In order to understand trusts, one must approach learning about trusts in multiple dimensions. This includes understanding the parties to a trust, benefits to using trusts, how to actually fund the trust, and more.
Intro: The Very Basics
Transfers in trust pass by operation of law. The caveat is that the mere existence of a trust is not sufficient to transfer assets - an unfunded trust is akin to a bank account with no money in it. Merely naming the property to be owned by the trust in the trust document is also insufficient.
A trust must be funded in order to transfer any assets. The owner of the property must be the trust, such as a bank account being owned by "The Doris Day Revocable Trust," or the Deed to a house naming "John Rockefeller, Trustee of the John Rockefeller Revocable Trust."
There are numerous, powerful benefits to utilizing trusts. Some of these benefits may be available using either Inter Vivos Trusts (those created during life using a separate instrument, sometimes referred to as "Stand Alone Trusts") or Testamentary Trusts (trusts created after death, typically by a section in a Will). However, certain powers and benefits only apply to inter vivos trusts.
A. Parties to a Trust
There are three primary parties to any Trust: The Settlor (also known as the Grantor or Creator), the Trustee and the Beneficiary. Each party may include more than one individual, such as two grandparents who create and fund a trust (the Settlors) who name their three children to administer to the property in the trust (the Co-Trustees) for the benefit of the Settlor's grandchildren (the Beneficiaries).
Settlor (or Grantor, or Creator) : The Settlor creates the trust, typically with the assistance of an attorney, executes the trust, and funds the trust. The Settlor of a trust can never change - once a trust is created by a party no other party can create it, though other people may be permitted to contribute to the trust.
Trustee: The Trustee is the fiduciary of the trust: He manages and invests the trust property, follows the terms of the trust, represents the interests of the trust (such as protecting the beneficiaries assets in the trust from creditors), and distributes trust funds to the beneficiaries. Trustees are entitled to a commission of approximately one percent (1%) of principal, income and distributions, but are not required to accept them. Upon the resignation, death or incapacity of a Trustee a Successor Trustee takes the initial Trustee's position and responsibilities. This allows for continuity of administration of trust assets. Because the creator of a testamentary trust is deceased at the moment the trust is created, it should be obvious that the testator should not name himself the trustee of his own testamentary trust.
Beneficiary: There are frequently several levels of Beneficiaries. There is typically an initial beneficiary(s), followed by one or more remainder beneficiaries once the initial beneficiary no longer receives trust funds. A beneficiary may compel the Trustee to account for trust funds and expenses, but there is still a question as to whether a Trustee has an obligation to inform a beneficiary of her right to receive trust funds prior to the time they are entitled to distributions. Again, the creator of the testamentary trust is deceased, and should not name himself the beneficiary of the trust.
Benefits of Using Inter Vivos Trusts
The general rule for estate planning practitioners is that use of inter vivos trusts is almost always the preferred way to distribute estate property. The only rational reason not to have an inter vivos trust implemented is when the client does not want to pay the added legal fees for the additional document(s). Probate is not required if all of the Settlor's potential testamentary assets are held in an inter vivos trust, but a Will should always be created in addition to a trust for any assets that are not titled correctly. Therefore, it is best to view an inter vivos trust as the complement to a Will, and not as a supplement.
1. Avoidance of Probate / Continuity of Asset Management
Trust assets pass by operation of law, thus are not Testamentary transfers, and thus do not pass through Probate. This is desirable for several reasons. Probate has filing fees that are not required for transfers in trust. These court fees are reasonable, but the paperwork required to Probate Testamentary assets is lengthy and may add substantial attorney fees to administration expenses. Probate also takes more time to accomplish than trust administration, due to the fact that multiple court requirements must be fulfilled. When a person passes away her assets are required to be frozen until Letters Testamentary have been issued. However, if a successor trustee is named in the instrument and agrees to serve, inter vivos trusts allow these assets to be administered, traded or transferred.
Probate is a public affair - even lineal descendants who are being disowned by the Testator are entitled to notice of Probate, whereas the administration of Trusts is a private affair. Administration and distribution of trust assets is much faster than going through Probate. Lastly, Inter Vivos Trusts (those created during the Settlor's life) require no court supervision, whereas Testamentary Trusts (those created by a Will at the death of the Testator) may require court oversight and supervision, thereby drastically increasing expenses.
Negatives aspects of trusts are (1) trusts are typically more expensive to create than Wills, and (2) a great deal of time may be required to fund the trust by renaming the Settlor's assets. In addition, the mere existence of a trust does not obviate the need to have a Will in place as well, since it is inevitable that some assets will not be owned by the trust.
If the Settlor / Testator does not perceive a conflict between family members he or she may choose to have a Pour-Over Will. This Will has standard Will provisions (naming an Executor, preferred Guardian of minor children, etc.), but also includes the entire content of his or her trust, which states how the estate is to be distributed. The property not owned by the Trust does go through Probate, but the beneficial testamentary pattern is maintained. This can be done by simply "copying and pasting" the trust into the Will. Therefore, even though the Pour-Over Will shall be a longer document than the trust itself, it may have less significance for transferring estate property.
More Benefits of Using Inter Vivos Trusts
2. Avoidance of Ancillary Probate
Certain property, such as cash in a bank account or securities in a brokerage account, are considered fungible for estate administration purposes - the fact that the financial institution is in a state other than the decedent's domicile has no relevance in determining the proper venue to Probate the assets. However, real property and the personal property located in that real property is different. Real property is unique: It cannot be transferred, so a decedent's estate owning real property in two or more states shall need a Will in each of those states and shall face Probate (or Intestacy) in each of those states.
The process of having to hold a Probate proceeding in a non-domiciliary state is known as Ancillary Probate. From a financial perspective this process has no benefit, as attorneys in two different states will need to do nearly identical work in order to settle the decedent's estate. Ancillary Probate can be avoided by having the out-of-state real property owned by a trust. Because property owned by a trust does not need to be Probated the real property in the second state avoids Probate entirely.
3. Types of Inter Vivos Trusts
The number of trusts that can be created during the Settlor's life and the terms that can be applied to them are only as limited as human imagination and certain laws will allow. One important rule does remain constant: Any and all trusts become irrevocable upon the death of the Settlor, even Revocable Trusts. What follows is a brief explanation of frequently utilized inter vivos trusts.
a. Revocable Trusts: Settlor's Alter Ego / Seamless Transition
Frequently the Settlor will serve as the initial Trustee and Beneficiary of his or her Trust: Trust property is administered by the Settlor for the benefit of the Settlor. Upon the Settlor's incapacity his or her choice of Successor Trustee can continue to use trust assets for the Settlor's benefit. Upon the Settlor's death the next Beneficiary begins receiving trust assets (typically a spouse, child, more distant family member, friend, or a charity). This is currently the most frequently utilized Trust: The trust acts as the Settlor's alter-ego by creating wealth, administering these assets and taking distributions, while also permitting near-seamless transition of administrative power and funds to other parties. In this vein, because the trust property is included under several Grantor Trust IRC sections any income generated by the trust is taxable at the Grantor's favorable income tax rate. However, a revocable trust is included as property included under IRC ?2038, so property held in revocable trusts are always included in the Settlor's gross estate for estate tax purposes.
b. Irrevocable Trusts
All trusts, including revocable inter vivos trusts, become irrevocable upon the death of the Settlor. Apart from Decanting under EPTL Section 10-6.6, irrevocable trusts cannot be changed. In addition, unless Grantor Trust Rules apply, the trust will need its own tax identification number and will need to pay taxes on any investment gains, even if this income is not distributed to the beneficiaries.
Funding Inter Vivos Trusts
Unlike testamentary trusts, which are funded through the Probate process, inter vivos trusts must be funded prior to the Settlor's death. An unfunded inter vivos trust is ineffective in transferring assets by the terms of the trust, which leads to the assets having to pass by the Settlor's Will (Probate), Intestacy or a form of operation of law transfer. It is absolutely essential that the attorney oversees the process of naming assets correctly to fund the Settlor's trust.
Example: An investment or bank account should be named The Margaret Smith Revocable Trust. In order to avoid Ancillary Probate, the Deed to an out of state residence should be titled to The Jeremy Roberts Revocable Trust, Jeremy Roberts as Trustee
Most financial institutions and insurance companies will require two aspects of the trust before they will allow the account to be owned by the trust: (1) The page with the Article naming the trust, and (2) the signature page of the trust. A less experienced estate planning practitioner should initially ask for the assistance of a financial planner and bank manager in correctly setting up a client's trust accounts; setting up these accounts typically does not cost the client any administrative funds. When retitling real estate to a trust as the owner a practitioner should work with a Title Insurance company to file the Deed; this will often lead to costs associated with changing the Deed with the municipality and fees owed to the Title Company for preparation, but these costs are often well worth the expense.
5. Using Inter Vivos Trusts to Transfer Operation of Law Assets
Certain operation of law assets, life insurance and retirement accounts in particular (as described further below), can name a trust as the beneficiary of the asset. This provides two important safeguards for the beneficiary. First, a trust beneficiary who may not have financial discipline can have life insurance or retirement plan proceeds distributed at intervals instead of all at one time. Second, as explained below, a beneficiary with creditor issues will not receive the asset, but rather have them held in trust until a settlement can be made with the creditor.
Creditor Protection / Naming the Correct Trustee
One substantial benefit of using trusts is the power to protect trust assets from creditors. A Settlor cannot protect his own property from creditors by placing it in a trust for his own benefit. In addition, state law permits a person's creditors to attach certain transfers which are made in anticipation of a lawsuit. However, a trust, whether it is an Inter Vivos or Testamentary Trust, does allow for creditor protection of Trust assets for almost anyone other than a Settlor (though a spouse or a beneficiary may not have complete protection). The rationale for allowing this protection is that the property held in trust is owned by the Settlor or his estate, so he and his successor fiduciaries may dispense with the funds as they see fit. In New York it is assumed that the Settlor desires this protection for his beneficiaries, even if the trust is silent as to this protection.
For example, a family member who has defaulted on his debts is the beneficiary of a trust. Under the trust instrument the trustee is permitted to withhold trust distributions if he believes it would be prudent to do so. When the beneficiary's creditors demand payment the trustee can continue to withhold distributing trust funds to the beneficiary until the creditors negotiate for a lower settlement amount (perhaps forty percent of what is owed, though the actual amount will vary depending on the circumstances).
This strategy will typically not succeed if the beneficiary also happens to be the trust's sole trustee or if the trustee is "beholden" to the beneficiary, such as a spouse, employee or child of the beneficiary. Some exceptions may be made if the distributions are based on an Ascertainable Standard for the trustee/beneficiary's health, education, maintenance or support [sometimes referred to by the acronym "HEMS"], but there are several intricacies that should be understood before naming a beneficiary as the sole trustee of his or her own trust. To avoid these problems it is advisable to include trust language permitting a trustee or trust protector to appoint a disinterested co-trustee.
Estate Tax Credit Shelter Trusts (for Married Couples)
Another advantage of both testamentary and inter vivos trusts is their ability to shelter estate assets from estate taxes. A Credit Shelter Trust, also known as an "A/B Trust," is typically not its own document, but a provision in a trust or Will that holds aside the estate tax credit amount upon the death of a married decedent. This credit shelter amount may be referenced as either the federal exemption amount, the New York state exemption amount, or specifying neither, allowing the then-serving trustee to make the determination. The practitioner should typically avoid refering to the exemption as a Pecuniary Formula (a specific dollar amount) which would make it rigid and inefficient due to changes in future legislation, but should instead use a Fractional Formula (defines the parameters of the numerator and denominator of the bequest) to determine the credit shelter amount.
Qualified Terminal Interest Property ["QTIP"] Trusts may be suitable when only one spouse has substantial assets and does not want the other spouse to have unfettered access to the principal of his or her credit shelter amount. At a minimum a QTIP must leave an income interest to the less wealthy spouse while permitting the wealthy spouse to name the residuary beneficiary and utilize the less wealthy spouse's estate tax exemption. A QTIP is typically used when the wealthy spouse is remarried but has children from a prior marriage, or when the wealthy spouse does not feel the surviving spouse will be responsible for managing a CST's principal. In order for a QTIP Trust to be effective in utilizing the non-wealthy (surviving) spouse's estate tax exemption amount the trust must meet the following requirements: (1) the property must pass from the decedent, (2) the surviving spouse must have a "qualified income interest for life" in the property, and (3) the decedent's Executor or Trustee must make a valid election to treat the property as a QTIP, at which time the election becomes irrevocable.
Supplemental Needs Trusts
Of the many irrevocable trusts that are available in addition to those already mentioned, perhaps the most frequently utilized one is the Supplemental Needs Trust ["SNT"] . It is crucial that an estate planning attorney understand how to use SNTs, even if they are not drafting the documents themselves, and may want to partner with an elder or disability law attorney to ensure the SNT is effective.
SNTs are irrevocable discretionary spendthrift trusts that terminate at the death of a named beneficiary who has a severe and chronic or persistent disability (even if the recipient is over the age of 65). SNTs are meant to supplement (not supplant) government benefits which the individual is eligible, such as Medicaid, Supplemental Security Income and Social Security Disability Income. Funds transferred to these trusts are meant to be used for a disabled beneficiary for any purpose that is not being paid for by a government program. Vacations, wide screen televisions and clothing are all permissible expenses. However, the beneficiary cannot be the trustee, and can never receive trust funds in the form of cash or a check.
SNTs can be created inter vivos or testamentary, but it is often best to avoid testamentary SNTs to minimize future Surrogate's Court supervision and associated legal fees. The trust document must clearly state that the beneficiary cannot have power to assign, encumber, direct, distribute or authorize distribution from trust. The be submitted to the Department of Social Services to assure the trust conforms with state requirements, and must name a remainder beneficiary.
"Third Party SNTs," meaning those created and funded by a settlor other than the beneficiary, and must be established by a parent, grandparent, legal guardian, or court, even if the funds being used are for an individual who also has full mental capacity. Because the trust courpus is from a third party the remainder trust principal is directed to a named remainder beneficiary at the death of the disabled individual. "First Party SNTs" are created with the beneficiary's money (typically from an unforeseen inheritance or lawsuit), and must contain a payback provision for Medicaid.
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