Creating an Estate Plan with Trusts
When most people think of estate planning the first idea that comes to mind is a will, but a trust is a useful tool that helps individuals plan for certain scenarios. These instruments can often be complex and confusing, but their use in a properly prepared estate plan has significant advantages. The biggest advantages of using trusts is the flexibility they provide. For example, they can be used to:
- Avoid probate
- Tax planning
- For a loved one’s special needs
- Control over assets after death, or
- Gifts to charity
Don’t worry: Although trusts can seem daunting, they are fairly simple once you get the hang of the language and terminology. So let’s start with the basics.
Simply put, a trust is an entity that holds property. The assets held by this entity are collectively called the principal or corpus of a trust. Typically, the trustee invests the principal for safe keeping for the benefit of a beneficiary. There are three parties to a trust: the grantor (also known as a settlor), the trustee, and the beneficiary.
- The Grantor: This party creates the trust and funds it.
- The Trustee: The trustee is usually appointed by the grantor and is charged with properly managing the principal and income of the trust for the benefit of the beneficiary.
- The Beneficiary: The beneficiary is the party who receives the benefit of the assets held by the trust. The beneficiary almost always lacks control over how the assets are managed but does get to enjoy the use of the property.
A trust is created when the grantor executes the trust document and moves assets into it. That can mean the grantor moves cash, stocks, bonds, real estate, or other financial assets into the trust name.
- Example: Nick and Ginger are married and they have three children under the age of 18. Nick and Ginger want to make sure that at their death their assets go to Peggy to hold for the benefit of their children until they are old enough to manage those assets themselves. So they decide to create a trust within their will. At the surviving spouse’s death, their assets are placed in trust and Peggy is named the trustee. Peggy would then manage the assets for the children’s’ benefit until they turn a certain age, as determined by Nick and Ginger.
When a trust is created, the grantor places certain rules and guidelines on how the assets are to be used for the benefit of the beneficiaries that the trustee must follow. For example, the assets could be used for the beneficiary’s college expenses, medical bills, or to simply maintain the beneficiary’s standard of living. The trustee has a responsibility to the beneficiary to ensure that the assets are properly managed and are being used for the benefit of the beneficiary. This duty to the beneficiary is called a fiduciary duty. If the trustee violates this fiduciary duty he can be removed from his position.
Generally, a trust serves one of the following purposes:
- Asset Management: It is very common for a donor to want an individual to have the benefit of an asset but they do not want the individual manage or have control over the asset. For example, a parent wants to make a gift to a child but the child may be too young or too immature to handle the property. A transfer of these assets to a trust at the donor’s death would be good solution to that issue.
- Provides for a Division of Interests: If a donor wants to split the interest in a gift of property he can do so with a trust. For example, a wife could leave the income from an asset (i.e. rental property, investments, etc.) to the husband for his lifetime and then the actual asset or principal would pass to wife’s children.
- Postpone the Delivery of a Gift: A trust allows the donor to delay the delivery of a gift until a certain event occurs (i.e. a beneficiary turns a certain age, or achieves a certain level of education, etc.) For example, a grandparent could leave property to a grandchild but the grandchild dictate that the grandchild receive one half of the property at age 25 and the other half at age 30.
- Shelter Assets: A trust can be used to keep assets away from creditors or to ensure that governmental assistance for a disabled beneficiary will continue. For example, a father believes that his son is responsible with money but has concerns about potential creditors in the future. If the father puts the money into a trust that contains a spendthrift clause, the assets will generally be protected from the child’s creditors.
- Avoiding Probate: Probate is the court supervised process of distributing assets from the deceased person to a beneficiary. Probate takes approximately 6 to 8 months at a minimum to complete, depending on the state in which the deceased resided. As such, many people want to avoid probate due to the length of time it requires and the cost of paying an attorney. Assets places into a revocable living trust will not pass through probate. An experienced lawyer can help devise a plan that will help avoid probate and its expenses.
Example of Different Types of Trusts
There are numerous amounts of trusts. Some of the most common are:
- Revocable Living Trust: Most of the time, a revocable living trust is created in order to avoid probate, ensure secrecy of your assets, and to help plan for incapacity.
- Trusts for Children: Because state law prohibits minors from inheriting any asset until they turn 18, a minor’s trust is created in an estate plan to make sure those assets are properly managed and to help avoid a guardianship.
- Special Needs Trust: This is a type of trust that is created for individuals that usually have some sort of mental or physical disability. A trustee is appointed to manage the assets for the beneficiary’s lifetime. This trust also is used often to prevent the loss of any governmental assistance the beneficiary is receiving, such as Medicaid or Social Security Disability.
Revocable Living Trust
When we begin to review of client’s estate plan we explain to the client that they generally have two ways to distribute their assets at their death: through a will or a revocable living trust.
A will is a document that states, in part, how you want the assets that you own in your name only to be distributed at your death.
By contrast, a revocable living trust, is an entity that is created during your lifetime. The trust typically states that as the creator of the entity, you are able to use all of its assets for your benefit. You act both at the trustee and the beneficiary during your life. After your death, the document appoints a successor trustee and that person is responsible for distributing your assets per your wishes as set forth in the trust document. After all assets are distributed, the revocable living trust is concluded and dissolved.
What are the Advantages?
There are three primary benefits that a revocable living trust provides when compared to a traditional will:
- Avoids Probate: The primary reason most people create a revocable living trust is to avoid probate. Remember probate is required when you have an asset in your name only that no one else can access. Probate is avoided when all assets that are in your name are re-titled in the name of the revocable trust. The revocable living trust then owns the assets, not you. You are only the trustee, the person that controls the assets but does not personally own them. As such, at your death, your trust now owns everything and probate can be avoided.
- Real Estate in Other States: If you have real estate in more than one state, placing these properties in a revocable trust avoids probating your estate in these locations. So let’s say you have a primary home in Clarksville, Tennessee and a lake house in Kentucky. You would likely have to probate the Kentucky property in that state because Tennessee courts cannot control Kentucky property. However, if the property was in a revocable living trust probate can be avoided in Kentucky. The revocable living trust survives your death and the successor trustee can then distribute the assets to the beneficiaries..
- Secrecy: If your estate has to go through probate, there is a chance that the general public could learn of your assets if an inventory or accounting is required by the court. Documents filed in probate court are still public and are accessible by anyone. By contrast, revocable living trusts are private documents and they are not generally filed with the court. Placing your assets in a revocable trust can help ensure that your assets are kept private.
- Helps Plan for Incapacity: When you create a revocable living trust you act as the trustee for your lifetime or until you become unable to serve. Should you be incapable of managing your own affairs, the successor trustee that you have named in the revocable living trust takes over the trust and manages the assets for your benefit.
What Are the Disadvantages?
A revocable living trust is not for everyone. When we meet with clients we lay out the pros and cons for these trusts and compare them to a traditional will. Here are some of the disadvantages that you should be aware of when you are planning your estate:
- Complexity: For people not familiar with revocable living trusts, they can be confusing due to their complexity. It does take a bit of time for someone to wrap their head around how the revocable trust operates. This issue is especially true for family members that may serve as successor trustees and have no clue what to do.
- Not Great for Small Estates: If your estate is very simple and does not have many complexities, a revocable living trust may not be the best fit for your estate plan. Revocable living trusts can work well with more complex estate plans, but generally we recommend basic wills for simpler estates.
- More Work On the Front End: A revocable living trust does take more work for both you and the lawyer to set up than creating a will. The estate planning lawyer has more paperwork and documents to create and you must ensure that all your assets are accounted for and placed in the name of the trust. This requires you to visit banks, credit unions, and other financial institutions to change the title on accounts to the name of the revocable trust.
- Costs More: A revocable living trust does cost more on the front end to create than a will due to the amount of work that goes into creating a revocable living trust on the part of the lawyer.
Trusts for Children
One of the most common type of trust are those created for children, especially minor children. In considering whether your children need a trust consider the following factors:
- How old are the children?
- How mature are the children?
- What do you want the children to do with the money?
- How old do you want the children to be before giving them control over certain assets?
- Are there any special needs for the children?
Your answers to these questions are a good starting point to determine whether a minor’s trust is needed and worth establishing.
Guardianships for Young Children
If you have children or grandchildren under the age of 18, its generally a good idea to consider creating a trust for them. If you leave them an inheritance valued over $20,000.00, they will not be able to receive it without a guardian being appointed. Here’s why: Under state law, minors cannot inherit. Depending on the size of the minor’s inheritance, a guardianship would have to be established in order for the minor to receive the benefit of the inheritance. A guardianship holds the assets for the benefit of the minor until they turn 18. Once they reach that age, the funds are dispersed to the beneficiary.
Guardianships have certain drawbacks:
- The beneficiary receives the assets at 18, perhaps not the most mature age.
- The court must establish a guardianship, meaning that there will be attorney fees and court costs
- Often the funds must be held in a restrictive bank account or the guardian must be bonded
- You do not get to name the person who would be appointed the guardian
Create a Trust to Avoid Guardianship
The best way to avoid establishing a guardianship is to create a trust for minors in your estate plan. When such a trust is created it allows the trustee to manage the money for the beneficiary without having to go to court. It also avoids additional attorney fees and court costs. Perhaps most importantly, creating a trust means that you have the ability to say who will be managing the assets.
One question you must answer is how old do you want your children to be before they can control the money you put in trust? Strongly consider making the over the assets until the children are at least a mature age. You know your children and grandchildren. At what age would you be comfortable with them managing their own assets?
Children with Behavioral Problems
In today’s society, it is not uncommon to see parents want to limit access to certain funds that they may leave their kids. Perhaps a son has a drug or alcohol problem or a daughter has a large amount of debt and has spending issues. Whatever the case may be, many parents to not feel comfortable giving children with these type of issues substantial amounts of money without some limits on how it may be used. Under those circumstances, a trust would be a viable solution to those issues. A parent could name a responsible party as trustee and direct the trustee that the money could only be used to for the benefit of the child. The parent could limit the use of the money to education or healthcare, or even provide for housing. By limiting the use of the assets, it allows the trustee to preserve the balance of the trust but also provides a benefit to the child.
Special Needs Trusts
A special needs trust is created to supplement the needs of a person with a disability. This type of trust allows that person to be eligible to receive governmental benefits such as SSI (Supplemental Security Income) or TennCare/Medicaid. Even if your loved one is not currently receiving governmental assistance, placing an inheritance in a special needs trust is critical to ensuring that they qualify for those benefits should they apply. One of the most critical aspects of a special needs trust is that it must state that the assets of the trust can only be used to supplement the beneficiary’s needs. The assets cannot be used for the beneficiary’s day-to-day living expenses.
Example of How a Special Needs Trust Works
Mitch and Abby are married and have one child together, Lamar, who has a mental disability. Lamar is 18 years old and due to his disability he will never be able to care for himself. He will always need a caregiver. Lamar has qualified for SSI and Medicaid and his parents do not want Lamar to lose those benefits if they pass away and he receives a large inheritance. They want Lamar’s inheritance to be used to supplement those governmental benefits.
They then meet with an attorney to discuss their needs. That attorney designs a special needs trust that would allow the trustee to use the money for Lamar’s supplemental needs at the discretion of the trustee. What this means is that Lamar would have no control over how the assets are used. Further, the trust states specifically that the assets cannot be used in such a manner which would disqualify Lamar from receiving SSI and Medicaid. Mitch and Abby decide to name Mitch’s brother Ray as trustee of this trust. If Ray cannot serve, they have named a corporate successor trustee as the back up. At Lamar’s death, they decide the remaining assets will be conveyed to Vanderbilt Children’s Hospital.
Under this setup, the child will qualify for vital governmental programs and be able to have extra money if needed for in home healthcare, medical devices, furniture, vacations, or other such supplemental needs.
Appointing a Trustee
When considering who should be appointed trustee, it is important to consider someone fairly young. Chances are that if the beneficiary of the trust is a child then the administration of the trust could last for quite sometime. You want someone in place that will be around for a while. Additionally, consider naming a corporate trustee that has experience in handling special needs trusts. Corporate trustees are important to bear in mind as they will likely be around for much longer than any individual person serving as trustee and can continue to look after the beneficiary in perpetuity.
Also, consider the physical and mental burden on the trustee to care for a disabled person. Before deciding on a trustee, be sure to speak with the proposed trustee to ensure they are willing to serve. Explain to them in detail the significant responsibility they are to have if they chose to serve as trustee.
Consider Making Distributions Unequal
If your estate plan has multiple beneficiaries and one of them requires a special needs trust, think about making the distributions unequal. Here’s why: A disabled person most likely will need greater resources than a healthy individual over the long run. As such, to guarantee that beneficiary with a disability has enough assets over time, consider providing more to this beneficiary than the others. After all, you can always name the other healthy beneficiaries as the ultimate recipients of the special needs trust in the event that the disabled beneficiary passes away.
Use of the Assets of Special Needs Trust
So if the assets cannot be used for day to day living expenses, what exactly can the funds be used for? This can be a tricky question and you want to be sure that you consult with a special needs trust attorney if there is a question about how the trust assets should be spent. Below are a list of assets that can be used to supplement the needs of a beneficiary without costing them their government benefits:
- The home of the disabled person – assuming that the individual lives in the home or intends to return home if in a nursing home
- A vehicle
- Furniture and home furnishings
- Personal items such as jewelry, heirlooms, or clothing
- Education expenses
- Travel expenses
- Entertainment expenses
Do You Need a Trust?
It depends on your situation and the goal you are trying to accomplish. Consider the following questions:
- Are you worried about taxation?
- Are you in a second marriage and trying to find a way to plan for your spouse and children?
- Do you have creditor issues?
- Do you have a child with a physical or mental disability?
In many cases a trust is a useful instrument in helping to manage some of these issues. But remember, your personal situation will largely dictate whether one would be a right fit for your estate plan. Speak with a lawyer and let them advise you on whether a trust would be a right fit for your estate plan and the goals you wish to accomplish.