properly drawn and funded, can be extremely helpful in many situations such as:
- To avoid a guardianship - If property is held in a Trust, a successor trustee can step in and take over management of assets if the trustor becomes disabled. This avoids the delay and expense of going to court to appoint a guardian to manage the property.
- To avoid probate - Probate is a process where a court oversees the distribution of a person’s estate after that person dies. A properly drawn Trust is a separate entity that does not die when the trustor dies. The successor trustee can take over management of the Trust estate and do everything the Trust provisions allow, such as paying expenses and taxes and distributing the Trust assets to the beneficiaries without court supervision.
- Maintaining privacy - Trusts, unlike Wills, are generally private documents. If you leave a Will that goes to probate, the public will be able to obtain a copy of your Will and learn additional information about your estate. In a guardianship, all your private affairs may be discussed in open court and become part of the court records available to the general public. A Trust can protect your privacy in most situations.
- Help keep certain property separate from other property - For example, if you want your daughter to get your vacation home, and your son to get your house in the suburbs, if you create a separate Trust for each property there would be no question of commingling or of who gets what.
- Make challenges to your wishes for distribution of your property more difficult - If you think someone might challenge a Will because they do not like how you want to leave your property, you can make such a challenge much more difficult by using a Trust instead of a Will. To prove a Will invalid the challenger has to show that you were incompetent at the time the Will was executed. A Trust is not just drafted, executed, and funded at one point in time. It is set up, property is transferred to it (possibly at different times), and the Trust operates, perhaps for years, before the death of the Grantor. It is much more difficult to prove that the Grantor was incompetent or unduly influenced during the whole time period when the Trust existed and operated than to prove the deceased was incompetent at the one point in time when a Will was signed. For example, if you cut a close relative out of receiving assets, or if you leave less to one child who has already received more financial help than the others during your lifetime, that person might threaten or bring a Will challenge if you use a Will to distribute your property. If you use an Inter Vivos Trust instead of a Will, the Trust will be more difficult to challenge.
Fees and Costs
The cost of creating and administering a Trust can vary considerably, depending on its type and duration. A lawyer’s fees to create a Trust, for example, will usually be based on the time involved in consulting with you and in planning and preparing documents. Therefore, before you hire a lawyer, you should discuss fees (for example, whether hourly or flat fees are charged). Ask for an estimate or arrange a written fee agreement.
A trustee’s fee may vary with the skill and expertise the trustee offers. Charges may also be influenced by the size and complexity of the Trust estate. This affects the nature and amount of services required, such as record-keeping, asset management and tax planning.
In addition to legal and trustee expenses, there may be accounting, real estate management or other service fees. Other common charges include annual, minimum, withdrawal and termination fees.