Trusts

What is a Trust? (Plus, advantages and disadvantages of having one)

 

What is a Trust?

  • A trust is an expression of who you want to receive your assets and what
    • Identify beneficiaries
    • Identify assets and/or percentages to be bequeathed
  • Directs how debts, expenses and taxes are paid

Advantages of Having a Trust

  • Avoids probate and its costs
  • Guaranteed bequeath
    • Excludes subsequent spouse control or rights
  • Provides absolute privacy
  • Doubles the federal estate exemption
  • Total control of assets given to a minor
  • If an illness or accident leaves you incapacitated, your successor trustee can handle your financial affairs without the need for a court appointed guardian or conservator.
  • If the beneficiaries of your trust are minor children or others who might not use an inheritance as you intend, the trust can continue to hold the assets until they reach a more mature age.
  • If you own real property in more than one state you avoid the expense, time and hassle of multiple probate proceedings.
  • By using a trust, a husband and wife can maximize both their federal estate tax exemptions.
  • Trusts are generally more difficult to contest than a traditional will. To invalidate a will you must either prove it was signed under duress or that the maker was incompetent on the day it was signed. To invalidate a living trust you would have to prove it was invalid not only on the day it was signed but each and every day it was in existence thereafter.
  • It is almost impossible to contest a Living Trust. When a will is contested the assets are frozen and they cannot be distributed until the claim is resolved. Assets placed in a living trust are not frozen pending the outcome of a legal challenge. Anyone wishing to contest the trust must file suit against each of the beneficiaries; in the meantime the assets in the trust can be distributed.

Disadvantages of Having a Trust

  • Higher cost to prepare
  • Not easily changed
  • Re-execute, witness and notarize new documents or addendum

Trust Funding

Trust funding is simply changing the name of an asset to the name of the Trust.

Trust funding is necessary to make sure that:

  • To avail of all trust & tax laws the trust grantor must:
    • Transfer title of real estate into the name of the trust or trustee
    • Change the name on each financial asset to that of the trust including Brokerage accounts, bank accounts
    • IRA’s, 401(k)’s, 529 plans already in trust
  • To completely avoid probate, a Grantor must transfer all assets into Trust including:
    • Personal Assets
      • Jewelry, vehicles, etc.
    • How do you re-title?
      • Catch-all ‘Exhibit A’ which places all of an estate’s assets into Trust
    • A common attorney mistake is to leave person assets outside of Trust. If an estate has more than $100,000 of assets outside of Trust, then the estate is subject to probate.

Trust Types

Asset Protection Trust

An Asset Protection Trust includes all of the benefits or a Living Trust which are:

  • Avoids probate and its costs
  • Guaranteed bequeath
    • Excludes subsequent spouse control or rights
  • Provides absolute privacy
  • Doubles the federal estate exemption
  • Total control of assets given to a minor

An Asset Protection Trust also provides protection against judgments by separating ownership from the risky activity. The specifics are as follows:

  • Use for physicians, high risk business, rental property
  • Change in ownership to named trustee
  • Higher set up fee
  • May require annual fee
  • Several trusts are written to separate residences, financial assets and the at risk activity

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Business Trust

The term “business trust” is not used in the Internal Revenue Code. The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business. If the grantor maintains control of the trust, then grantor trust rules will apply. Otherwise, the trust would be treated as a simple or complex trust, depending on the trust instrument.

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Charitable Trusts

  • Charitable Lead Trust

    A charitable lead trust pays an annuity or unitrust interest to a designated charity for a specified term of years (the “charitable term”) with the remainder ultimately distributed to non-charitable beneficiaries. There is no specified limit for the charitable term. The donor receives a charitable deduction for the value of the interest received by the charity. The value of the non-charitable beneficiary’s remainder interest is a taxable gift by the grantor.

  • Charitable Lead Annuity Trust

    A charitable lead annuity trust is a charitable lead trust paying a fixed percentage of the initial value of the trust assets to the charity for the charitable term.

  • Charitable Lead Unitrust

    A charitable lead unitrust is a charitable lead trust paying a percentage of the value of its assets, determined annually, to a charity for the charitable term.

  • Charitable Remainder Trust

    In a charitable remainder trust, the donor transfers assets to an annuity trust or unitrust. The trust pays the donor or another beneficiary a certain amount each year for a specified period. In an annuity trust, the payment is a specified dollar amount. In a unitrust, the payment is a percentage of the value of the trust, as valued each year.

    The term of the trust is limited to 20 years or the life of the designated recipients. At the end of the term of the trust, the remaining trust assets must be distributed to a charitable organization. Contributions to the charitable remainder trust can qualify for a charitable deduction.

    This charitable contribution deduction is limited to the present value of the charitable organization’s remainder interest. Revenue Procedures 89-20, 89-21, 90-30, and 90-31 provide sample trust forms that the Service will recognize as meeting charitable remainder trust requirements.

  • Pooled Income Fund Trust

    A pooled income fund is an unincorporated fund set up by a public charity to which a person transfers property, reserving an income interest in, and giving the charity the remainder interest in that property. The Code and Regulations under Section 642 establish trust requirements. These funds file Form 1041.

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Children’s/Gifting Trust

A Children’s/Gifting Trust is a special controlled fund for children who have not reached the age of emancipation or are of special needs. Some of the features of the Children’s/Gifting Trust are as follows:

  • Allows for regulation of fund usage
    • Education, income, purchases, etc.
    • Handicapped child’s needs
  • Uses annual tax free gift allowance to make contributions to trust
  • Removes funds out of the grantors taxable estate
    • Reduces estate tax computation
  • Funds can be invested in any commercially reasonable endeavor

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Common Law Trust

Contrary to the claims of promoters, “common law trusts” no longer exist since all states now have statutes relating to the creation and operation of trusts.

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Delaware Business Trust or Alaska Business Trust

A trust established to hold and invest assets with greater flexibility than allowed by most trusts. Permits limited liability, creditor protection, and valuation discounts. These trusts are a creation of the Delaware and Alaska legislatures and have no impact on taxation of trusts for federal purposes. These “business trusts” have no special distinction in the Internal Revenue Code and would be a simple, complex, or grantor trust depending on the terms of trust instrument.

The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business. Filing requirements would depend on this classification.

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Electing Small Business Trust (ESBT)

An ESBT is a statutory creature established by IRC Section 641(d). By meeting the requirements of an ESBT, a trust may own S Corporation shares. ESBT’s must file Form 1041 and the S Corporation income is taxed at the trust’s highest marginal rate. No income distribution deduction is allowed to beneficiaries. To be treated as an ESBT, an election must be made.

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Family Foundation Trust

A Family Foundation Trust allows for:

  • Control disbursement to charities & charities use of the funds
  • Avoid unnecessary gift, estate & capital gains taxes
  • Gifts into the trust are tax deductible
  • Provides income to current and future generations for the management of the foundation

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Foreign Trust

Through 1996, a trust was foreign if the trustee, corpus, and administration were foreign. Since 1996, a trust is foreign unless a U.S. court supervises the trust and a U.S. fiduciary controls all substantial decisions. U.S. taxpayers are subject to filing Form 3520, Creation of or Transfer to Certain Foreign Trusts, Form 3520-A, Annual Return of Foreign Trust With U.S. Beneficiaries, and Form 926, Return by a Transferor of Property to a Foreign Estate or Trust, when contributing property to a foreign trust. These trusts are usually U.S. tax neutral and are treated as grantor trusts with income taxed to the grantor.

Foreign trusts that have income attributable to U.S. sources and are not grantor trusts are required to file Form 1040NR, U.S. Nonresident Alien Income Tax Return. Foreign trusts that have income attributable to U.S. sources and are grantor trusts would have that income directly attributable to the grantor (if U.S. grantor income, it must be included on Form 1040; if nonresident alien grantor income, it must be included on Form 1040NR).

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Funeral Trust

This is an arrangement between the grantor and funeral home/cemetery to allow for the prepayment of funeral expenses. The funeral trust is a “pooled income fund” set up by a funeral home/cemetery to which a person transfers property to cover future funeral and burial costs. These are grantor trusts with the grantor responsible for reporting income. The trustee may make an election on qualified pre-need funeral trusts to not be treated as a grantor trust, with the tax being paid by the trustee.

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Grantor Retained Annuity Trust (GRAT)

Millions of homeowners have taken advantage of the current low interest rate environment by refinancing their home mortgages. Low interest rates also make certain estate planning vehicles particularly attractive. A Grantor Retained Annuity Trust (GRAT) is one such vehicle that may facilitate the transfer of wealth to the next generation with little or no transfer tax cost.

A GRAT is an irrevocable trust funded with a single contribution of assets, which pays a percentage of the initial contribution, either fixed or with a predetermined increase (the annuity), back to the donor for a term of years, and then distributes the assets remaining at the end of the term to beneficiaries other than the donor.

The objective of a GRAT is to shift future appreciation on the assets contributed to the GRAT to others at a minimal gift tax cost. For the strategy to be successful, the assets transferred to the GRAT must appreciate at a rate greater than the IRS assumed rate of return. The difference between the actual rate of return on the investment and the IRS assumed rate of return will pass, gift tax free, to the beneficiaries at the end of the GRAT term.

With this estate planning vehicle, a donor transfers assets to a trust from which the donor retains the right to receive an annuity for a set period of time (for example, four years), after which time the remainder passes to the donor’s children or other beneficiaries, either outright or in trust. Under the terms of the GRAT, the donor retains the right to receive an amount equal to the value he or she transferred to the GRAT plus interest, and the remainder beneficiaries receive everything in excess of that value.

By way of illustration, assume a donor transfers $1,000,000 of assets to a four-year GRAT in a month in which the IRS assumed rate of return, determined monthly, is four percent. The GRAT will provide for four annual annuity payments of 27.5 percent of the value of the assets initially contributed to the GRAT ($275,489). If the assets in the GRAT do not yield sufficient income to fund the annuity payments, principal of the trust will be distributed back to the donor to satisfy the payments. At the end of the four- year period, the beneficiaries will receive the remainder of the trust.

The taxable gift resulting from the transfer of property to the GRAT is the present value of the remainder interest, determined using the four-percent, IRS-assumed rate of return. Under the facts in the example, the taxable gift is minimal because, given the high annuity payout level, the donor will receive back almost all of the trust assets if they earn the assumed four-percent-investment return, and the gift tax is based on the anticipated remainder value of the GRAT at the end of the annuity period.

Based on the IRS’ computation method, under the above example the donor’s taxable gift would be de minimis, and would use a negligible amount of the donor’s exemption from federal gift tax. A so-called “zeroed out GRAT” is a GRAT in which the annuity payment is calculated to produce no taxable gift.

Assuming the GRAT in the example had an actual annual investment return of 20 percent, at the end of the four-year term, $594,771 of assets would be left in the GRAT for the benefit of the donor’s children after the required annuity payments are made to the donor. Measured against the use of a negligible amount of exemption from federal gift tax at the creation of the GRAT, this is an outstanding result from a gift tax standpoint.

If the trust assets do not appreciate as expected and the GRAT has a rate of return of, say two percent, the donor will receive back all of the trust assets through the annuity payments, and nothing will be left for the benefit of the remainder beneficiaries; but the donor will not have wasted an appreciable amount of his or her exemption from federal gift tax.

Comparing the favorable result in the preceding paragraph against the unfavorable scenario highlights a key tax benefit of the GRAT – when it works, the results are excellent, and when it does not work, the loss is minimal. Based on this characteristic, a GRAT would be an excellent vehicle to hold a highly speculative investment that has the potential for significant appreciation – but also substantial downside risk – or equity investments that are less risky, but still have potential for double-digit appreciation.

There are a few other material tax points to consider regarding the GRAT:

  • If the donor dies before the end of the annuity period, the trust assets will be includible in the donor’s estate, and the advantages of the GRAT strategy will be lost. This favors use of a relatively short annuity period. In addition, it is generally easier to “beat” the IRS rate of return over a short period than a long period (for example, a 20-percent, annualized rate of return on an investment over a two-year period happens more frequently than a 20-percent, annualized rate of return on an investment over a 10-year period). Recognizing this fact, the IRS has become sensitive to the use of short-term GRATs, and a two-year annuity term is considered an aggressive strategy. A four- or five-year term is less aggressive.
  • A GRAT should be taxed as a “grantor trust” for income tax purposes, and this has several benefits. First, the donor will report the GRAT income (during the annuity period) on the donor’s individual income tax return and pay the resulting taxes from the donor’s own funds. Therefore, the GRAT strategy generally will produce gifts to the ultimate beneficiaries if the pre-tax return on its assets exceeds the IRS assumed rate. Second, as a grantor trust, the GRAT can pay the donor the annuity using appreciated property without the distribution being treated as a taxable sale of the property. Thus, if the donor funds the GRAT with illiquid stock, the GRAT can make annual annuity payments to the donor in kind, using the stock.
  • Funding a GRAT with hard-to-value property, such as real estate, partnership interests or shares of a closely held business, poses valuation challenges. For example, if the donor funds the GRAT with illiquid assets and plans to have the annual annuity payments made from the GRAT by distributing back to the donor assets in kind, rather than selling assets to make the payment, the donor will need to value the assets on the date they are contributed to the GRAT and on each annuity payment date thereafter.
  • It is better to have multiple GRATs, each holding a different investment, than a single GRAT with a diversified portfolio. This will prevent investments that do not appreciate substantially from diminishing the overall return of the GRAT. There is no limit on the number of GRATs a person can create.

With a stock market on the rebound and interest rates remarkably low, the GRAT is an exceptional estate planning option deserving of your consideration.

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Intentionally Defective Grantor Trust

Generally, a defective grantor trust is an irrevocable trust for the benefit of children and/or grandchildren in which the grantor does not retain any income interest. The trustee is someone other than the grantor. The spouse may be the trustee.

The trust is structured so that the grantor is treated as the owner of the trust for income tax purposes only under the rules set forth in Code Sections 671-678. These are known as the grantor trust rules; they were designed to impose income tax on the grantor even though the grantor is not the income beneficiary of the trust. This unique taxing feature provides planning opportunities to achieve gift and estate tax benefits for the grantor. The most significant of these benefits is to “freeze” the value of a closely-held business interest or real estate owned by the grantor.

Estate Tax Consequences of the Defective Trust

The grantor trust rules do not apply for gift and estate tax purposes. This means that even though the grantor is taxed on the trust income, the trust assets will not be included in the grantor’s estate, provided the grantor does not retain any interest, power or right which would cause inclusion under the provisions of Code Sections 2036 (transfer with a retained life estate) or 2038 (revocable transfers).

When the trust is made defective, it is flawed in a manner so as to result in income tax inclusion but not estate tax inclusion. The difference in treatment between the income tax laws and the estate tax laws presents planning opportunities for grantors using intentionally defective trusts for income tax purposes but without gift and estate tax consequences.

Using the Defective Grantor Trust as an Estate Freezing Technique

The intentionally defective grantor trust (IDGT) is most effectively used as an estate freezing device. The grantor creates a trust which is defective for income tax purposes (but not for estate and gift tax purposes) for the benefit of his or her children and/or grandchildren. The grantor sells assets (stock in a closely held or family business, real estate, marketable securities, limited partnership interests) to the trust in exchange for an installment note with interest. The IDGT works best if the sold assets are subject to discounts in determining their fair market value and if it is expected that the sold assets will appreciate in value at a rate greater than the interest rate payable on the note.

The installment note should be for a term of years (i.e., 10 or 15 years) may be self liquidating or payable in installments with a balloon or an interest only note with a balloon payment on the due date. If the IDGT purchases life insurance on the grantor’s life, then the note should be an interest only with a balloon payment and, if possible, the note should be renewed and kept outstanding until death.

When the grantor dies, only the fair market value of the note is included in the grantor’s estate. That value will be less than the outstanding principal of the note depending on several factors, including the payout of the note, the interest rate, the absence of security, default provisions, covenants and other note terms.

The IDGT technique freezes the value of the note in the grantor’s estate. Any increase in value of the sold assets will not be taxed in the grantor’s estate and will inure to the benefit of the trust beneficiaries.

Creating the IDGT

Before selling assets to the IDGT, the grantor should initially contribute property having a value equal to about ten percent of the fair market value of the assets to be sold. The reason is to avoid having the sold assets constitute the sole source of payment for the note and to avoid any sham transaction argument by the IRS. If the sold assets are the sole source of payment, then it might be argued that the transaction is a transfer with a retained interest causing the property to be included in the grantor’s estate.

The Gift Tax Consequences of the IDGT

With respect to the sold assets, there should be no gift tax consequences since there is no gift or generation-skipping transfer. The contributed assets represent a taxable gift to the remainder persons for which the $10,000 annual gift tax exclusion is not available since the contribution is a gift of a future interest. If the sale is at a price less than fair market value, then there would be a gift of the difference. It is therefore important that a qualified appraisal be obtained.

No gift is made by the grantor if the safe harbor interest rate prescribed by Code Sec. 7872 (the Applicable Federal Rate or AFR) is used. If the note does not provide for adequate interest, then, under Code Sec. 7872, the loan is recharacterized as part loan and part “gift loan.” A gift loan is a loan where the foregone interest is in the nature of a gift. If the note does not provide for adequate interest, then there is a gift based upon the discount rate in effect at the date of the loan.

It is important that the note provide for adequate interest to avoid a gift loan. If there is a gift loan, the effect of the discounting may mean that a substantial portion of the note will be treated as a taxable gift. For term loans, Sec. 7872 requires use of a discount equal to the applicable federal rate (AFR) in effect at the time the loan is made.

Benefits of Taxing Trust Income to the Grantor

Although the grantor is taxed on income that he or she does not receive, the grantor is reducing his or her estate by the amount of the tax. The payment of tax by the Grantor on trust income amounts to a tax-free gift to the beneficiaries. The trust benefits from using pretax dollars to pay the installment note.

The Income Tax Consequences on the Transfer to IDGT

There are no income tax consequences on the sale of the asset to the trust. The IRS position is that there is no gain or loss recognized in transactions between the grantor and the trust when the grantor is treated as the owner of the trust for income tax purposes. [Rev. Rul. 85-13, 1985-1 CB 184; IRS Letter Rulings 9010065 and 9211026.] It should be noted that this position is contrary to the decision in Rothstein, 735 F2d (CA-2 1984), which held that the transaction was a sale.

IRS Guidance for Structuring IDGT

A 1995 private IRS ruling provides guidance for structuring an IDGT. In IRS Letter Ruling 9535026, Parent established an irrevocable trust for the benefit of his three children with his wife and a bank as trustees. The trust was divided into three separate shares, one for each child. Each child also made transfers to his or her respective trust. Each child’s trust has been divided into two trusts, one holding property contributed by the father and the other holding property contributed by the child. The beneficiaries of each separate share are the child, the child’s spouse and descendants and their spouses. Trust income and principal may be sprinkled among the beneficiaries as determined by the trustees.

In the ruling, each child proposes to sell to his or her respective separate trust (RST) stock in an installment sale. The RST will give each child a promissory note equal to the fair market value of the stock with sufficient interest such that the loan will not be characterized as a below market loan under Code Sec. 7872. The note will pay interest only for 20 years. The principal will be due at the end of the 20 year term. The note is secured by the stock.

The IRS ruled as follows:
  1. Each RST is a grantor trust since the income of each RST may be distributed to the grantor and the grantor’s spouse (without the consent of an adverse party). Code Sec. 677(a).
  2. The transfer of assets to an RST is not recognized as a sale for federal income tax purposes. Therefore, any gain or loss on the sale of the stock to the RST is not recognized.
  3. Interest on the note is not deductible by the RST and is not taxable income to the grantor child. The grantor’s basis in the stock carries over to the RST. If an RST sells any stock, the gain or loss is taxed to the respective grantor child.
  4. If the note does not provide for adequate interest, then, under Code Sec. 7872, the loan is recharacterized as part loan and part “gift loan.”

IDGT Example

Parent creates an IDGT funded with a contribution of $100,000. Grantor thereafter sells limited partnership interests to the IDGT for its fair market value (after appropriate discounts) of $1 million taking back an installment sale note with an adequate interest rate. When Parent dies 10 years later, the balance owing on the note is $500,000, but the limited partnership interests have increased in value to $2 million. Parent’s estate includes the discounted fair market value of the note (which should be less than $500,000 with discounting). All of the increased value of the stock escapes any tax in the grantor’s estate.

Defective Trust Structures

The grantor trust rules contain several structures which are used for creating a defective trust for income tax purposes. This list is not exhaustive, but may be helpful:
  1. The grantor has the power, in a nonfiduciary capacity, to reacquire the trust corpus by substituting property of equivalent value.
  2. The grantor retains the right, in a nonfiduciary capacity, to either sell trust assets or change the nature of trust assets.
  3. If more than half of the trustees are related or subordinate to the grantor’s wishes and have the power to sprinkle income or corpus among the beneficiaries.
  4. If a non-adverse party has the power to add beneficiaries, other than after-born and after-adopted children.
  5. If the income may be used to pay insurance premiums on the grantor’s life, provided the trust actually holds such insurance.
  6. If trust income may be paid to the grantor’s spouse.
  7. the grantor retains the power to borrow trust assets without adequate security.

Comparing the IDGT and the SCIN

The defective trust strategy may seem to be similar to the self-cancelling installment note (SCIN). The major difference is that a SCIN is treated in the same manner as an installment sale with a capital gain and interest component as part of each payment. With the IDGT, gain is not recognized because of the grantor trust rules.

The main advantage of the SCIN is that the unpaid balance of the note is not included in the seller’s estate, although the unrecognized or deferred portion of the gain is recognized in full by the estate at the time of death. [Estate of Frane, 998 F2d 567 (CA-8 1993).] With the defective trust, although the value of the note is included in the estate, none of the gain is recognized. Since the grantor trust is not subject to tax, it uses pretax dollars to pay the note. The taxes paid by the grantor reduce his or her estate. There are no comparable benefits with the SCIN.

Comparing the IDGT to GRATs and GRUTs

With a grantor retained annuity or unitrust (GRAT or GRUT), the grantor retains an income interest, either for a term of years or life. In order for the property and its appreciation to be excluded from the grantor’s estate, the grantor must survive the term of the trust. Additionally, the GRAT or GRUT usually results in a gift to the remaindermen. A gift tax return must be filed and gift tax paid, when applicable.

Conclusion

The impact of defective trust planning is substantial estate shrinkage and the transfer of asset appreciation from the parents to the children and/or grandchildren. While the defective grantor trust is a cutting edge idea, it is not for everyone.

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Irrevocable Life Insurance Trust (ILIT)

An Irrevocable Life Insurance Trust (ILIT) allows a grantor to make tax free gifts to heirs. Normally, the Trust is set up prior to the purchase of life insurance, but any life insurance policy can be later changed to allow for an ILIT.

Some of the advantages of an ILIT are as follows:

  • Excludes life insurance from estate tax calculation
  • Trust is owner & beneficiary of life insurance policy
  • Requires non-grantor trustee
  • Crummey notifications are mandatory every time a gift is made to the Trust

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Living Trust

A Living Trust is the most basic type of Trust and the type of Trust that most people need.

Some specifics and an overview of Living Trusts follows:

  • The Grantor’s ownership and usage does not change, so they have complete enjoyment of all of their assets.
  • Grantor(s) is owner, trustee & beneficiary
  • No asset protection for judgments
  • Easy to administer, up-keep and changes
  • Low cost set up fees
  • No annual fees

A living trust, also known as a Revocable Living Trust or a Family Trust is a legal document that holds title or ownership to your real property and assets. When you create a Revocable Living Trust you transfer ownership of your assets to the trust. Transferring assets is typically called “funding.” When you transfer title you DO NOT relinquish any control. You can still buy, sell, borrow or transfer.

To many the living trust looks a lot like a will. It includes the details and instructions for how you want your estate to be handled at your death. However, unlike a will a properly funded trust:

Will I lose control of my assets with a Living Trust?

No! The living trust is a written legal document that allows you, as the trustee(s), unlimited access to and full control of your assets during your lifetime. It also enables you to pass property after your death to family, friends and/or loved ones. It allows you to appoint someone (a successor trustee) to make certain your property goes to the ones you choose after your death.

I thought a Will avoids probate?

Many individuals are under the impression that their will alone is sufficient to avoid probate. Unfortunately, a will is simply an expression of your wishes and must go through some kind of court process before the assets can be distributed to the heirs. The reason for probate is needed because the owner of the property or asset is deceased. Once the owner of the asset has died, probate court is the legal process needed to take their name off the title of an asset and put it in the new owner’s name.

Will Joint Tenancy avoid Probate?

Putting your children’s name on your property does not avoid probate, rather it only puts it off for a few more years. To learn more about joint tenancy and why it is a poor option click here.

“A fully funded Revocable Living Trust will avoid probate.”

How does a Living Trust work?

For a trust to be effective it has to own title to the property or asset. Remember, when you transfer title of your assets into the trust it is called “Funding your Trust.” Funding is the process of transferring the name on accounts or property to the name of the trust. For example, accounts in the name of Bill and Mary Stevens, would now be held as “Bill and Mary Stevens, Trustees of the Stevens Family Trust dated date signed and year”.

Who are the people involved in my living trust?

To better understand the trust, we thought it would be important to explain the different roles of the people who would be involved.

Grantor

This is the person who sets up the trust. This would be you. The grantor has many names such as the creator, settlor or trustor. As the grantor, you have full control to manage or change the trust at any time.

Trustee

The trustee is the person who will manage the assets in the trust. Again, this will most likely be you while you are alive. When a trust is created, the trustees are usually the same individuals as the grantor. For married couples, usually the husband and the wife both act as co-trustees. You do not have to be your own trustee if you do not want to or do not feel you are able to. You can name a child or friend or even an institution to manage your affairs for you while you are alive.

Successor Trustee

This is the person who will manage your assets for you when you die or if you should become incapacitated. This person or persons will have the right to manage your affairs without the need for any probate court. The successor trustee will immediately have the same powers that you as grantor/trustee had to buy, sell, borrow, or transfer the assets inside the trust.

More importantly, the successor trustee has the right to distribute the trust’s assets according to your instructions in the trust. This immediate control can allow your estate to be transferred to your children or loved ones right away avoiding the time delay of probate which can usually consume anywhere from 6 months to 2 years.

Fortunately for you and for the protection of your heirs, the successor trustee does not have the legal right to change your trust. The trust becomes irrevocable or unchangeable after the death of the grantor(s). However, the successor trustee does have the right to manage the assets in the estate, but must do so for the benefit of the beneficiaries.

“You can choose one or two or more people working together as a successor trustee.”

Beneficiaries

The people who will receive the benefit of the trust’s assets are called the beneficiaries. Typically the estate will go to the surviving spouse. If there is no surviving spouse, assets will pass to the people you named in your trust. You are not limited to who you want to receive your estate. You can name your children, relatives, friends, or a charitable organization to be your beneficiary.

What happens when I die?

After you pass away, your successor trustee or co-trustee will have the same responsibilities an executor would have if you would have prepared a will. However, since your trustee does not have to report to a probate court everything can be done more efficiently and privately.

Advantages to the Living Trust

  • If an illness or accident leaves you incapacitated, your successor trustee can handle your financial affairs without the need for a court appointed guardian or conservator.
  • If the beneficiaries of your trust are minor children or others who might not use an inheritance as you intend, the trust can continue to hold the assets until they reach a more mature age.
  • If you own real property in more than one state you avoid the expense, time and hassle of multiple probate proceedings.
  • By using a trust, a husband and wife can maximize both their federal estate tax exemptions.

Trusts are generally more difficult to contest than a traditional will. To invalidate a will you must either prove it was signed under duress or that the maker was incompetent on the day it was signed. To invalidate a living trust you would have to prove it was invalid not only on the day it was signed but each and every day it was in existence thereafter.

It is almost impossible to contest a Living Trust. When a will is contested the assets are frozen and they cannot be distributed until the claim is resolved. Assets placed in a living trust are not frozen pending the outcome of a legal challenge. Anyone wishing to contest the trust must file suit against each of the beneficiaries; in the meantime the assets in the trust can be distributed.

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Personal Residence Trust

A personal residence trust involves the transfer of a personal residence to a trust with the grantor retaining the right to live in the residence for a fixed term of years. Upon the shorter of the grantor’s death or the expiration of the term of years, title to the residence passes to beneficiaries of the trust. This is an irrevocable trust with gift tax implications.

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Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) involves the transfer of a personal residence to a trust with the grantor retaining a qualified term interest. If the grantor dies before the end of the qualified term interest, the value of the residence is included in the grantor’s estate. If the grantor survives to the end of the qualified term interest, the residence passes to beneficiaries of the trust. A QPRT is a grantor trust, with special valuation rules for estate and gift tax purposes, governed under IRC 2702.

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Qualified Subchapter S Trust (QSST)

A QSST is a statutory creature established by IRC Section 1361(d)(3). By meeting the requirements of a QSST, a trust may own S Corporation shares. An election must be made to be treated as a QSST and once made is irrevocable.

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Rabbi Trust

An irrevocable trust that functions as a type of retirement plan or deferred compensation arrangement that offers a limited amount of security to the deferring employee.

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Supplemental Documents

  • Pour Over Will

    The pour over will is used to include all assets in your trust and to make sure that your estate is never subject to probate proceeding. It is a catch all that makes sure that all of your un-funded assets ‘pour’ into your Trust an avoid probate.

  • Durable Power of Attorney

    The durable power of attorney empowers a person you choose to take care of your financial affairs when you are not able to do so yourself. Your selected power of attorney has limited authority to maintain, protect and avoid the waste of your assets during times when you are not in a position to do so.

  • Special Medical Power of Attorney

    The special medical power of attorney empowers a person you choose to make medical decisions on your behalf when you cannot do so yourself. This power of attorney does not allow you to choose specific care but places the power of reasonable choice with your chosen representative. This power of attorney is important to be provided to all attending physicians and hospitals.

  • Living Will

    The advance medical directive allows you to choose the extent and types of life sustaining care after two (2) independent physicians certify in writing that you have no brain function and there is no chance of recovery or improvement from your present condition.

  • Guardianship Appointment of Minor Children (if applicable)

    The guardianship appointment of minor children is used to name a person or persons to care for your minor children. You may put parameters and conditions on the guardian for caring.

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