Estate Planning for Beginners – Part 3: Trusts and Their Uses

Estate Planning Part 3: Trusts and Their Uses
In the process of estate planning, one of the key decisions is establishing a revocable trust or a will that includes a trust. But what exactly is a trust? Like a will, a trust lays out instructions for the distribution of assets.

Previously, we’ve looked at what makes up a will and how assets can be transferred when the time comes. In this post, we’ll talk more in depth about certain trusts that can be useful when preparing your estate plans.

In the process of estate planning, one of the key decisions is establishing a revocable trust or a will that includes a trust. The will, in its simplest form, disposes of assets of the deceased person after the payment of all debts and taxes, if applicable. But what exactly is a trust? Like a will, a trust lays out instructions for the distribution of assets.

The most common use of a trust is for minor children followed by a spouse and lineal descendants. When minor children are involved, or where there may be some assets including life insurance proceeds, the testator may want to include a trust for the benefit of the minor children. In addition, a trust can be used for other individuals whether they be the spouse and/or aging parents.

A primary purpose of most trusts is to provide a timetable for the distribution of assets held by the trust where, for any number of reasons, the outright distribution at the death of the testator (you) may not be warranted.

The Testamentary Trust

When the use of a trust is warranted, the testator has two choices. The first is to include a trust or trust(s) within the body of his/her/their will. If this is the approach to be taken, the trust is referred to as a Testamentary Trust, or stated another way, coming from within the will.

When the trust is contained within the body of the will, the probate court/judge will have jurisdiction over the assets of the trust after your death, as well as all actions of any trustee until the trust terminates by its terms. The oversight by the court/judge may last anywhere from one year to seventy years or more. The court will most often require formal annual accountings which include annual fees for its oversight and may even question the actions of the then-serving trustee.

Before we go into this further, note that it is rare where we will recommend the use of a Testamentary Trust except for young singles and married couples with few assets.

The Revocable Trust or Living Trust

The second option is the use of a Living Trust, also known as a Revocable Trust. The primary types of Living Trusts consist of the Revocable Trust and/or the Irrevocable Trust. Although there are several other forms of living trusts, they are highly specialized.

Unlike placing the terms of a trust within the body of the will as one might do with a Testamentary Trust, a revocable trust is a separate standalone document, independent of the will.

A revocable trust does not eliminate the need for a will; however, it serves with the will to complete the estate plan. The revocable trust has two major sections: The first section is during the life of the settlor (you), and the second section covers the settlor after his/her/their death.

During your lifetime, you typically name yourself as trustee and possibly your spouse as a co-trustee. Since the trust is revocable, anything you place in the trust can be taken out at any time during your lifetime. But suppose you are in an accident and cannot act on your own behalf. Your named co-trustee or successor trustee can step in and stand in your place. The trust allows for the distribution to you during your lifetime for your care and support and it is much more flexible than if you depend upon a Durable Power of Attorney or if a court were to appoint a “conservator” of your assets.

Because you took the time to establish a standalone Revocable Trust when you were competent, your chosen co-trustee or successor trustee can immediately step in to manage the trust and pay all of your bills. (A testamentary trust has none of these advantages since it only comes into existence at the time of your death). Also, unlike a testamentary trust, at the death of the testator (this is you again), the assets of the trust plus any assets received from your will are no longer subject to probate court oversight or jurisdiction.

Mandatory accountings are not required although they are recommended to be presented to the beneficiaries or the respective representatives (assuming they are minors) rather than any court. We refer to this as the ability to avoid probate. The elimination of the probate court is desirable and worth the effort to avoid. In the rare situation when the family expects trouble among the beneficiaries after the death of the parents, court jurisdiction may well be warranted. (For more, see Estate Planning for Beginners Part 2).

For many people, privacy is important. When all the provisions are included in the will, the will and all the accountings are available to the public for all to see. On the other hand, if all your assets are in a revocable trust at the time of your death or come over from your will, there’s no need for any formal accounting. Your assets, and the terms of the trust, never become public.

As far as the selection of trustees are concerned, you can name an individual or corporate trustee or both. If you name an individual or two individuals as trustee, at least one of them should be a family member. You may even consider naming the guardian of the children, if applicable, as one of the trustees. The other trustee should have some background in finance or investments. You then must consider that a trustee is entitled to a fee which is typically charged quarterly or annually. A typical fee of up to one percent annually is considered reasonable for individual trustees. You may want to limit the fees (be careful here) by stating that the trustee may charge no more than one percent plus any out-of-pocket expenses for reimbursement. If there is more than one trustee, be sure to state specifically whether they are to share the fee or if they are both entitled to a full fee.

If a corporate trustee is desirable, then we recommend naming the family trustee with financial experience to serve as co-trustee. The advantage of a corporate trustee, such as a banker or independent trust company, is that they do not die and will likely always be there. The disadvantage is that you will never know who (which trust officer) will be assigned to the trust at the time of your death. In the alternative, you can give your individual or family trustee the power to appoint a corporate trustee. Regardless of who or what is named as a trustee, you want to provide the individual co-trustee or special trustee with the power to remove and replace the corporate trustee if necessary or desirable at any time in the future and keep in mind, a trust can last for many, many years.

Terms of the Trust

Depending upon the amount of money involved, we typically recommend split distributions from a trust. As an example, the term of the trust may read as follows (this is merely an example for illustration, it’s not meant to be legal advice): “The trustee may pay to or for the benefit of the children, in equal or unequal shares, as much of the income and/or principal as the trustee shall determine in its discretion for the maintenance, education, support and health of the children until such time as the youngest child reaches the age of 25.”

When the youngest child reaches the age of 25 or completed four years of postsecondary education, whichever comes first, the trust is to be split into his many shares as there are children surviving plus one share for any child who has died leaving children surviving. For any child who has reached the age of 25, the trust shall vest in an amount equal to 20 percent and the remaining 80 percent shall vest at age 30. You can pick whatever ages and percentages that you like as you certainly know your children better than we do.

It’s common for attorneys to use outright distributions rather than “vesting.” Vesting allows for the beneficiary to defer taking funds out of the trust if all is going well, knowing she, he, or they can access the vested funds at any time. Another major advantage is that as the grantor of the trust, you have provided for a line of succession by stating that if the beneficiary were to die with assets of the trust, the asset shall go as previously directed.

Why split distributions you may ask? This is to cover the possibility that if a child blows through the distribution at age 25, then they have another chance at age 30, when they are conceivably better prepared to handle the remaining funds.

An Example

Suppose there is a car accident. Both spouses are killed leaving two minor children: Tommy is seven and Barbara is four years old. 

We discover that the parents had received some good advice and had a testamentary trust in their will or revocable trust, leaving everything to each other or, if neither spouse survived, in trust for the children. If any child is under the age of 25, the assets are to be held in trust until the youngest child reaches the age of 25. When the youngest reaches that age, the assets are then to be split into as many equal shares as there are children surviving, plus one share for any child who has died leaving children surviving, otherwise to the surviving children of the grantor, per stirpes.

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