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Trusts
A trust is a legal relationship under which one individual (the "donor") transfers property to another (the "trustee"), who holds and manages the trust property for the beneficiaries in accordance with the provision of the trust document.
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Consistent and uninterrupted management of the assets before and/or after the donor's death, illness or disability
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Preserving assets by preventing the beneficiaries, or their creditors, from gaining direct access to the trust property
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Reducing income and/or estate taxes
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Eliminating or lessening costs and delays associated with probate administration
There are a number of questions you should consider before creating a trust:
- What do I expect to accomplish?
- Will a trust fulfill my wishes?
- How much will it cost to establish and administer a trust?
- Whom shall I select as a trustee?
You should create a trust only when there is a need or specific advantage, such as:
- Relief from the burdens of financial management
- Creation of a flexible estate plan and minimizing estate taxes
- A vehicle for lifetime gifting
- Providing support for an elderly or disabled family member
- Shifting income and tax liability for a period of time
- Facilitating charitable planning
- Avoiding public disclosure of assets in the probate process
Revocable ("Inter Vivos" or "Living") Trusts
Perhaps the most common form of trust utilized in modern estate planning is the "Inter Vivos" or "Living" Trust. These trusts are revocable and amendable, meaning that you can change their provisions or terminate them at any time. If you create such a trust during your lifetime, the trust will allow you to designate a trustee to administer the assets in the event of your incapacity. This can, in many cases, help you avoid the publicity, inflexibility and expense of a guardianship. In addition, assets which are held in your trust upon your death will avoid probate (although they still will be subject to estate taxes, if applicable). Probate is a very public procedure, which entails disclosing an inventory of your probate assets, as well as the identities and addresses of your beneficiaries. For this reason, many prefer the privacy afforded by a trust, which generally does not require such public disclosure.
Upon your death, these trusts generally become irrevocable (which means they cannot be changed), and the terms which you have provided will govern the ongoing administration of the funds over an extended period of time.
Trusts can be created which are irrevocable during your lifetime. These trusts can be created for the benefit of your spouse, children or grandchildren (or anyone else you would like to benefit). Transfers into irrevocable trusts are generally considered to be completed gifts, and thus can be useful in reducing the size of your taxable estate.
Irrevocable trusts are often utilized for making gifts to minors. These gifts can be utilized for educational funding, or many other purposes. Assets can be held for the beneficiary until the beneficiary attains the age of majority, or throughout the beneficiary's life lifetime. Assets held in such trust are generally unavailable to the creditors of the beneficiaries , so the trusts provide a high degree of asset protection (although under Massachusetts law you cannot create a trust that will protect you from your own creditors, you can provide this protection for others). These trusts also allow you to name an appropriate trustee to oversee the administration of the gifted funds in the event a beneficiary lacks the financial expertise or sophistication to do so.
Irrevocable trusts are also useful for owning life insurance. Many people do not realize that life insurance is subject to estate tax if it is either payable to the estate of the decedent, or if the decedent owned the policy upon death. On a $1 million policy, the estate tax may be as high as $500,000.00, under current law. Utilizing an irrevocable trust to own your life insurance can allow your death benefits to be received completely estate tax-free (as well as gift and income tax-free). This can provide your estate with much needed liquidity. Although the trust cannot pay your estate taxes directly (as this would make the proceeds taxable to the estate), the trustee can purchase the otherwise illiquid assets of your estate at their full fair market value, thus eliminating the need to hold a "fire sale" to cover your tax liability.
Trusts as Part of Your Estate Plan
Trusts are often used to minimize estate taxes and to provide ongoing support for the decedent's spouse and children. Most comprehensive estate plans include a marital/spousal trust and a family (credit shelter) trust. These two trusts are usually established within the same estate-planning document.
The marital trust is created (either during your lifetime or by will) for the exclusive benefit of one's surviving spouse, and is designed to be exempt from estate taxes due to the unlimited marital deduction (it should be noted that the unlimited marital deduction is not generally available if the surviving spouse is not a US citizen). The marital trust's income must be distributed to the surviving spouse for life, and the trustee if often given a discretionary power to use principal for the additional benefit of the surviving spouse. The surviving spouse may, but need not, be given rights to demand or receive principal (but there can be no other beneficiaries besides the surviving spouse during his or her life). The first spouse can maintain control over the disposition of the assets upon the death of the survivor- a very useful power in multiple-marriage situations. Alternatively, the surviving spouse can be given the authority to determine the disposition of the marital trust assets upon his or her death. If the surviving spouse is not a US citizen, estate taxes upon the death of the first spouse can be deferred by utilizing a special trust called a "Qualified Domestic Trust" or "QDOT." These trusts, which must have a US Trustee, provide that estate tax is only paid upon the distribution of principal to the survivor. This can be vitally important to the surviving spouse's financial well-being, because it allows full pre-tax investment of the first spouse's estate in order to generate income for the survivor.
Any property remaining in the marital trust upon the death of the survivor will be subject to estate taxes in the surviving spouse's estate, if the survivor's estate is large enough to be subject to such taxes.
A family trust is often utilized to administer the assets of the decedent's estate that are not subject to taxes due to the Applicable Exclusion Amount. This is the amount that the federal taxing authorities allow you to transfer freely to any individual or group of individuals during your life or upon your death. The credit is currently $1 million (for transfers during lifetime or at death). The estate tax credit will increase incrementally over the next few years (although credit for lifetime gifts will remain frozen at $1 million) --eventually reaching $3.5 million in 2009, unless Congress repeals the law before then, which many experts believe to be likely.
The family trust may be administered for the benefit of the entire family, or just the surviving spouse. Funds in the family trust will not be considered part of the surviving spouse's estate, so long as appropriate restrictions have been placed o his/her control and use of those funds. A properly drafted family trust may thus provide substantial estate tax savings, by allowing for the utilization of the Applicable Exclusion Amounts of both the first spouse to die and the surviving spouse, thus doubling the available exclusion.
After the death of the surviving spouse, the family trust can be administered for the benefit of your children and their issue. The beneficiaries may be given rights to demand principal distributions at certain ages, or the trustee may be given the authority to administer the funds over many subsequent generations. This can provide significant asset protection benefits, as well as substantial tax advantage.
One of the most difficult tasks in the creation of a trust is choosing the right trustee or trustees. You may choose as your trustee or trustees an individual and/or a bank authorized to exercise trust powers (a corporate trustee). You should name a successor trustee in case a trustee should cease to serve.
Factors you should consider in your choice are the trustee's:
- understanding of what you are trying to accomplish
- experience as a trustee
- experience in making investments
- experience in making trust decisions
- experience with your type of situation
- understanding of the beneficiary's needs
- ability and availability to serve for the full term of the trust
- reasonable fees and affordability
The trust will prescribe many of the duties of a trustee, and the law provides the rest. The trustee must manage the trust assets, invest them, keep records, prepare tax returns, make regular distributions of income (if required) and account to the beneficiaries. The trustee has a duty of loyalty and good faith. The trustee should be available to the beneficiaries to discuss the management and administration of the trust assets as well as the needs and objective of the beneficiaries.
In Massachusetts, the court ultimately determines the reasonableness of the trustee's compensation. Many corporate trustees (such as banks and trust companies) base their fees on a percentage of the income and a percentage of the principal each year. Banks publish fee schedules that are available to the public on request.
Remember that you are the author of your trust. You define its terms. You provide the guidelines under which the trustee will perform your duties. Your instructions may be simple or complex, but they should be clear. Provision for the distribution or accumulation of income and/or principal, the terms upon which your trust may be amended, who will be your successor trustee and a host of other issues will be essential components of your trust. Each of these decisions can have far-reaching consequences for yourself and your beneficiaries. These decisions should be made only after consultation with your lawyer and should be stated in a will or trust document prepared by him or her.
There are various types of trusts for you to consider in your individual, family and business planning. There can be significant tax advantages to you, your estate or your beneficiaries with a trust designed specifically for your needs. While not every type of trust is intended to produce a tax benefit, your lawyer can show you how skillful trust planning may help you save or at least defer the high cost of income, estate or gift taxes. If you already have a trust plan that was drawn some years ago, you should have your lawyer review it, as these laws change often. When you create a trust, you should keep in mind that tax treatment is only one factor which should be considered together with your non-tax planning needs.
Since a trust is part of a comprehensive estate plan, is should be established only after the most careful consideration has been given to its advantages and disadvantages.
A lawyer can help in several ways. A lawyer can help you decide whether a trust will meet your estate planning objectives. The lawyer can prepare the trust documents and explain how it will operate and what the tax consequences of this trust will be as well as the best way to rearrange your property so that it reaches the trust with a minimum of delay and expense. Your lawyer can help you in your selection of the appropriate trustee and then review with you the trustee's performance to insure that the trustee's duties are properly carried out.
