Attorney & Counselor at Law
ROBERT M PHILLIPS
A trust is any arrangement whereby property is transferred with the intention that it be administered by a trustee for another's benefit.
When I meet a new estate planning client for the first time and the discussion gets around to trusts, I often find clients falling into one of two categories: There are those who are absolutely certain that they need a trust (but are not certain of what a trust really is) and there are those who resist discussing trusts because they are absolutely certain they do not need a trust (trusts are "too complicated;" all they need is a "simple plan"). As you might expect, it often turns out that the circumstances of the client who "absolutely" needs a trust dictate that a trust is not the best solution, while the client who "absolutely does not" need a trust frequently is the best candidate for a trust.
While I can state "absolutely" that everyone should have a Will, not everyone needs a trust or should involve trust planning in their estates. But most people should. So, what is a trust?
Because there are so many different kinds of trusts, there are many different definitions of trusts. A basic definition taken from Black's Law Dictionary introduced this article. From this definition we can see that a trust is an "arrangement." Under this arrangement, someone gives assets to someone for the benefit of someone. That's simple enough. I like arrangements. And a trust could be the best arrangement that you ever make. For most trusts, this arrangement takes the form of a written agreement called a Trust Agreement and involves three "players."
The Players
The first player is the settlor, the person (or persons) who creates the trust. Think of the settlor as the Producer of a Hollywood movie-they are responsible for raising the money but they also get to pick the project that will be undertaken. Similarly, under trust law not only does the settlor usually make the initial transfer of property to the trust, they also get to define the purpose and all of the terms of the trust. By doing this, they "settle" the trust. They can do this while they are alive, in which case the trust is called an "intervivos" or "living" trust. Or, they can do this after their death, usually by terms included in their Will. In that case, the trust is called a "testamentary" trust.
All trusts need a second player, the trustee. A trustee is like the Director of a movie-they are responsible to see that the movie is created as the Producer expects. A trustee can be any one or more individuals or a commercial institution (such as a bank or trust company), or both. The trustee receives the property and must agree to the terms of the Trust Agreement (that is, the trustee agrees to carry out the terms of the Trust Agreement as the settlor expects).
Once the property is transferred from the settlor to the trustee, the legal title of the property is held by the trustee, not as an individual, but as trustee of the trust. Under the law, the trustee is a fiduciary and is solely responsible for the safekeeping, management, and distribution of the trust income and assets for the benefit of the third player, the beneficiary. Unlike the Director of a movie, however, a trustee is generally not free to change the "script" of the trust although a trustee is often called upon to use their discretion.
Finally, all trusts are created for the benefit of the third player, the beneficiary. Continuing the movie analogy, the beneficiaries of a trust are like the audience of a movie-all the effort and work of the Settlor/Producer and Trustee/Director have been geared for their enjoyment. Beneficiaries of a trust may be one or more individuals (such as your spouse, your children, your grandchildren or others) or organizations (such as educational and charitable organizations) or combinations.
The terms of the Trust Agreement specify the who, what, where, when and how benefits are to be distributed to the beneficiaries. No two trust agreements are ever alike. This is where the flexibility of trusts really shines. Generally, the settlor can specify whatever terms and conditions the settlor desires. For example, benefits could be available to a beneficiary for a lifetime or for a fixed period of time. A beneficiary could be entitled to only income from the trust property or only principal distributions, or both. Distributions from the trust could be mandatory or could be based on the needs of a beneficiary. Or, the settlor could specify that distributions are to be made solely at the discretion of the trustee.
In general, if you can think of a way and manner that you want to make benefits avail-able, it can be done that way. And this is one of the strongest advantages of a trust-you, as settlor, can be assured that the terms, conditions, and benefits that you desire, written in the Trust Agreement, will be carried out during the term of the trust, even if it extends past your lifetime.
Revocable Trusts
Perhaps one of the most important initial decisions the settlor must make when creating a trust is whether the trust is to be a revocable or irrevocable trust. If the trust is to be revocable, the terms and duration of the trust can be changed at any time during the settlor's lifetime by the settlor. This even includes the ability to completely revoke the trust and cause all of the trust property to be returned to the settlor.
In general, people create revocable trusts as "Will substitutes" in an attempt to avoid probate administration in those states where the probate process is slow, costly, or otherwise difficult. By creating a revocable trust and being careful to properly fund it with all of the settlor's assets during the settlor's lifetime, on the death of the settlor the trustee of the revocable trust will be responsible for the disposition of the settlor's trust estate according to the terms of the Trust Agreement. Without such a trust an executor or personal representative in a judicial probate proceeding would distribute the person's estate according to their Will.
Among other reasons, revocable trusts are very popular in states such as California, Pennsylvania, Florida, and other jurisdictions that permit the fees of the estate administrator (executor) and the attorney for the estate to be determined and calculated as a fractional proportion of the value of the decedent's probate estate (often four to five percent or more of the value of the probate estate).
However, if there is no probate, there will be no fees. Thus, to avoid probate, a revocable trust is created and all of the settlor's assets are transferred to the trust. On the death of the settlor, what does the settlor own? Nothing! All of their assets are owned by the trust, so there is nothing to probate.
Although initially diligent, over time many settlors often fail to be sure that all of their assets are titled in their revocable trust. The result is that a probate proceeding may still be required thus defeating one of the primary reasons for creating the trust. Fortunately, most states, including Colorado, have laws prohibiting the calculation of fees based on estate value, so revocable trusts are not as compelling in those states. There are, however, other good reasons for certain persons to establish a revocable trust, even in those states that have abolished this fee structure.
Irrevocable Trusts
In contrast to revocable trust, the terms and duration of an irrevocable trust cannot be changed by the settlor. Ever. The trust will end by its own terms. Why would a settlor create a trust that can never be changed? The answer is that if a purpose of creating the trust is to reduce taxes or to wrap the assets in a protective envelope of asset protection, an irrevocable trust must be used.
Most tax-advantaged estate planning strategies developed today use irrevocable trusts. Whether the objective is to reduce income taxes in the hands of the settlor or estate taxes payable by the settlor's estate, the common estate planning strategy is to reduce the value of the settlor's estate. Fewer assets, less tax. By transferring assets to a trust that one cannot revoke, those assets are deemed removed from the settlor's estate just as if the settlor had given those assets away. There are, however, major differences between giving an asset directly to someone and giving that same asset to an irrevocable trust for the benefit of that same person.
If the asset is given directly to a donee (for example, an individual or a charitable organization), either during the donor's lifetime or later, the settlor has no control over the asset in the hands of the donee. The donee can do with the asset whatever they please. They can sell it, squander it, lose it, have it seized by a creditor, the government or a former spouse, or even give it away themselves. There is no way to ensure that the donee will ever derive any benefit from the asset as there is no protection of the asset in an outright gift. Furthermore, while a minor donee can own assets in their own name, they cannot legally manage such assets. Other costly procedures (such as conservatorships, custodianships, etc.) will be necessary until the child becomes an adult.
On the other hand, if the asset is transferred to an irrevocable trust for the benefit of the donee (again, either during the settlor's lifetime or after the death of the settlor), the settlor can be assured that none of the problems noted above associated with outright gifts will occur. The assets will be managed for the benefit of the beneficiary for as long as the settlor desires in the manner that the settlor expects.
Whether an outright gift or a gift in trust, the settlor wants to benefit the donee. Using an irrevocable trust, the settlor can be more certain that the beneficiary will receive the benefits of the assets.
Revocable Trust
· terms of trust can be changed by settlor
· used as a "Will substitute"
· when desirable to avoid probate
· can reduce estate administration fees
· provides continuity of management of assets
· may offer additional privacy
Irrevocable Trust
· terms cannot be changed once created
· used to minimize or reduce taxes
· can provide significant asset protection
· permits continuing control over gifts
· allows splitting of gifts between family and charitable organizations
In this article, I have introduced and discussed what a trust is, briefly reviewed how a trust is created, defined who the players involved in a trust are, and explained what the major differences are between several common types of trusts (e.g., living versus testamentary, revocable versus irrevocable, etc.). In Part II of this article, I will explore irrevocable trusts in more detail including several common types of irrevocable trusts such as Life Insurance Trusts, Generation-Skipping Trusts, Charitable Trusts, Personal Residence Trusts, QTIP Trusts, Crummey Trusts and others, and how they may be of benefit to you and your beneficiaries.
© 2005 Robert M. Phillips.
All Rights Reserved.
When I meet a new estate planning client for the first time and the discussion gets around to trusts, I often find clients falling into one of two categories: There are those who are absolutely certain that they need a trust (but are not certain of what a trust really is) and there are those who resist discussing trusts because they are absolutely certain they do not need a trust (trusts are "too complicated;" all they need is a "simple plan"). As you might expect, it often turns out that the circumstances of the client who "absolutely" needs a trust dictate that a trust is not the best solution, while the client who "absolutely does not" need a trust frequently is the best candidate for a trust.
While I can state "absolutely" that everyone should have a Will, not everyone needs a trust or should involve trust planning in their estates. But most people should. So, what is a trust?
Because there are so many different kinds of trusts, there are many different definitions of trusts. A basic definition taken from Black's Law Dictionary introduced this article. From this definition we can see that a trust is an "arrangement." Under this arrangement, someone gives assets to someone for the benefit of someone. That's simple enough. I like arrangements. And a trust could be the best arrangement that you ever make. For most trusts, this arrangement takes the form of a written agreement called a Trust Agreement and involves three "players."
The Players
The first player is the settlor, the person (or persons) who creates the trust. Think of the settlor as the Producer of a Hollywood movie-they are responsible for raising the money but they also get to pick the project that will be undertaken. Similarly, under trust law not only does the settlor usually make the initial transfer of property to the trust, they also get to define the purpose and all of the terms of the trust. By doing this, they "settle" the trust. They can do this while they are alive, in which case the trust is called an "intervivos" or "living" trust. Or, they can do this after their death, usually by terms included in their Will. In that case, the trust is called a "testamentary" trust.
All trusts need a second player, the trustee. A trustee is like the Director of a movie-they are responsible to see that the movie is created as the Producer expects. A trustee can be any one or more individuals or a commercial institution (such as a bank or trust company), or both. The trustee receives the property and must agree to the terms of the Trust Agreement (that is, the trustee agrees to carry out the terms of the Trust Agreement as the settlor expects).
Once the property is transferred from the settlor to the trustee, the legal title of the property is held by the trustee, not as an individual, but as trustee of the trust. Under the law, the trustee is a fiduciary and is solely responsible for the safekeeping, management, and distribution of the trust income and assets for the benefit of the third player, the beneficiary. Unlike the Director of a movie, however, a trustee is generally not free to change the "script" of the trust although a trustee is often called upon to use their discretion.
Finally, all trusts are created for the benefit of the third player, the beneficiary. Continuing the movie analogy, the beneficiaries of a trust are like the audience of a movie-all the effort and work of the Settlor/Producer and Trustee/Director have been geared for their enjoyment. Beneficiaries of a trust may be one or more individuals (such as your spouse, your children, your grandchildren or others) or organizations (such as educational and charitable organizations) or combinations.
The terms of the Trust Agreement specify the who, what, where, when and how benefits are to be distributed to the beneficiaries. No two trust agreements are ever alike. This is where the flexibility of trusts really shines. Generally, the settlor can specify whatever terms and conditions the settlor desires. For example, benefits could be available to a beneficiary for a lifetime or for a fixed period of time. A beneficiary could be entitled to only income from the trust property or only principal distributions, or both. Distributions from the trust could be mandatory or could be based on the needs of a beneficiary. Or, the settlor could specify that distributions are to be made solely at the discretion of the trustee.
In general, if you can think of a way and manner that you want to make benefits avail-able, it can be done that way. And this is one of the strongest advantages of a trust-you, as settlor, can be assured that the terms, conditions, and benefits that you desire, written in the Trust Agreement, will be carried out during the term of the trust, even if it extends past your lifetime.
Revocable Trusts
Perhaps one of the most important initial decisions the settlor must make when creating a trust is whether the trust is to be a revocable or irrevocable trust. If the trust is to be revocable, the terms and duration of the trust can be changed at any time during the settlor's lifetime by the settlor. This even includes the ability to completely revoke the trust and cause all of the trust property to be returned to the settlor.
In general, people create revocable trusts as "Will substitutes" in an attempt to avoid probate administration in those states where the probate process is slow, costly, or otherwise difficult. By creating a revocable trust and being careful to properly fund it with all of the settlor's assets during the settlor's lifetime, on the death of the settlor the trustee of the revocable trust will be responsible for the disposition of the settlor's trust estate according to the terms of the Trust Agreement. Without such a trust an executor or personal representative in a judicial probate proceeding would distribute the person's estate according to their Will.
Among other reasons, revocable trusts are very popular in states such as California, Pennsylvania, Florida, and other jurisdictions that permit the fees of the estate administrator (executor) and the attorney for the estate to be determined and calculated as a fractional proportion of the value of the decedent's probate estate (often four to five percent or more of the value of the probate estate).
However, if there is no probate, there will be no fees. Thus, to avoid probate, a revocable trust is created and all of the settlor's assets are transferred to the trust. On the death of the settlor, what does the settlor own? Nothing! All of their assets are owned by the trust, so there is nothing to probate.
Although initially diligent, over time many settlors often fail to be sure that all of their assets are titled in their revocable trust. The result is that a probate proceeding may still be required thus defeating one of the primary reasons for creating the trust. Fortunately, most states, including Colorado, have laws prohibiting the calculation of fees based on estate value, so revocable trusts are not as compelling in those states. There are, however, other good reasons for certain persons to establish a revocable trust, even in those states that have abolished this fee structure.
Irrevocable Trusts
In contrast to revocable trust, the terms and duration of an irrevocable trust cannot be changed by the settlor. Ever. The trust will end by its own terms. Why would a settlor create a trust that can never be changed? The answer is that if a purpose of creating the trust is to reduce taxes or to wrap the assets in a protective envelope of asset protection, an irrevocable trust must be used.
Most tax-advantaged estate planning strategies developed today use irrevocable trusts. Whether the objective is to reduce income taxes in the hands of the settlor or estate taxes payable by the settlor's estate, the common estate planning strategy is to reduce the value of the settlor's estate. Fewer assets, less tax. By transferring assets to a trust that one cannot revoke, those assets are deemed removed from the settlor's estate just as if the settlor had given those assets away. There are, however, major differences between giving an asset directly to someone and giving that same asset to an irrevocable trust for the benefit of that same person.
If the asset is given directly to a donee (for example, an individual or a charitable organization), either during the donor's lifetime or later, the settlor has no control over the asset in the hands of the donee. The donee can do with the asset whatever they please. They can sell it, squander it, lose it, have it seized by a creditor, the government or a former spouse, or even give it away themselves. There is no way to ensure that the donee will ever derive any benefit from the asset as there is no protection of the asset in an outright gift. Furthermore, while a minor donee can own assets in their own name, they cannot legally manage such assets. Other costly procedures (such as conservatorships, custodianships, etc.) will be necessary until the child becomes an adult.
On the other hand, if the asset is transferred to an irrevocable trust for the benefit of the donee (again, either during the settlor's lifetime or after the death of the settlor), the settlor can be assured that none of the problems noted above associated with outright gifts will occur. The assets will be managed for the benefit of the beneficiary for as long as the settlor desires in the manner that the settlor expects.
Whether an outright gift or a gift in trust, the settlor wants to benefit the donee. Using an irrevocable trust, the settlor can be more certain that the beneficiary will receive the benefits of the assets.
Revocable Trust
· terms of trust can be changed by settlor
· used as a "Will substitute"
· when desirable to avoid probate
· can reduce estate administration fees
· provides continuity of management of assets
· may offer additional privacy
Irrevocable Trust
· terms cannot be changed once created
· used to minimize or reduce taxes
· can provide significant asset protection
· permits continuing control over gifts
· allows splitting of gifts between family and charitable organizations
In this article, I have introduced and discussed what a trust is, briefly reviewed how a trust is created, defined who the players involved in a trust are, and explained what the major differences are between several common types of trusts (e.g., living versus testamentary, revocable versus irrevocable, etc.). In Part II of this article, I will explore irrevocable trusts in more detail including several common types of irrevocable trusts such as Life Insurance Trusts, Generation-Skipping Trusts, Charitable Trusts, Personal Residence Trusts, QTIP Trusts, Crummey Trusts and others, and how they may be of benefit to you and your beneficiaries.
© 2005 Robert M. Phillips.
All Rights Reserved.
TRUST ME (Part 1 of 3)