estates and trusts: an overview
During the early 1500's in England landowners found it advantageous to convey the legal title of their land to third parties while retaining the benefits of ownership.
Because they were not the real "owners" of the land, and wealth was primarily measured by the amount of land owned, they were immune from creditors and may have absolved themselves of some feudal obligations.
While feudal concerns no longer exist and wealth is held in many forms other than land (i.e., stocks, bonds, bank accounts), the idea of placing property in third party hands for the benefit of another has survived and prospered. This is the idea of a trust.
Generally, a trust is a right in property (real or personal) which is held in a fiduciary relationship by one party for the benefit of another. The trustee is the one who holds title to the trust property, and the beneficiary is the person who receives the benefits of the trust. To understand the laws governing trusts a good starting point is the Restatement (2nd) of Trusts.
Many trusts are created as an alternative to or in conjunction with a will and other elements of estate planning. State law establishes the framework for determining the validity and limits for both.
The Uniform Probate Code has shaped state law in this field. It includes provisions dealing with affairs and estates of the deceased and laws dealing with specified nontestamentary transfers, like trusts and their administration. The theory behind the Code is that wills and trusts are in close relationship and thus in need of unification. Since its creation, over thirty percent of states have adopted the Code substantially in whole.
Since many individuals neither set up trusts nor execute wills, state intestate succession laws are an important complement to trust and estate law. They determine where an individual's assets go upon death in the absence of a will.
A trust is traditionally used for minimizing estate taxes and can offer other benefits as part of a well-crafted estate plan.
A trust is a fiduciary arrangement that allows a third party, or trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be arranged in many ways and can specify exactly how and when the assets pass to the beneficiaries.
Since trusts usually avoid probate, your beneficiaries may gain access to these assets more quickly than they might to assets that are transferred using a will. Additionally, if it is an irrevocable trust, it may not be considered part of the taxable estate, so fewer taxes may be due upon your death.
Assets in a trust may also be able to pass outside of probate, saving time, court fees, and potentially reducing estate taxes as well.
Other benefits of trusts include:
- Control of your wealth. You can specify the terms of a trust precisely, controlling when and to whom distributions may be made. You may also, for example, set up a revocable trust so that the trust assets remain accessible to you during your lifetime while designating to whom the remaining assets will pass thereafter, even when there are complex situations such as children from more than one marriage.
- Protection of your legacy. A properly constructed trust can help protect your estate from your heirs’ creditors or from beneficiaries who may not be adept at money management.
- Privacy and probate savings. Probate is a matter of public record; a trust may allow assets to pass outside of probate and remain private, in addition to possibly reducing the amount lost to court fees and taxes in the process.
Basic types of trusts
|Marital or “A” trust
Designed to provide benefits to a surviving spouse; generally included in the taxable estate of the surviving spouse
|Bypass or “B” trust
Also known as credit shelter trust, established to bypass the surviving spouse’s estate in order to make full use of any federal estate tax exemption for each spouse
Outlined in a will and created through the will after the death, with funds subject to probate and transfer taxes; often continues to be subject to probate court supervision thereafter
|Irrevocable life insurance trust (ILIT)
Irrevocable trust designed to exclude life insurance proceeds from the deceased’s taxable estate while providing liquidity to the estate and/or the trusts’ beneficiaries
|Charitable lead trust
Allows certain benefits to go to a charity and the remainder to your beneficiaries
|Charitable remainder trust
Allows you to receive an income stream for a defined period of time and stipulate that any remainder go to a charity
Using the generation-skipping tax exemption, permits trust assets to be distributed to grandchildren or later generations without incurring either a generation-skipping tax or estate taxes on the subsequent death of your children
|Qualified Terminable Interest Property (QTIP) trust
Used to provide income for a surviving spouse. Upon the spouse’s death, the assets then go to additional beneficiaries named by the deceased. Often used in second marriage situations, as well as to maximize estate and generation-skipping tax or estate tax planning flexibility
|Grantor Retained Annuity Trust (GRAT)
Revocable vs. irrevocable
There are many types of trusts; a major distinction between them is whether they are revocable or irrevocable.
Revocable trust: Also known as a living trust, a revocable trust can help assets pass outside of probate, yet allows you to retain control of the assets during your (the grantor’s) lifetime. It is flexible and can be dissolved at any time, should your circumstances or intentions change. A revocable trust typically becomes irrevocable upon the death of the grantor.
You can name yourself trustee (or co-trustee) and retain ownership and control over the trust, its terms and assets during your lifetime, but make provisions for a successor trustee to manage them in the event of your incapacity or death.
Although a revocable trust may help avoid probate, it is usually still subject to estate taxes. It also means that during your lifetime, it is treated like any other asset you own.
Irrevocable trust: An irrevocable trust typically transfers your assets out of your (the grantor’s) estate and potentially out of the reach of estate taxes and probate, but cannot be altered by the grantor after it has been executed. Therefore, once you establish the trust, you will lose control over the assets and you cannot change any terms or decide to dissolve the trust.
An irrevocable trust is generally preferred over a revocable trust if your primary aim is to reduce the amount subject to estate taxes by effectively removing the trust assets from your estate. Also, since the assets have been transferred to the trust, you are relieved of the tax liability on the income generated by the trust assets (although distributions will typically have income tax consequences). It may also be protected in the event of a legal judgment against you.
Deciding on a trust
State laws vary significantly in the area of trusts and should be considered before making any decisions about a trust. Consult your attorney for details.