Trusts and Wills Defined, Part 2: What is a Trust?

This article is reproduced by permission from Living Trusts for Everyone: Why a Will is Not the Way to Avoid Probate, Protect Heirs, and Settle Estates by Ronald Farrington Sharp, newly released by Allworth Press. © Ronald Farrington Sharp 2010. If you want to know a good deal about estate planning and trusts but don't want a 400-page boring book to read, I highly, highly recommend getting this one. It's short, to-the-point, and very informative.

A trust is also just a written document. It also says who gets what, when they get it, and who is in charge of seeing that that happens. The person in charge is the trustee. The difference is that a trust does not have to go through the probate court.

The reason a trust is not probated is that when a trust is signed, it becomes a legal entity that has the ability to own things. I often analogize it to the hardware store down the street. Smith’s Hardware is a corporation. The corporation owns the building, the inventory, the delivery truck, the hardware bank account, the money in the cash register—all the hardware store assets. The Smiths own the corporation. If they die, the corporation is, in a sense, still alive and will keep selling hardware. New owners come in and take over the business operation.

A trust is similar. In a trust, the trust owners (the “grantors,” “trustors,” or “settlors”) transfer their assets into the name of the trust. Let’s call it “The Smith Trust.” After they sign the trust document, The Smiths then “fund” the trust. In other words they transfer their assets into the trust name. This is done in a few ways, but typically real estate is deeded into the name of the trust by using a quit claim deed. Bank accounts may either be put into the name of The Smith Trust or may pay on death (POD) to the trust (kind of like a beneficiary designation). Life insurance is transferred by naming the trust as the beneficiary.  Tax deferred accounts like IRAs and 401(k)s may have the trust as the primary or contingent beneficiary.

The idea is to have The Smith Trust own all the Smiths’ assets. That way, at the death of the Smiths, there is nothing left in their individual names for the probate court to administer.  The trust owns their stuff, but they own the trust. They die and the trust still owns their stuff, but the trust document then kicks in. The trust says who takes over at their death to carry out their instructions on who gets what and when.

The great thing is that there is no court order needed for the trustee to take over after the Smiths die. The trustee merely has to show proof that they are dead and show the trust to prove who is the trustee. Then, literally the day after they die, the trustee can begin carrying out their instructions on distributing the trust assets. How the trustee does all this is explained in simple language in the last chapter.

Now, of course, the trustee still has to do the normal things that need to be done when a person dies. The garage has to be cleaned out, the credit card bills and funeral and burial expenses paid, and the last year’s income tax filed, but the trustee just goes ahead and does these things. No lawyer is needed and no legal or court fees are due.

People worry that a trust will tie up their property. Not true.  In a revocable trust, the trust owners (grantors) have full rights to all trust assets during their lifetime. They can sell these, give them away, mortgage them, or even burn them up or gamble them away if they want without anyone’s permission or any special paperwork. A trust is a death planning device and does not complicate the owner’s life—if it is put together properly.
Now the trustee is in a different position after the death or disability of the grantors. We call a trustee that name because this is someone the grantor picks who is trustworthy. Trustees have legal responsibilities to the trust beneficiaries. Trustees cannot, in most cases, change the terms of the trust in the way the grantors can. They can only follow the instructions of the grantors. And the trustee cannot do anything risky with the trust assets. State law requires a trustee to be very conservative in investing and dealing with trust assets. A trustee is called a “fiduciary” because they have a special responsibility to the beneficiaries to safeguard the trust assets for the benefit of the beneficiaries until all the trust assets are ultimately distributed as the grantors have instructed.

Your own lawyer may tell you that a simple will is all you need and that you do not have enough assets to consider a trust. Your lawyer is either lying to you or is ignorant of the facts about trusts. Many lawyers have been minimally trained in trust law and believe that the only reason to have a trust is for wealthy people to avoid estate taxes. Wrong.

The fact is that nearly everyone would be better off with a trust than with a will. In most cases the only person who benefits from your having a will instead of a trust is your lawyer.  Attorney fees for making the will and probating the estate are a lawyer’s bread and butter.

Of course, sometimes a lawyer can arrange it so a trust is no better or cheaper than a will. Some attorneys charge what they call a “settlement fee” to help the family wrap up the trust after death. This may be a percentage of the trust assets. The services provided by the lawyers are not, for the most part, legal services but they are charged for just as if they were. I will speak more to the issue of attorney fees and trust settlement later.

I have been talking so far about a simple trust for the normal family situation—what the IRS calls a revocable grantor trust, and which is often called a living trust. There are a lot of kinds of trusts with a lot of functions, including estate tax avoidance and charitable purposes, but most of the situations normal people find themselves in are easily handled using a simple revocable trust. In the next chapter I will explain who absolutely should have a trust and what it will do for them.

One more note: It is possible to put the provisions for a trust in the language of the last will and testament. A trust of this kind is called a testamentary trust. It may contain all the provisions of a stand-alone trust document and accomplish the same things. But because it is in a will, the trust is not created until probate is finished. It is then funded with some or all of the assets left after the probate process is completed and all the costs deducted.

Anyone with this type of trust is losing the major benefit of probate avoidance. This is not the type of trust you want. The testamentary trust is a great deal for the lawyer, since he gets paid for doing the trust as well as probating the estate. Good estate planners no longer use testamentary trusts. If one is recommended to you, be sure you ask why a revocable living trust is not being prepared instead.

Comments

[Doug @ CheapScholar.org]

My wife and I created a will after the birth of our first son. Three years later and 2 more kids, we continue to update our will. The will is more a tool to help protect our underage kids and make sure they are cared for by the appropriate family members if we were to both encounter an unfortunate situation that led to our untimely demise.

After reading the two posts (Wills & Trusts), I definitely see great benefit for setting up a trust later in life as our assets accumulate. I am tempted to purchase this book and encourage some other family members and friends to check it out. I think many of us have a big misconception about trusts and wills and can probably benefit from this information.

[Troy]

This article is somewhat disengenious.

While trusts are very beneficial, they are not universally necessary as depicted.

Anything with a beneficiary designation (real estate, retirement accounts, bank accounts, etc) will avoid probate regardless of a trust.

And even if you have a trust, it is unwise to place real estate in the trust while alive. The proper thing is to prepare a beneficiary deed and name the trust as the beneficiary.

So if you have some real estate, some retirement accounts and bank accoutss, even if they are worth millions of dollars, probate is avoided due to beneficiary designations.

The main purpose of a trust is to set up detaild instructions for the disposition of assets over a specified timeframe to varying entities, like children. And avoid probate on non-financial assets.

[jeffinwesternwa]

You CAN put a PoD (beneficiary) on almost ALL assets in a simple (but, it could be a large) estate. So if you are in a state that doesn't charge much and probate is simple - along with the lines of passing the property in an estate, a PoD, Will, - with that beneficary info on ALL assets, AND: with non-PoD/beneficiary property NAMED in the will, you can accomplish passing a non complicated estate. But, I'd agree, "mixed" families (remarried kids, stepchildren, etc.,) high cost probate (like CA) states, etc., should consider a trust...

[MasterPo]

MasterPo agrees about the usefulness of a trust.

However, MasterPo disagrees about the authors position on testamentary trusts. There can be very good reasons for establishing a trust at the time of your death and not right now.

For example, if you have a large estate (defined anyway you'd like) and small children (or even teens) as the heirs it's very logical NOT to want your estate to go directly to the children directly but rather be held in trust until they mature to be able to handle that kind of asset.

At the same time if your children are much older (and hopefully you have done a good job teaching them how to handle assets) you may want your final assets to go directly to them. A will can be written to specify that upon your death if your children are under a certain age your assets are to be put in trust, over a certain age it goes direct to them.

ps- As MasterPo mentioned in the prior article there are definate tax and record keeping issues with a trust to be considered too. Plus the fact that you can't (normally) be both the grantor and the trustee.

[Ian G]

I really appreciate this series on wills vs trusts. Still learning, but a good fundamental series to now perform a bit more research.

[Paul Williams]

@MasterPo - I'm not sure why you think the age of your children has anything to do with deciding whether you should have a testamentary trust or a revocable living trust. Both can handle either situation you mentioned, but the revocable living trust avoids probate.

And you CAN be the grantor and trustee in a revocable living trust - that's the whole point. There are no tax issues in that case - it's a "grantor trust" so trust assets are taxed as if you still own them personally. And there are very few record keeping issues for a revocable living trust while you are alive (aside from the document itself and records showing the assets within the trust).

Out of curiosity, what training do you have in the issue of estate planning? Your protests to the ideas in this article show that you must have very limited experience with trusts. Based on this comment and your comment in the last post it sounds like you've only dealt with irrevocable trusts. But that's not what the author is recommending, so your arguments don't hold much water.

[MasterPo]

Paul - Age has a lot to do with it. Would you leave a $1 million dollar estate to a 15 y/o?? MasterPo hopes not. MasterPo agrees that a trust (revocable or irreveocable) avoids probate but the reality is setting up a trust just isn't realistic for all persons at all stages of their lives. 20 years ago MasterPo would not have even considered a trust. Today MasterPo and Mrs. MasterPo are actively involved in trusts.

You are mistaken about the tax issue. Assets registered to a trust (revocable or irrevocable) receive 1099's in the name and tax ID of the trust. It is the trust (via the trustee), not the grantor, that has to file a tax return for the income (or cap gains/loss)of the trust. And trusts are taxed at the corporate rate, not the individual rate.

ps- Not that it should matter, truth is truth, but MasterPo holds both ChFC and CLU designations. (though NOTHING MasterPo posts is to be taken as financial or investment advise - gotta put in that disclaimer. ;-) )

[Paul Williams]

MasterPo - Age has nothing to do with it at all. If you leave a $1M estate to a 15 y/o, you can have provisions in the (revocable or irrevocable) trust to delay distribution. You can do the same thing with a will by using a testamentary trust.

And I'm not mistaken about the tax issue. If a trust is considered a grantor trust (as in the case of a revocable living trust), then any taxable income flows through to the grantor's tax return. See http://www.irs.gov/instructions/i1041/ch02.html#d0e2407 As long as the grantor retains control of the trust assets (as in the case of a revocable living trust) the trust is ignored for income tax purposes and the grantor is taxed as normal. No separate trust tax rates. Obviously, this changes once the trust becomes irrevocable after the grantor's death but that's not the point here.

Regarding your designations, it seems to me that there's quite a bit of overlap between the two, so why not just go with the ChFC since that covers most all of it? One last thing - can you stop referring to yourself in the third person? Just makes it difficult to respect your opinions (in my opinion...).

[Kathy F]

Paul: Thanks so much for your comments. I have a revocable living trust myself. MasterPo statements were shaking me up. Grantor cannot be trustee? I thought I was the grantor and trustee while I was alive. Trust tax issues? I had been handling taxes on my mutual funds in the trust on my own personal tax return.

I am single with no kids and no relatives in state. I wanted the trust to make things easier for my brother who would be my executor and trustee. I also used the trust to set up minor trusts for my niece and nephew.

I am curious about Troy's comment. "And even if you have a trust, it is unwise to place real estate in the trust while alive. The proper thing is to prepare a beneficiary deed and name the trust as the beneficiary." Why is it unwise to place real estate in the trust while alive? I also have never heard of a beneficiary deed before and would like to know about it.

I think I might purchase this book on trusts. I am interested in the last chapter for letting my surviving trustee know how to distribute trust assests.

[Paul Williams]

You're welcome, Kathy. I think MasterPo was speaking specifically to one type of trust that he's had experience with, but his statements don't apply to grantor trusts (revocable living trusts).

I'm not sure why Troy things it is unwise to put real estate in a trust while you're alive. I know some people have difficulty with getting a mortgage/refinance/HELOC when the property is in trust and there are some recording fees for signing the deed over to the trust. You can solve the loan problem by taking your property back out of the trust and putting it back in after the process is over. Of course, this only applies to revocable trusts.

[Paul Williams]

Ah, stupid typos. *things should be *thinks in that second paragraph...

[MasterPo]

Paul - At the time in MasterPo's life the CLU stood him in better standing. At that point getting the ChFC was just a couple more courses.

[LPA]

I am all for anything that puts as much as possible of the estate in the hands of the intended beneficiaries. At first blush, these vehicles might appear complicated, but there is no substitute for consultting a properly qualied professional.