Many people have heard that they should have a trust. However, how many people know what a trust is?
You could say that a trust is a contract between the person creating the trust (the grantor) and the person who will manage the trust (the trustee). The grantor can also be called a trustor, settlor or creator, depending on the region of the country where the trust is created and the preferences of the drafter of the trust.
There are four requirements for a trust:
1. A grantor;
2. A Trustee;
3. Assets that are placed into the trust; and
4. A beneficiary or beneficiaries of the trust.
A trustee is a fiduciary. A fiduciary must act in the best interest of the beneficiaries of the trust. The trustee must strictly adhere to the terms of the trust. She must also avoid any conflicts of interest that would impair her ability to act in the best interest of the beneficiaries. Trust property must be kept separate from other assets. In other words, they must never be commingled with the assets of any other person or entity. The trustee must keep a record of everything that goes into the trust and everything that comes out of the trust.
Before the assets are distributed, the trustee must present an accounting to the beneficiaries so that they know that the trust was administered properly. The accounting shows what was paid into the trust and what was paid out of the trust during the period of the time that the trustee managed the trust. Whenever a trustee signs a document on behalf of the trust, she should make sure that she signs as trustee to make it clear that she is acting in her capacity as trustee.
If a trust is not funded, it is just a piece of paper. For the trust to be effective with respect to any particular asset, the asset must be placed into trust. For instance, George set up a trust to avoid probate. He had a bank account that was just in his name and he did not transfer it to his trust. When he died, his will had to be probated so that he could pass his bank account to his beneficiaries. If he had transferred the bank account into his trust, probate would have been avoided.
Some assets should not be transferred into trust, such as IRAs, 401(k)s and other qualified retirement accounts. Transferring them into trust will cause adverse tax consequences.
Trusts can be created in one’s will or created while the person is living. A trust created in one’s will is a testamentary trust and a trust created while one is alive is a living or inter vivos trust.
A trust can be revocable or irrevocable. The choice of whether a trust is revocable or irrevocable depends on why the trust is being created. For example, if the person creating the trust wants access to the assets of the trust, he would create a revocable trust. However, if the person creating the trust wants to minimize estate taxation or protect the assets in the trust from the cost of long term care (Medicaid planning), he would create an irrevocable trust.
Trusts can be created for many purposes. For instance, a trust might be created to avoid probate. By avoiding probate, the beneficiaries of the person’s estate will not have to go to court to probate their loved one’s will. There are times when avoiding probate is especially important:
- when one is expecting a will contest because a natural heir is being disinherited;
- when all of the natural heirs of the person cannot be located;
- when the individual has property in multiple states, causing the necessity of probate in every state where the person has property; or
- it is anticipated that Medicaid will have a lien against the estate.
A living trust can provide a person’s estate with liquidity. Example: Barry had a Last Will and Testament and a Power of Attorney. His only liquid asset was a bank account in the amount of $100,000. Barry dies. Barry’s family needs to bury him and they need to pay his property taxes and other expenses of his residence. He also has other bills that need to be paid. Once Barry passes away, his Power of Attorney is no longer effective. Furthermore, his Last Will and Testament will not be effective until the executor goes to court and obtains Letters Testamentary. Thus, there is no money to pay Barry’s bills or to bury him. If Barry had a trust, the trust would survive him and there would be money to pay these items.
A trust can be created to protect the inheritance of someone who is disabled. This is called a Special Needs Trust or a Supplemental Needs Trust. If a person is receiving government benefits such as Supplemental Security Income or Medicaid and he receives his inheritance outright, he will lose his government benefits. However, if the inheritance is kept in a Supplemental Needs Trust, he will keep his Supplemental Security Income and Medicaid while at the same time having the benefit of his inheritance.
Sometimes a parent will decide to entrust the funds to a sibling instead of setting up a trust for the disabled individual. This is a mistake. Even if the sibling can be trusted to use the funds on behalf of the disabled person, what if the sibling dies, get sick, gets divorced or must declare bankruptcy? If the disabled person’s inheritance is in trust, it is protected from the foregoing. If it is not in trust, the disabled individual could lose her entire inheritance.
If a person is a minor or just irresponsible with money, a trust should be set up for that person. A beneficiary may have a bad marriage or might have potential creditors that will want to attach her inheritance. These are reasons why one might set up a trust on behalf of a beneficiary.
A trust might also be set up for the purposes of long term care planning (Medicaid planning). At the current time, if an individual needs a full-time aide, the cost is over $100,000 a year on Long Island. A nursing home will cost over $162,000 a year. Thus, one might wish to put his property into trust to protect it in the event he needs long-term care.
Trusts have many purposes. I hope that this article has enlightened you about what a trust is and what it does.