Most people do not engage in any estate planning. Among the small group of people who do, most use a will to pass their estate on to their loved ones. Wills can be a great tool, but it is crucial to understand the benefits of having a trust.
A common misunderstanding is that trusts are only for people who have accumulated a lot of assets during their lifetime. While establishing a trust certainly benefits the wealthy, there are many benefits having a trust provides to people of all income levels.
What is a Trust?
A trust is an agreement between the owner (the grantor) and a trustee, who must hold and manage the property in the trust for the benefit of someone else (the beneficiary). In other words, a trust is simply a contract that tasks a third party with managing your assets during your lifetime and distributing your assets after death.
A trustee is a person whom the grantor puts in charge of managing and administering the trust according to the terms laid out by the grantor. Trustees are tasked with fiduciary duties that require the trustee to act in the interests of the trust beneficiaries (e.g., no self-dealing) and act with care in managing the assets. There are severe consequences for trustees who violate these fiduciary duties, including fines and possible criminal charges.
What Can I Use a Trust For?
There are many different types of trusts. At its most basic form, a trust will enable you to pass on your estate to your loved ones while avoiding probate. The main benefits of a trust are the flexibility to distribute assets over time (unlike a will, which provides for a one-time lump-sum distribution) and avoiding probate.
The flexibility to choose how assets will be distributed is essential for many individuals and their families. For example, say you want to leave money to a child (or an adult), but you are worried they will spend it quickly. Making distributions over time can be crucial to preserving the assets for your loved ones to provide ongoing support.
A will goes through the court-supervised process for administering an estate called probate. Avoiding probate is a priority for anyone who has experienced probate for a friend or a loved one. The probate process takes one to two years to administer your estate, and the court will take a fee of around 10% of the value of your estate. On top of that, probate is a public process, meaning your will is a matter of public record. This invites others to contest (challenge) the will, which results in more time and money.
Among other things, a trust can provide the following benefits:
Manage and control spending and investments to protect beneficiaries from poor judgment and waste;
Avoid probate of trust assets and keep the transfer private;
Protect trust assets from creditors whom beneficiaries owe money to;
Protect premarital assets from the division between divorcing spouses;
In the event the grantor is incapacitated, funds can be set aside to support the grantor;
Manage unique assets that are not easily divisible, e.g., vacation homes, pets, recreational vehicles, mineral interests, timber and commercial real estate;
Manage closely held business assets for planned business succession;
Hold life insurance policies, pay premiums and collect the tax-free proceeds to care for beneficiaries, fund closely-held stock redemptions or purchases, and provide liquidity to the estate;
Provide a vehicle for charitable gifting that can reduce income taxes and benefit the grantor, his or her spouse and their children;
Provide tools for Medicaid and means-tested benefit eligibility for the grantor, a surviving spouse and disabled children;
Provide structured income to a surviving spouse that protects trust assets for descendants if the spouse remarries; and
Reduce income taxes or shelter assets from estate and transfer taxes.
Funding - How to Get Property into a Trust?
A trust must be “funded” with assets to operate as intended. Funding is the process of transferring assets into the trusts. For example, the funding process for real estate involves executing a deed to transfer the property into the trust. For a checking account, the funding process involves making the trust the account owner or moving the money from your original account to the trust account.
You would be surprised how many people forget to fund their trust. A trust agreement can only operate on assets that are moved into the trust estate. An unfunded trust (i.e., no assets in the trust) is an expensive piece of paper with no use.
Categories of Trusts
Trusts fit in one of two categories- a testamentary trust or a living trust (inter-vivos trust).
Living or Testamentary Trust
A testamentary trust is a trust that is created as part of a will. As such, a testamentary trust must go through probate. It devises some or all of the probate estate to a named party as trustee. The trustee will administer the estate according to the will after the grantor’s death. However, the instructions are unknown until after the grantor passes. It is important to note that there is no legal effect of a testamentary trust until the grantor’s death.
A living or inter-vivos trust is a separate trust agreement (distinct from the will) that takes effect immediately during the grantor’s lifetime. Living trusts describe how the assets will be managed while the grantor is alive and upon the grantor’s death. The grantor then appoints a trustee to manage and distribute the assets to the beneficiaries after the grantor’s death.
A key feature of living trusts is that they DO NOT go through probate. Instead, the trustee simply follows the instructions laid out in the agreement–easy!
Living trusts can be revocable or irrevocable, while testamentary trusts can only be irrevocable.
Revocable vs. Irrevocable
A revocable trust is a trust where the grantor retains the right to revoke the trust. The right to revoke the trust allows the grantor to change or terminate the trust during their lifetime. The flexibility to make changes is beneficial as decisions may change after actual life events. One thing to remember is that trusts are presumed revocable unless the grantor expressly relinquishes that right. Thus, it is important to specifically state the trust is irrevocable if that is the goal.
Revocable trusts are great for planning for mental disability and avoiding probate. With the power to make changes throughout the grantor’s lifetime, revocable trusts offer a flexible way to manage and administer your assets.
An irrevocable trust is one where the grantor gives up the right to revoke the trust or one that becomes irrevocable upon their death. As such, the grantor cannot change specific provisions once it is established. Irrevocable trusts have many different applications and can offer solid protection for the grantor’s assets. However, because irrevocable trusts provide increased protection, the grantor must give up some control of the assets. This is because the assets are no longer in the grantor’s name like they are in a revocable trust. So, for example, the grantor will not be able to access accounts in the irrevocable trust as frequently as they could with accounts in a revocable trust.
As you can see, having a trust provides many different benefits. Whether you want to be flexible with your distributions, protect your beneficiaries from creditors, or protect your assets from lawsuits, a trust is the way to go. So, give us a call today to schedule your free 1-hour initial consultation to learn more and see how Jabbour Law can craft an estate plan that meets you and your family's needs!