Estate Planning for the Savvy Client

by Mary L Barrow

  Mrs. B., who has a six-year-old son, Timmy, is making out her Will. Because it is undesirable to leave a large amount of money to a minor child, the Will includes a trust for Timmy. The Will may say something like, “I give and bequeath to my Trustee, John Doe, the sum of X dollars, to be held, administered and disposed of as follows. My Trustee is authorized to pay from time to time so much, or none, of the net income of the trust as may be advisable, in the discretion of my Trustee, for the health, education, maintenance and support of my son, Timmy. When my said son reaches the age of 25 years, my Trustee shall distribute to my said son the entire balance of the trust.”

  There are generally three parties to a trust:

  The grantor (sometimes also known as the settlor, trustor or by other names) is the person who intends to place property in trust. In the above example, Mrs. B is the grantor.

  The trustee is the person or institution who legally owns the property for the benefit of another person, and is charged with safeguarding, investing and distributing the property as directed by the terms of the trust. In the above example, John Doe is the trustee.

  The beneficiary is the person who will receive the benefit of the property, but only under the terms of the trust. In the above example, Timmy is the beneficiary.

  A trust divides property ownership into two separate pieces–legal ownership and beneficial ownership. The trustee is the legal owner of the property in the trust, and the beneficiary is the beneficial owner of the property in the trust.

  In our example above, John Doe, as trustee, is the legal owner of the property in the trust. However, he cannot use the property for his own benefit because he is not the beneficial owner. He can use the property only for the legitimate expenses of the trust and for the benefit of Timmy, who is the beneficial owner of the property in the trust.

  John Doe will be legally obligated to safeguard and invest the trust property until Timmy is 25 years old. During that time, John Doe will also decide when and how much of the trust money to spend for Timmy’s health, education, maintenance and support. When Timmy turns 25 years old, John Doe will pay to Timmy whatever property remains in the trust and the trust will terminate.

  Why You May Want a Trust

  Trusts can be extremely useful in estate planning, and there are many different types of trusts that are used for many different purposes. Here is a sample of some of the reasons you may want a trust as part of your estate plan:

  If you are leaving assets to a minor child. As we have seen, a trustee can manage the assets until the child reaches a certain age.

  If you are leaving assets to a beneficiary who may not be capable of managing money, or who may not want to manage money, such as an elderly or inexperienced person. A trustee can manage and distribute the assets for the benefit of that person.

  If you leave assets to someone who is disabled and receives government benefits (or may be entitled to receive government benefits in the future), you may inadvertently disqualify that person from receiving benefits. You can avoid that outcome by using a certain type of legally sanctioned trust (usually called a “special needs trust” or “supplemental needs trust”).

  If you leave assets to a beneficiary who may have unpaid creditors, such as a beneficiary with problems managing money, drug or alcohol problems, marital problems, or who is in a profession with a high risk of being sued, you can use a trust to protect assets from the beneficiary’s creditors.

  If you are in a second marriage and have children from a prior marriage. In this situation, if you die first and leave assets to your spouse, there is no guarantee that your spouse will leave anything to your children when he or she later dies. Instead, you can create a certain type of trust, sometimes called a marital trust or a QTIP trust. With this type of trust, the trust property is used for the benefit of your surviving spouse as long as he or she lives, and then whatever is left goes to your children (or whoever else you specify).

  If your estate may be subject to estate taxes. There are certain types of trusts used for estate tax minimization.

  If you want to avoid probate. In What Is Probate? in Chapter 1, we discussed some of the factors you might want to consider in deciding whether the benefits of avoiding probate are worth the costs. One way to avoid probate is by using a revocable living trust, which we will discuss in more detail in the next chapter.

  If you are concerned that you may become incapacitated. In the last chapter, we discussed using a power of attorney in case you are incapacitated. A revocable living trust is another tool that can be useful if you are incapacitated, and we will discuss that in more detail in the next chapter.

  Two Types of Trusts

  Your trust can be one of two distinct types. Let’s look at the characteristics and consequences of each.

  Testamentary trusts. One type is a trust you create by including trust language in your Will (as Mrs. B. did in our example). This is known as a “trust under Will” or testamentary trust. Some of the characteristics of a testamentary trust are as follows:

  A testamentary trust legally exists only after you die and your Will is probated.

  Because the trust doesn’t exist until after you die, you can’t also be the trustee of your testamentary trust.

  Likewise, because the trust doesn’t exist until after you die, you can’t fund your testamentary trust during your life. A bit later, I’ll explain what it means to “fund” your trust.

  Living trusts. The other type is a trust you create by using a separate, stand-alone legal document. This is known as an “intervivos” or living trust. Some of the characteristics of a living trust are as follows:

  A living trust is created during your life. It legally exists when you sign the trust document with the necessary legal formalities.

  You can be both the grantor and the trustee of your living trust. The fact that the living trust exists during your lifetime makes this possible.

  You can fund your living trust during your life. That is, you can choose to transfer legal title to property to the trustee. The fact that the living trust exists during your lifetime makes this possible.

  How a Trust Is Created

  A trust is usually created in writing by a legal document (the trust document). As we just discussed, the legal document which creates the trust can be a Will, or instead it can be a type of contract between the grantor and the trustee. This type of contract is traditionally called a trust indenture or trust agreement, but it may also be called by other names.

  The trust is created by a valid trust document, that is, a probated Will or a properly signed trust agreement. The trust document spells out:

  the terms and conditions the trustee must follow when dealing with property in the trust,

  when the trust will end, and

  how the remaining property will be distributed when the trust ends.

  How a Trust Is Funded

  It is important to distinguish the concept of creating a trust from the concept of funding a trust. Although you may have validly created a trust (by your Will or with a trust agreement), it is not funded until you transfer property to the trust. In other words, the trust is funded only when the trustee legally owns some property, known as the trust property. (Trust property is sometimes called the “trust corpus” or other names).

  The way you fund a testamentary trust is by leaving property to your trustee in your Will. For example, “I give and bequeath my residuary estate to my trustee, in trust, to be held, administered and distributed as follows…” The way you fund a living trust is by transferring property to your trustee, either during your life (for example, by making your trustee the owner of your bank account) or by Will.

  What Does a Trustee Do?

  The trustee is the person you are “trusting” to safeguard and invest the trust property, pay all the legitimate debts, expenses and taxes of the trust, and distribute the remaining property in accordance with the terms of the trust document.

  A trustee’s role is simil
ar to that of an executor, but with some important differences. While an executor’s job is fairly short, typically lasting a year or two until the estate is settled, the role of a trustee can continue for many years.

  Another important difference is that, unlike an executor who usually has little flexibility, a trustee may be called upon to exercise discretion. This means that if the trust tells the trustee to use the trust property for the “health, maintenance and support” of a beneficiary, it will be up to the trustee to decide specifically what may be desirable for the beneficiary’s “health, maintenance and support.”

  These decisions may be extremely difficult for any number of reasons. For example, let’s say the trust was established because the beneficiary is a spendthrift. The beneficiary might demand that the trustee pay for a new sports car or pay off the beneficiary’s credit card bills. The trustee will need to decide if such expenditures are a prudent use of the trust funds. The trustee may have to consider many factors, such as the size of the trust fund and the beneficiary’s other income.

  As another example, let’s say there is more than one beneficiary of the trust. Should the trustee expend more money on one beneficiary than another? What if one of the beneficiaries needs medical care that, if paid for by the trust, would leave very little for the other beneficiaries? Should the trustee pay for that?

  Sometimes these types of questions are answered by the express terms of the trust, but many times they are not. The trustee, therefore, is the one who will need to decide.

  Who Should You Name as Your Trustee?

  As with naming an executor, you have a lot of choice in choosing a trustee. Your trustee can be any adult individual, such as a family member, friend, your accountant, or your attorney. Another possibility is a corporate trustee, such as a bank or trust company.

  Your trust may have more than one trustee, who must act together as co-trustees. If you have more than two trustees, usually the majority rules. As with co-executors, it’s very important that your co-trustees work well together. For example, although it may be tempting to “include” all of your children as co-trustees, if they cannot agree, they may have to get the court involved to resolve disputes.

  One advantage to having a corporate trustee, such as a bank or trust company, is that they are professionals who are used to dealing with issues of discretion. Typically, a corporate trustee will have an experienced committee to deal with requests from beneficiaries. Bear in mind that the trust may have to be a certain minimum value in order for a bank or trust company to agree to act as trustee.

  Another option that works well in some situations is to have two co-trustees, one of whom is an individual familiar with the beneficiaries and the family situation, and the other of whom is a professional corporate trustee.

  If you are considering a corporate trustee, you may want to meet with a few banks or trust companies in advance in order to get a sense of how they work, what they charge for their services, and whether they would meet your needs. Your attorney may be able to refer you to some reputable corporate trustees. If you choose a corporate trustee, make sure the trust provides a method for replacing the corporate trustee with a different corporate trustee in case situations change, such as a corporate merger or changes in personnel.

  Remember

  Do you need a trust? Check some of the reasons you might want one, which are listed in this chapter.

  Before you set up a trust, know why you’re doing it.

  There is more than one way to create a trust. You can create a trust either by including trust language in your Will (a “testamentary trust”) or by a separate document (a “living trust”).

  CHAPTER 6

  Revocable

  Living Trusts

  YOU MAY HAVE HEARD the term revocable living trust (which I’ll refer to as an “RLT”). RLTs have become important, useful, and much talked about tools in estate planning, but what are they exactly? More important, do you “need” one? As with other estate planning tools, you should know first what you want to accomplish, and second whether an RLT is the best way to meet your goals.

  What Is a Revocable Living Trust?

  An RLT is a stand-alone legal document that creates one or more trusts. In other words, you don’t set it up in your Will, but in a separate document that works in conjunction with your Will. It’s called a “living” trust because it exists while you’re alive. It’s a “revocable” trust because you can change or revoke its terms, or even revoke the whole thing, if your situation changes.

  An RLT is also sometimes called a “Will substitute.” That’s because, just like a Will, an RLT can specify who gets the trust property when you die. Property you own in an RLT passes according to the terms of the RLT, regardless of what your Will says.

  In its simplest form, an RLT tells the trustee how to use the trust property during your life, as well as how the remaining trust property must be distributed upon your death.

  An RLT can also contain within it other types of trusts, for example, a trust for a minor child as in the example in Chapter 5, Do You Need a Trust?. You can think of an RLT as a container for different types of trusts, much as you can think of an IRA as a container for different types of investments.

  Do You Need a Revocable Living Trust?

  As we saw in Chapter 1, Basics You’ll Want to Know, an RLT is an optional part of an estate plan and works together with your Will, power of attorney and advance directives to create your total estate plan. It will cost you additional time and money not only to set up the RLT, but also to fund it with your assets.

  Many times when I ask clients why they “need” an RLT, they have no idea. Some just hem and haw, some just give a vague (or incorrect) answer, but eventually what it comes down to is that they don’t know. I have found this to be the case both with clients who don’t yet have an RLT and with clients who have already spent considerable time and money to set up an RLT.

  In the rest of this chapter, we’ll discuss two of the major and most important uses of RLTs:

  using an RLT to avoid probate, and

  using an RLT to help if you become incapacitated.

  Your attorney might suggest other reasons why an RLT would be useful in your specific situation.

  The next section will help you consider whether you want to avoid probate. Let’s say you do want to avoid probate. Does that mean you “need” an RLT? Not necessarily. Re-read Chapter 2, The Number One Misconception About Wills, and remember that property that passes by beneficiary designation (such as life insurance, IRAs, 401(k)s, annuities, pensions and the like) already avoids probate. So does property that passes by law (such as jointly-owned property).

  If your goal is to avoid probate, then an RLT is one option you can use (along with others). If you use an RLT, you should still have a Will (see You Still Need a Pourover Will later in this chapter).

  Why Avoid Probate?

  In Chapter 1, Basics You’ll Want to Know, we talked about probate, which is a legal proceeding in which a deceased person’s Will is submitted to a court. The court then determines whether or not the Will is valid and appoints an executor to carry out the terms of the Will. There is usually ongoing court supervision of the progress of the estate administration and certain requirements the executor will have to fulfill before the estate can legally be closed.

  We also talked about the popular misconception that probate must be avoided at all costs. But the reality is that it depends. Probate procedures vary enormously, not only from state to state, but even from court to court. Let’s discuss in more detail some of the factors that might make you want to avoid probate where you live. Your attorney can guide you based on his or her experience with probate in your jurisdiction.

  Probate May Be Slow and Burdensome

  In some places the probate process is simple and quick, while in others it is slow, expensive and burdensome. You may feel that the probate process in your state adds value; for example, by having a judge oversee the settleme
nt of your estate; or you may feel that the process is more bureaucratic in nature and something you would rather avoid.

  Probate May Be Expensive

  Probate fees vary enormously from state to state; they usually depend on the value of property. In some states you can avoid probate fees by placing property in an RLT, but in others the probate fee is computed on the value of all property, not just probate property. If your state has high probate fees that you can avoid by placing property in an RLT, you might want to do that in order to take advantage of that opportunity.

  Probate May Require Court Involvement in Trusts

  Some states require ongoing court supervision of trusts created by Will (testamentary trusts), but not of living trusts, like an RLT. What does this mean?

  Say you want to create a trust for a minor child, and that you want the trust to exist until the child is 25 years old. If the child is young, the trust may have to exist for many years.

  In the case of this particular type of trust, you have the choice of two ways of creating the trust. You could create it as part of your Will (a testamentary trust), or you could create the trust as part of your RLT.

  If you create the trust by Will (a testamentary trust), state law may require the trustee to submit annual accountings to the court for its approval. This requirement creates an additional expense for the trust and adds a burden of both time and energy on the part of the trustee. On the other hand, if you create the trust in an RLT, normally the trustee is not required to obtain judicial approval of annual accounts (unless the trustee or a beneficiary specifically requests it). If this is the case in your state, you may want an RLT to avoid the expense and delay of ongoing court supervision of your trusts.