The trust. For many people, trusts are an intimidating legal construct they don’t want to be bothered with, perhaps feeling as though it is a needless complication created by lawyers to make money. Although having a trust may not be appropriate for some families, it can be a stable platform with which to address a number of problems outside of a courtroom, ultimately saving money and heartache. Consequently, it has become central to most. Below, I touch on several common trusts, but please note, these descriptions are far from exhaustive on the subject.
But first, what is a trust? Well, imagine that the concept of ownership isn’t one right, it is a bundle of rights. If I own a piece of real estate, I have the right to sell it, to develop it, to live on it. These rights can be split from one another. For instance, I can rent the property to someone, so I no longer have the right to live on the property, but I still own it. I can transfer my right to sell the property by selling someone an exclusive option to purchase it, but still maintain possession of the property. This concept of fractured ownership rights is important to a trust.
The trust itself can be viewed as a separate, individual person. It can open a bank account, purchase land, invest in the stock market, etc. But of course, someone must direct it to do so. This person is the trustee. The trustee has the authority to direct the trust and to act on its behalf, which is the “ownership interest.” However, unless the trustee is also a beneficiary, he or she cannot use any of the trust assets for his or her personal benefit.
The remaining interest in the trust is called the “beneficial interest.” Beneficiaries of the trust are those named as recipients of assets from the trust. The beneficiary does not have the right to direct the investment of funds held by the trust, and generally does not have the authority to demand a distribution from the trust. However, when the trust distributes the income generated from an investment, it goes to the beneficiaries in a manner that is set forth in the trust’s terms.
The settlors or grantors of a trust typically hold both the ownership and beneficial interests until death or incapacity. At that point, a named successor trustee assumes the ownership interest, and is typically instructed to distribute the trust assets to specified beneficiaries. One of the most attractive features of a trust is that all of the above can be done outside of probate and privately. No one needs to see what the trust is worth, how much each person is getting, or the identity of anyone disclaimed. All of those details are publicly available if an estate passes through probate.
Here, I will take a moment to review some of the most common types of trusts.
Inter Vivos Revocable Trusts
The inter vivos revocable trust is one of the most common estate planning trusts. The term “inter vivos” means during life. Just as the name suggests, this is a trust created while you are still living. “Revocable” means that the person who created the trust, the “settlor” or “grantor,” can amend, modify, or terminate the trust at any time. Frequently, two spouses will have a joint inter vivos revocable trust.
A joint revocable trust, generally speaking, will remain revocable after the death of the first spouse; although, there may be several provisions that become irrevocable. One spouse may want the gifts they designate for children of a previous marriage to be honored, so the surviving spouse has no authority to remove those gifts from the trust. However, upon the death of the second spouse, the trust becomes irrevocable. A named successor trustee will be installed and given authority to distribute the trust assets.
At this point, the trust operates as a mechanism to distribute the assets of the now deceased couple to their beneficiaries, usually children. The trust provides great flexibility, as well as privacy, in managing the couple’s final affairs. Most importantly, the trust need not go through probate court, which is a time consuming and costly endeavor.
Testamentary trusts are trusts spring into being at upon the settlor’s death through the operation of the decedent’s estate plan. A common example is the creation of a testamentary trust for a minor beneficiary. If the grantor of an inter vivos revocable trust wants to make gifts to his grandchildren upon his death, of which some are under the age of 18, he may state that the gift shall then be held in trust by the grandchild’s legal guardian until the age of 25. Essentially, the first trust is concluded through distribution, and a portion the distributed assets are used to fund a second trust to preserve a gift for an underaged grandchild.
Testamentary trusts differ from inter vivos trust, in that an inter vivos trust is operative during the settlor’s lifetime and plays a role in the settlor’s asset management. The trust can be amended or terminated at the direction of the settlor. A testamentary trust is strictly used as a manner in which to distribute the assets of the deceased settlor. Sometimes, however, the testamentary trust can cause unnecessary expenses.
For instance, if a grandfather’s will states that 10% of my estate is to be held in trust for the benefit of my granddaughter, upon his death, the personal representative of the estate is obligated to create a trust to fulfill that purpose. But what is the estate is only $15,000, and the trust would be only be funded with $1,500. Holding the funds in trust is hardly efficient, when the child’s mother could simply open a bank account for the child. However, unless the will provides a mechanism through which a trustee can terminate and distribute the trust if the amount of money to be held is toof low for it to be sensible, the trustee and beneficiary must go to a court and ask to terminate the trust.
Special Needs Trust
A special needs trust serves a very different purpose but operates under the same basic principles as inter vivos revocable trusts. There are many individuals who cannot provide for themselves, whether it is food, housing, or medical care. Our society has decided that we are responsible for meeting everyone’s basic needs. Consequently, we have programs such as Medicaid, Medicare, Social Security, Disability, and food subsidization to assist those in need. Yet we only provide these benefits to persons who meet certain criteria, much of which revolves around the total amount of assets an individual owns.
Consider a situation where a life-long disabled woman, who has been cared for by her mother her entire life, receives substantial governmental assistance. Without the medical coverage, housing subsidies, and food stamps provided by the government, she would not have adequate resources to survive. What happens when her mother passes away? Setting aside the appointment of a new guardian, what about mom’s assets? Medicaid asset thresholds can be as low as $2,000, depending on the circumstances. If her mother passes a significant inheritance to her daughter of $100,000, what happens to all of her government assistance? Well, it goes away. Some of you may know from personal experience, 24-hour medical care is extremely expensive, and the inheritance would be depleted in very short order. Upon depletion of the assets, be it 6-months or a year, she’d be eligible for government assistance again, but would be forced to again jump through all the hoops required to obtain benefits and may find that she is now ineligible for the same type and amount of benefits.
Basically, a $100,000 gift provided her no benefit; it paid for expenses that the government was already covering. In fact, the gift caused problems. Does the fractured ownership structure of a trust provide a solution? Kind of…
If the disabled daughter above was the beneficiary of a testamentary trust, where a close family friend was trustee and had full ownership interest of the assets, would Medicaid be satisfied. The answer is no. The beneficiary of a trust must count the assets of the trust (or their interest therein) as part of their assets to meet eligibility requirements. That is, unless the trust meets some very specific criteria. First, the trust must be irrevocable. This means that the person funding the trust cannot take their assets back nor can the terms of the trust be changed. Second, any distributions for the beneficiary must be at the sole and complete discretion of the trustee. In short, the trustee is under no obligation to ever distribute to the beneficiary. Finally, the trustee is restricted to using trust assets for the care, comfort, and well-being of the beneficiary, and is limited to certain categories of benefits, such as healthcare, hygiene, education, food and non-food grocery items, music, including instruments, vacations, concerts & events, etc. Other categories, such as luxury items, watercraft, original paintings and sculptures, or income real estate, such as an apartment building, are not permitted.
Upon the death of the beneficiary, the trust assets will be distributed according to the direction given by the original settlor. Sometimes, the disabled person has children, but if this isn’t the case, the funds could be then directed to other family members, friends, or charities.
Trusts may seem intimidating and difficult to fully understand. The experienced estate planning attorneys at Neumann Law Group are happy to answer any questions you may have. If you are considering having an estate plan prepared, contact us for a free consultation.
Benjamin W. Bryant, J.D.
Neumann Law Group