A trust is an estate-planning tool that is essentially a relationship created at the direction of an individual, called the trustor or settlor. The trust directs one or more people, called the trustee(s), to hold the trustor’s property subject to certain duties to use and protect it for the benefit of other people, who are known as the beneficiaries.
It can be created for a wide array of reasons, such as the financial benefit of the person who created the trust, financial support for a surviving spouse or minor children, or for a charitable purpose.
Different Kinds of Trusts
There are several different types of trusts. However, all of these fall under two categories: living and testamentary. A living, or inter-vivos, trust begins during the life of the trustor. A testamentary trust transfers property into the trust only after the death of the trustor through a will. For a testamentary trust, the trust property must go through probate prior to creation of the trust.
- Revocable Trust: A revocable trust is a trust created while the trustor is still living. Upon the trustor’s death, the trust becomes irrevocable. A revocable trust allows the trustor the freedom to revoke or modify the trust however they want without needing the consent of anyone else.
- Irrevocable Trust: Similar to a revocable trust, an irrevocable trust can be created while the trustor is still alive. However, an irrevocable trust is different from a revocable trust in that it cannot be revoked or changed by the trustor upon its creation without the consent of the beneficiary or beneficiaries.
- Credit Shelter Trust: A credit shelter trust is created for the benefits it provides the trustor regarding state and federal tax exemptions. These benefits only really exist for those who are exceptionally wealthy and whose fortunes exceed the multi-million dollar limit. This trust allows a married investor to avoid estate taxes when passing assets on to their heirs. The structure of the trust is such that upon the death of the investor, the assets specified in the trust agreement are transferred to the beneficiaries. Another benefit of this trust is that the spouse of the trustor maintains rights to the trust assets and the income they generate during the remainder of their lifetime.
- Generation-Skipping Trust: A generation-skipping trust is a type of trust agreement wherein the trust assets are passed down to the trustor’s grandchildren, not children. This allows the trustor’s children to avoid the estate taxes that would apply if the assets were transferred to them.
- Qualified Personal Residence Trust: A qualified personal residence trust (QPRT) is a trust wherein the advantages lie in the significant savings that may be had in transfer costs of property. The QPRT is created through the transfer of a personal residence to an irrevocable trust where the trustor retains a right to live in the residence for a fixed term of years.
- Irrevocable Life Insurance Trust: Under an irrevocable life insurance trust, the trustee invests proceeds from the trustor’s life insurance policy upon their death and administers the trust for one or more beneficiaries.
- Qualified Terminable Interest Property Trust: A qualified terminable interest property (QTIP) trust is created to permit a trustor to give a life estate in property to their spouse without the transfer being subject to the federal gift tax. The spouse receiving the property has an income interest in the trust but does not have a power of appointment over the principal.
- Land Trust: A land trust is a private agreement between two parties. One party, the trustee, agrees to hold title to property in trust for the benefit of the beneficiary.
- Charitable Trust: A charitable trust is a trust set up for a charitable purpose. While these trusts are not tax-exempt, a charitable contribution deduction is allowed under a specific section of the Internal Revenue Code. A charitable trust can be private or public, but to be classified as a public charity, it must meet the requirements for one of the exclusions.
- Secret Trust: A secret trust is a trust that arises when property is left to a person through a will with the understanding that they will act as the trustee of that property for the benefit of beneficiaries who are not named. A fully secret trust is a trust where the will is completely silent as to the existence of the trust and all that is mentioned is that the trustee is receiving the property. A semi-secret trust is where the will provides that the trustee is to hold the property in trust, but does not specify the terms of the trust or the beneficiary.
- Special Needs Trust: A special needs trust is designed for beneficiaries who are disabled, either physically or mentally. The trust is created to permit the beneficiary to enjoy the use of the property or funds from the trust without affecting their ability to receive government benefits for their disability. This type of trust can also be created for the beneficiary if the beneficiary, due to their disability, is unable to handle their own financial affairs.
- Spendthrift Trust: A spendthrift trust that gives an independent trustee full authority to make decisions as to how the trust funds may be spent for the benefit of a beneficiary who is financially irresponsible or in a great amount of debt. Creditors of the beneficiary cannot reach the funds in the trust, and the funds are not actually under the control of the beneficiary.
- Totten Trust: A Totten trust is created when the trustor places money in a bank account or security with instructions that upon their death the proceeds in the account be distributed to the named beneficiary. The typical verbiage of a Totten trust includes the language that the account is held “in trust for the beneficiary.”
- Discretionary Trust: A discretionary trust is a trust that provides for beneficiaries to receive specific, stated funds from the trust with specific instructions outlined in the trust. A discretionary trust, like a spendthrift trust, is created for the benefit of a beneficiary who is not able to handle their financial affairs in a responsible manner and the Trustor wishes to protect those assets while still providing for the beneficiary.
- Custodial Trust: A custodial trust is a bank account, trust fund, or brokerage account that is set up for a beneficiary but held in trust by a responsible person. This person is called a custodian, not a trustee. The custodian owes the same fiduciary duty to the beneficiary to handle the assets in the best interest of the beneficiary.
- Crummey Trust: A Crummey trust allows a person to make lifetime gifts to an individual free from gift or estate taxes as long as the value of the gift is equal to or less than the permitted value of $14,000 per individual and $28,000 per married couple, while also protecting the money in a trust. The “gift” in the trust does not come under the immediate control of the beneficiary, but is saved for the benefit of the beneficiary at a future date.
- Bypass Trust: A bypass trust is an irrevocable trust. It is created when a settlor deposits assets into the trust and pays trust income and principal to the surviving spouse for the duration of their life. This transfer of assets to the bypass trust for the benefit of the spouse is tax-free under the unlimited Marital Deduction. A bypass trust is really only relevant if the value of the estate exceeds the current estate tax exemption for that state.
- Asset Protection Trust: An asset protection trust is a trust that provides for funds to be held on a discretionary basis. These trusts may be set up to avoid the negative effects of estate taxes, divorce proceedings, and bankruptcy on the beneficiary of the trust. This type of trust shields the assets from the reach of creditors.
Requirements for a Valid Trust
The process of creating a trust is relatively simple. However, the following requirements must be satisfied in order for the trust to be valid:
- Intent: The trustor must have intended to create the trust when it was created.
- Trustee: There must be a person placed in charge of managing the trust for the benefit of the beneficiary and transferring the assets to the beneficiary. If a specific person is not designated, the court may appoint someone.
- Beneficiary: The trust must state who is to receive the trust’s assets.
- Purpose: There must be a specific purpose for the trust that does not involve furthering illegal activity.
- Assets: The trust must have assets, such as money or property, in it. A trust cannot exist if there are no assets to put into it.
What Can Be Placed in a Trust?
As stated above, an important element of a trust is that the trust contains assets. It is important to note that if the asset has a title, such as a piece of real estate or stocks and bonds, the title of the asset be transferred in the name of the trust. When it comes to personal property, such as jewelry, clothing, and furniture, these items do not have title. However, these items can also be transferred to the trust by transferring your rights to the property to the trustee to be held for the benefit of the named beneficiaries in the trust.
For items such as life insurance policies, retirement accounts, pension plans, and health savings accounts, these items cannot be transferred to the trust as the distribution of these items are determined by the beneficiary named in the individual policies. Therefore, the named beneficiary listed for these policies must be the trustee in order for the assets coming from these items to be placed in trust.
Who Is Considered a Valid Beneficiary?
Anyone can be a beneficiary of a trust, so long as they are properly named as a beneficiary in the trust document. Most people list their spouses, children, grandchildren, and friends as beneficiaries. However, pets, co-workers, strangers, or employees may also be beneficiaries, depending on the trust itself. The beneficiaries of a trust must be definite and certain. This means they must be ascertainable at the time the trust is created. The description provided of a beneficiary must be specific enough for the court to determine who they are with specificity.
What Is a Successor Trustee?
In most living trusts, a settlor will name themselves as the trustee of the trust during his lifetime. However, a successor trustee should be named in the event the settlor becomes incapacitated or dies. The successor trustee must act in the same manner as the original trustee and possesses the same fiduciary duty to act in the best interests of the beneficiaries.
What Is a Pour-Over Will?
Many people neglect to transfer some property into their trust before they die. A pour-over will is a specific type of will used in conjunction with a trust to correct this particular problem. The will is called a pour-over will because it “pours” over the property that the deceased owned at the time of their death into the trust they set up.
Therefore, in the event the deceased passes away before transferring all their property into their trust, a pour over will ensures that all property is transferred into the trust. A pour-over will prevents the property outside of the trust from having to go through probate, an element that the trustor was attempting to avoid when they created their trust.
Getting Help with a Trust
Regardless of whether you have a small or large estate, it is important to contact an estate attorney when planning out how you want your estate to be distributed. The potential tax implications and legal formalities relating to the validity of a will and trust are essential elements to ensuring that your estate is protected. A lawyer near you can explain to you the best avenues to take to protect your assets for the best interest of your beneficiaries and family.