- Overview of trusts
- Steps to establish a trust
- Effect of omitting property from trust
- Persons who should consider using a trust
- Advantages of a trust
- Disadvantages of trusts
- Trustee’s bond
- Power of attorney to augment trust
- Tax considerations
Revocable living trusts have become an increasingly popular estate-planning device in recent years. The main advantage that prompts most people to use a trust rather than a will is that a trust can avoid the necessity of probate if properly set up. Some other advantages are mentioned below. However, trusts are not without their disadvantages, some of which also are mentioned below.
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A trust is a legal document which, in effect, creates a new fictional legal entity – the trust itself. A trust involves three parties:
- Grantor or grantors: A grantor is a person who creates a trust and places property and/or money in the trust. More than one person can be a grantor of a trust. For example, it is common for a husband and wife to join as grantors in creating a family trust.
- Trustee: The trustee is the person appointed by the trust document to hold the property and money placed into the trust and to administer the trust. It is possible, and even common, for the grantor to serve as the initial trustee, with provisions being made for a successor trustee upon the death or disability of the grantor. Often a bank trust department is named as successor trustee.
- Beneficiary or beneficiaries: A trust must have at least one beneficiary and may have many beneficiaries. In the estate-planning context, the initial beneficiary is usually the grantor during his or her lifetime, with provisions being made for the trustee to distribute the trust’s property and money to other specified beneficiaries after the grantor’s death.
The term “revocable living trust” simply means a trust that has been established during a grantor’s lifetime which can be revoked or amended during the grantor’s lifetime. Just as it may be necessary to change wills from time to time, it is desirable to make a trust revocable so that it can be revoked or amended at a future date if circumstances change.
The two main steps involved in establishing a trust are:
- The preparation and signature of the trust document, and
- The transfer of property and money to the trust.
If a goal of the trust is to avoid the probate process, it is very important to ensure that all property that might otherwise be subject to probate is legally conveyed to the trust. In that way, upon the death of the grantor, the trustee will be able to distribute the remaining property and money to the specified beneficiaries without the intervention of the Probate Division and the delays and expense attendant to the probate process.
The need to put all property into a trust to avoid probate raises one of the possible disadvantages of using a trust for estate-planning purposes. The pitfall is that if the grantor overlooks putting one or more items of property into the trust, then the omitted property may have to pass through probate anyway, thus defeating one of the purposes of the trust.
To address this problem to some extent, in conjunction with the trust, Scott Law Firm also always prepares what is called “pour-over” will, the sole purpose of which is to transfer into the trust through the probate process any property that may have been omitted from the trust. In this way, the trust controls the ultimate distribution of property, but the need for a probate process still defeats one of the goals of the trust.
The problem of omitting property from a trust can arise not only when the trust is originally set up, but also later if the grantor acquires additional property and fails to make sure that it goes into the trust.
In view of the omitted-property problem, Scott Law Firm’s view is that the trust estate-planning device is generally more appropriate for older persons who are at a stage of life when they infrequently acquire and dispose of property. At a younger age, when it is more common to frequently acquire and dispose of property, the danger of omitting property from a trust is greater and therefore a will may be a more appropriate estate-planning device.
Our opinion that trusts are more appropriate for older persons also meshes nicely with the plan embodied in a typical estate-planning trust. This plan is:
- The grantor initially establishes the trust and puts all money and property into the trust.
- The grantor acts as the initial trustee and makes provisions for a successor trustee in the event the grantor becomes disabled or incapacitated.
- The grantor is the sole beneficiary during his or her lifetime.
- The grantor/initial trustee continues to handle most affairs of life without undue complications, simply establishing one or more trust bank accounts to handle financial transactions and doing business pretty much as usual.
- Later, when the grantor/initial trustee becomes unable to continue handling his or her own affairs, the successor trustee takes over management of the trust’s property and money and pays for the support and care of the grantor.
- Still later, after the grantor’s death, the trustee distributes the trust’s property and money to the ultimate trust beneficiaries.
Besides avoiding the time and expense of the probate process, some other advantages of a trust are:
- Administration of a trust is a private matter among the grantor, trustee and beneficiaries. In contrast, probate proceedings are a matter of public record.
- Under a trust, property usually can be distributed to ultimate beneficiaries much more quickly than is possible through the probate procedure.
- “Ancillary” probate proceedings in other states where the grantor owns property can be avoided by conveying the out-of-state property to the grantor’s trust.
- Property in a trust remains available for the maintenance and support of a grantor who becomes physically or mentally incapacitated without the time and expense involved in a court-supervised conservatorship – see the Guardian and Conservator page.
While revocable living trusts can be advantageous in particular situations, some other possible disadvantages in addition to the omitted-property problem mentioned above should be considered before selecting a trust as the primary estate-planning device.
Among possible disadvantages are:
- No matter how careful a grantor is, there is no absolute guarantee that all property will go to the trust. For example, if the grantor is killed in an automobile accident caused by another person’s negligence, the grantor’s probate estate would be the beneficiary of the negligence claim. (This scenario illustrates the importance of having a pour-over will in conjunction with a trust.)
- A parent cannot nominate a guardian and/or conservator for minor children in a trust, but can do so in a will.
- While a divorce automatically disqualifies a divorced spouse under a will signed before the divorce, the same is not true with the trust. (Therefore, to avoid conferring benefits on a former spouse, the grantor of a trust should promptly revoke or amend the trust upon a dissolution.)
- A revocable living trust is a more complicated document than a will and therefore is more costly to prepare and set up. However, the additional cost at the outset usually is substantially less than the expense of probate.
If the grantor of a trust wants an individual rather than a bank trust department to act as successor trustee, the grantor should carefully consider whether to require the successor trustee to post a bond for faithful performance of duties. If a bond is required, the bond premiums usually must be paid out of trust assets.
If a person has selected a revocable living trust as the primary estate-planning device, a durable power of attorney also should be considered.
The agent under a durable power of attorney can be the same person named as successor trustee in the trust. A durable power of attorney can give the agent the power to take some actions that cannot be authorized in a trust. For details, see the Powers of Attorney page.
Following are some of the tax considerations involved in deciding whether to use a trust:
A common misconception is that the use of a revocable living trust is necessary to avoid or minimize estate taxes on a large estate. Actually, eliminating or minimizing estate taxes can be accomplished with either a will or trust. See the Estate Taxes page.
A trust has no effect on the income tax a grantor owes during the grantor’s lifetime. As a matter of fact, if the grantor is also the trustee or a co-trustee, all income earned by the trust can be reported directly on the grantor’s personal income tax return, with no separate return being required from the trust itself.
Revocable living trusts may not be appropriate for holding certain assets. A tax accountant should be consulted on such issues. One example is that if a trust owns stock in a Subchapter S corporation, certain technical requirements must be complied with in order to avoid terminating the corporation’s Subchapter S status. Another example is that if the trust is named as primary beneficiary of a qualified pension or retirement plan or an IRA account, a surviving spouse would be precluded from exercising a “spousal rollover” and deferring income tax until a later date.
After a grantor’s death, some tax rules applying to trusts are not as flexible as those available to a probate estate. For example, a trust is restricted to using a calendar year for its fiscal year, whereas a probate estate may elect a fiscal year other than a calendar year. Another example is that while probate estates are exempt from making estimated income tax payments for the first two years, trusts must make estimated income tax payments.
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