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Tuesday, February 07, 2012 |
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Practice Home | Wills | Trusts | Powers of Attorney | Health Care Directives
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Trusts |
FREQUENTLY ASKED QUESTIONS
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What is a trust?
In a general sense, a trust is nothing more than an arrangement whereby one
person agrees to hold property for the benefit of another. We create trusts all
the time without even thinking about it. For example, how many times have you given
money to a baby sitter in case he or she needed something for the kids? In a strictly
legal sense, your baby sitter accepted the money and agreed to hold it and use it
for their benefit. That is the essence of a trust - someone agrees to hold money
or property for the benefit of someone else. In a pragmatic sense, you trusted your
baby sitter to hold on to the money and use it for the purpose you intended. Although
you may not have discussed this with your baby sitter, there probably was an implied
understanding that whatever wasn’t spent would be returned to you. Even the most
complicated trusts have the same basic components as the baby sitter example; i.e.:
- Someone is the creator of the trust. We call this person the "grantor."
Other people call the creator of a trust the "donor," or the "settlor," or the "trustor."
All these terms are used interchangeable. In our baby sitter example, you were the
grantor because you created the trust between you and the baby sitter.
- Someone agrees to hold money or other property for the benefit of someone else.
We call this person the "trustee." There may be more than one trustee and the trustee
need not be a person. It may be a corporation with trust powers, such as a bank.
In our baby sitter example, your baby sitter agreed to serve as the trustee.
- Some money or other property must be held by the trustee for the benefit of someone
else. We call this money or other property the "principal" of the trust. Some people
also call this money or other property the "corpus" of the trust. The principal
(or corpus) of the trust never stays the same; some is spent by the trustee, some
is invested - earning dividends and interest, and some of the principal appreciates
and/or depreciates in value. Collectively, we call all of this money or property
the "trust fund."
- Someone else must benefit from the trust. We call this person the "beneficiary"
of the trust. There may be more than one beneficiary. In that case, they are collectively
called the "beneficiaries." In our baby sitter example above, your children were
the beneficiaries of the trust.
All trusts have these four basic components.
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Are there different kinds of trusts?
Yes, there are different kinds of trusts. First, there are testamentary trusts and
there are living trusts. A "testamentary trust" is a trust created under a Last
Will and Testament. As such, a testamentary trust becomes effective only after the
testator’s death and, even then, the Will must be approved and admitted to probate.
A "living trust," on the other hand, is a trust created during the grantor’s lifetime,
and the trust becomes effective immediately upon its creation. Living trusts are
created by a written instrument, called a "trust instrument." If the grantor is
also the sole trustee, then the trust instrument is called a "declaration of trust,"
because the grantor simply declares his or her intentions to the world. However,
if someone other than the grantor is a trustee, then the trust instrument becomes
a "trust agreement," because the grantor and the trustee must agree on the terms
of the trust.
Since living trusts are created during one’s lifetime, they can be either revocable
or irrevocable. A "revocable trust" or "revocable living trust" is one that can
be amended or changed, or even terminated, during the grantor’s lifetime. In almost
all cases, it is the grantor who reserves this right when the trust is created.
Even so, the trust becomes irrevocable upon the grantor’s death because only the
grantor retains the right to amend or terminate the trust.
An "irrevocable trust" or "irrevocable living trust" is one that cannot be amended
or changed, or even terminated, during the grantor’s lifetime. Once created, an
irrevocable trust is governed exclusively by the terms of the trust instrument without
any control by the grantor. For this reason, irrevocable trusts are created almost
exclusively to obtain favorable income tax and/or estate tax benefits for the grantor,
although irrevocable trusts are also created by the courts in divorce cases and
property settlement cases involving minor children. A Life Insurance Trust is an
example of an irrevocable trust that is often created by individuals to exclude
the death benefits of a life insurance policy from federal estate taxation.
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How do living trusts avoid probate?
First, we have to digress for a moment. One of the benefits of living in this country
is our right to own property and to be able to transfer that property to our intended
beneficiaries upon our death. We not only have that privilege, we also have a system
of laws and regulations that are designed to bring that privilege to fruition. First,
we have the right to designate the person or persons who will receive our property
upon our death. We can exercise that right through a Last Will and Testament if
we wish. If we choose not to exercise that right, then the state will still try
to get our property to the "natural objects of our bounty." Second, whether we choose
to designate the beneficiaries of our property through a Last Will and Testament
or not, the transfer of property to our beneficiaries is made possible by the probate
court system of the state in which we live.
The probate court system is designed to settle decedents’ estates and transfer property
to designated beneficiaries. However, it is important to know that all property
does not pass through probate. Property that is owned jointly with another person,
when there are rights of survivorship, does not go through probate. Jointly-owned
property passes automatically to the surviving joint owner. Married couples often
own their property jointly, such as bank accounts, cars, even their home. When one
spouse dies, the surviving spouse automatically becomes the sole owner of the property
without going through probate. Death benefits payable under life insurance policies
also avoid probate if a valid beneficiary designation is on file. Upon the death
of an insured, the insurance company issues a check directly to the designated beneficiary.
The same is true with annuity contracts and retirement plans, including IRAs. As
long as a valid beneficiary designation is on file, the death benefits payable under
those properties are paid directly to the designated beneficiaries. There is no
need for probate with these types of properties because a procedure to determine
the intended beneficiary is already in place. Of course, if a valid beneficiary
designation is not on file, or if the designated beneficiaries do not survive the
owner, then these types of property will be paid to the owner’s estate, which then
passes through probate.
For all practical purposes, the only property that does pass through probate is
property that was owned solely by a deceased person at the time of his or her death.
Think about it for a moment. Let’s assume that you are married and both you and
your spouse are retired. You own your home, your car, your bank accounts, and everything
else in joint name. Let’s assume further that you die and your spouse survives you.
All of your jointly-owned property automatically becomes owned solely by your spouse
as a matter of law. There is no probate of that property. Now let’s assume that
your spouse dies. Who gets her property? How do we transfer the house, and the car,
and the bank accounts when your spouse is the sole owner and she’s no longer here?
We would have a real problem if it weren’t for the probate court system. First of
all, your spouse has the right to designate the beneficiary of all her property
under a Last Will and Testament. If she fails to make a valid Last Will and Testament,
then the state will determine the beneficiary based upon existing laws. Finally,
the probate court will appoint someone to represent your estate (most likely a child
or other relative, if available) and authorize that person to identify your assets,
pay your bills, and then transfer your property to the proper beneficiaries. The
authority of the probate court allows for the orderly transition of property upon
death. Without it, there would be total chaos. As vital as the probate court system
is - and as good as the probate court system is - it is not always perfect. There
are administrative delays and there are costs. In too many cases, the delays seem
to go on forever and the costs eat up a good portion of the estate. It is these
delays and these costs that have caused many people to seek alternatives to the
probate court system.
So, how does a living trust avoid probate? Earlier we mentioned
that certain types of property do not pass through probate because they already
have a designated beneficiary. Life insurance policies, annuity contracts, retirement
benefits, and jointly-owned property all fall into this category. Property held
in a living trust also falls into this category because the trust instrument provides
for a designated beneficiary of the trust property upon the death of the grantor.
Living trusts are recognized as legal entities in every state, and laws of every
state exempt property in a living trust from probate.
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Have living trusts always been used to avoid probate?
No, the use of living trusts solely to avoid probate is actually a relatively new
phenomenon. Although living trusts have been around for hundreds of years, their
purpose has been largely the same as testamentary trusts; that is, both were used
primarily to hold and manage property for the benefit of surviving family members
following the death of the owner. At some point around the mid-twentieth century,
estate planners discovered that living trusts had certain advantages over testamentary
trusts, including the following:
- Unlike testamentary trusts, living trusts are not dependent upon the admission
of a Last Will and Testament to probate. And, it is just as easy to create a living
trust under a separate trust instrument as it is to create a testamentary trust
under a will.
- A living trust is created under a separate instrument, so it can be changed or
terminated without going though the legal formalities of creating a will.
- Under most state laws, probate courts do not have jurisdiction over living trusts.
Living trusts are private and not open to public inspection. Therefore, trustees
operate under much less scrutiny and disgruntled heirs have a much harder time voicing
their opposition.
While living trusts were being created with greater frequency after the 1950s, they
were seldom funded during the grantor’s lifetime. The intended purpose for a living
trust was still to hold and manage property for the benefit of surviving family
members following the death of the owner. Since the trust was unfunded during the
owner’s lifetime, the property had to pass through probate into the living trust
after the owner’s death via his Last Will and Testament. When used in this manner,
the Last Will and Testament was called a "pour-over will" because it was used to
pour-over the probate property into the living trust.
In the 1970s and 1980s, estate planners began to realize that living trusts offered
more benefits than previously thought. Here was a time-tested legal entity that
had been used for hundreds of years to hold and manage property for others. It was
also being used by many wealthy individuals to have their assets professionally
managed for their own benefit. It wasn’t long before estate planners realized that
a living trust was also a very effective way to avoid probate and the horror stories
associated with the probate process.
For all these reasons, the use of revocable living trusts has grown rapidly over
the past several decades, and it is likely that the popularity of living trusts
will continue for years to come.
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Is it a good idea to avoid probate?
It depends. The Probate process is designed to protect anyone who may
have an interest in your estate, even the people not listed in your will. Because
of the protections afforded to your heirs in your will and your heirs at law, Probate
takes a relatively long time to complete. In Massachusetts, a reasonable rule of
thumb for the time it takes to complete probate is 18 months. Typically, a probate
in Massachusetts costs about 5% of the probate estate - these expenses consist of
filing fees, attorney's fees, executor's fees, accountant fees, appraisal fees,
etc.
Massachusetts does provide for a simple procedure called a “Voluntary Probate,”
which can be used to settle an estate if the assets subject to probate are less
that $15,000, excluding an automobile.
Even with larger estates that are fully supervised by the probate courts, there
seems to be a concerted effort to help families get through the probate settlement
process with as little aggravation as possible. A lot depends on each family’s relationships
and interactions with one another. Cooperation among family members greatly increases
the likelihood of an uneventful probate.
The following are a few of the more important factors to consider when deciding
whether you wish your estate to go through probate:
- Your intended beneficiaries are not of legal age. The law does
not allow a minor to hold property in his or her name. If you name a minor as beneficiary
of your property, the probate court will appoint a guardian to hold the property
until the minor reaches majority age. Creating a trust to hold that property for
the minor would be much better than having the court appoint a guardian because
you can spell out the terms of the trust, you can designate one or more people of
your own choosing to serve as trustee, and you can hold the property in trust beyond
the age of majority. You can create a testamentary trust for this purpose and such
trust will be monitored by the courts until its termination, but a living trust
may be better because it will allow you to avoid probate and the court’s continual
supervision.
- Your intended beneficiary is a spendthrift. It may be that you
want to leave property to a particular person, but you know that it will all be
spent in a short period of time. Or, maybe you're concerned that your intended beneficiary
will get a divorce and all of the property will end up with the spouse. Or, maybe
you have an elderly parent or relative that you want to provide support for after
you're gone, but you want the property to pass to your children after that parent
or relative dies. In all these cases, the only way to accomplish your objective
is to place the property in trust. Again, a testamentary trust can be used for this
purpose, but a living trust may serve you better because it will allow you to avoid
probate as well.
- An impending disability is likely. If your age or medical condition
is such that you have a real concern about managing your property on your own during
your life, then a living trust may enable you to have a hand-picked manager take
over for you without any court intervention. For this purpose, a revocable living
trust is much better than a durable power of attorney, although both may be advisable.
- You own real estate in another state. If you own real estate
outside of your state of domicile, then an ancillary probate will be required in
the state where the real estate is located. However, if that real estate is held
in a living trust rather than your own name at the time of your death, then an ancillary
probate of that property will not be required.
- You have concerns over privacy. If you are concerned about other
people knowing your business if you become disabled or die, then a living trust
is something you should consider. A living trust will allow you to transfer management
to someone you know and trust without fear of having your business made public.
- You may have disgruntled heirs. If your loved ones are likely
to fight over your property, then a living trust will make it harder for them to
do so on the grounds of incapacity, undue influence, and the like. If your only
objective is to avoid probate, then you have to carefully weigh the costs of setting
up and funding a living trust against the costs and delays associated with probate.
However, if one or more of the above factors are legitimate concerns, then the scales
become more noticeably tipped in favor of a living trust.
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Are there disadvantages to a living trust?
Although there are very significant benefits to be gained from a living
trust, there may be some disadvantages as well. The following are some of the disadvantages
often associated with a living trust:
- Lifetime effort. It takes more time and effort to implement a
living trust than it does to just make a will. Where the objective is to avoid probate,
it is critical that assets be re-titled in the name of the trust once the trust
instrument has been created. Furthermore, once the living trust has been completed
and fully funded, it is important that the entire estate plan be monitored from
time to time to insure that all assets are properly titled and that your overall
objectives are being met.
- Costs. There are more initial costs associated with a living
trust than there are with just a traditional will, although these costs may turn
out to be far less than the costs of probate. There are additional costs to plan
the living trust and the overall estate plan and there are additional costs in transferring
assets to the living trust. If someone other than the grantor is acting as trustee,
then there may be trustee fees as well. However, if the additional costs associated
with a living trust are within the normal cost parameters for this type of work,
then the benefits should far out weight the costs.
- Lack of court supervision. One of the benefits of the probate
system is that someone is watching over your interests and the interests of your
loved ones. That does not normally happen with a living trust because the probate
courts do not have jurisdiction over living trusts. While many individuals prefer
to keep the courts out of their business, it could also be a disadvantage under
certain circumstances.
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If I have a living trust, do I still need a will?
Yes. A will is still necessary because it is very unlikely that you
will have all of your property in a living trust upon your death. There may be a
bank account in your own name or there may be debt owed to you by someone. There
may be an income tax refund or a stock dividend paid to you. Whatever property is
not in your living trust will pass through probate if it is owned solely by you.
A will is the only way that you can designate a beneficiary for that property.
As a practical matter, a Last Will and Testament and a revocable living trust go
hand in hand. The revocable living trust is set up to hold property during your
lifetime and it serves as an excellent vehicle for the management of your property
in the event of incapacity. It also serves to avoid probate on any property in the
trust upon your death. Furthermore, it becomes an excellent vehicle to hold and
manage your property for any beneficiaries that are minors or spendthrifts, etc.
Although it is recommended that you fund your trust as soon as possible, you can
fund it at any time. Once the vehicle is in place, then the decision is up to you.
The Last Will and Testament is a fail-safe devise to pick up any property that did
not get into your living trust during your lifetime and "pour it over" to your living
trust after your death. In that way, your living trust becomes the sole vehicle
for disposing of your property after your death.
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Are there income tax benefits with a revocable living trust?
No. With a revocable living trust, the grantor retains the right to
amend or change the trust instrument or to revoke or terminate the trust at any
time. Because the grantor retains that much control over the property, the federal
tax laws hold that the grantor still owns the property. Therefore, the grantor must
report the income of the trust on his or her tax return, and must pay the taxes
on that income, the same as if the property had never been transferred to the trust.
If someone other than the grantor is acting as trustee, then the trust is required
to obtain its own Tax Identification Number (EIN). All trust investments will be
listed under that EIN, and the trust will file its own federal and state income
tax return. Most revocable living trusts that are established for estate planning
purposes will not have a trustee other than the grantor. In that case, the income
tax reporting of income earned by the trust during the grantor's lifetime will not
present any particular problems. However, once someone other than the grantor is
serving as trustee, then the federal and state tax laws become more complicated
and beyond the abilities of most grantors. For that reason, professional tax preparation
and advice is highly recommended.
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Can a living trust reduce estate taxes?
A revocable living trust does not reduce estate taxes, per se. That's
because the grantor retains the right to amend or terminate the trust and to take
back the property at any time. Under the tax laws, the grantor's right to take back
the property means that he or she still owns it. And, if you own property, then
you're going to be taxed on its income while you're alive and it's going to be subject
to the estate tax when you die.
However, it’s important to realize that a living trust can - and often is - used
as a vehicle to take advantage of certain estate-tax saving techniques available
under the estate tax laws, which can save your heirs more money than you might imagine.
These techniques are perfectly legal and are fully sanctioned by the tax laws and
the Internal Revenue Service.
It is important to note, too, that these estate tax saving techniques can be utilized
through a testamentary trust as well. So, it is not necessary that you have a living
trust in order to achieve these tax savings. Still, a living trust is generally
preferred over a testamentary trust for other non-tax reasons, including the fact
that the living trust has built-in trustees named by the grantor to manage his or
her affairs during any periods of incapacity. The trustee’s powers survive the grantor’s
death and continue until all terms of the trust have been accomplished. Everyone
must look at their own circumstances to decide which course of action is best for
them.
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Will a revocable living trust protect my property from creditors?
No, creditors can reach the property in a revocable living trust during the
grantor’s lifetime since the grantor is still considered the owner. Generally, after
your death, all property you owned -- including assets held in a living trust --
is subject to your lawful debts. For example, if your house is held in trust and
passes to your children at your death, a creditor could demand that they pay the
debt, up to the value of the house. Ownership of real estate is always a matter
of public record, so creditors can always find out who inherited real estate. It
can be more difficult for creditors to know who inherits other property, however,
because a trust document, unlike a will, is not a matter of public record.
On the other hand, probate can also offer a kind of protection from creditors. During
probate, known creditors must be notified of the death and given a chance to file
claims. If they miss the deadline to file, they're out of luck forever.
The above questions and answers are provided for informational purposes only, and
do not constitute legal advice. Individual circumstances differ significantly, and
I can give my legal opinion on a matter only after consulting with you and considering
the particulars of your situation.
Please contact me at you convenience if you wish
to discuss your specific estate plan.
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