WHAT ARE THEY?
When talking about "trusts" with clients and friends, I have found that many people do not truly understand what a trust is, how they are created, what their purpose is, or how they work. Trusts can be a confusing concept for many people. For this reason, some clients prefer not to incorporate them into their planning for fear of complexity. In reality, trusts can be fairly simple and straightforward but first, it is important to understand the basics of what a trust is and how they operate.
A LEGAL DOCUMENT & THREE KEY PLAYERS
In the simplest of terms, a trust is a legal document, basically an agreement, that outlines a legal relationship between certain parties. This relationship describes how property, such as money, is to be used for the benefit of (a) certain person(s).
In this legal document, the first key player is the person who creates the trust. This person is known as the "grantor" (also referred to as "settlor" or "trustor"). The grantor requests that another person, the "trustee", follow his instructions laid out in this legal document to take care of and use certain property for the benefit of another person, the "beneficiary".
In legal speak, we say that the trustee "holds property for the benefit of another person" but this statement often confuses people because they often assume that "holding property" means that if a trust account is at the bank, then the bank is the trustee, and that is not always the case. The bank could be holding the account but your Uncle Bob could be the trustee.
With that said, even though there are "three" key players described above, that does not necessarily mean that three different people have to play each role. In fact, in some types of trusts, one person could play two roles. That means that one person could create the trust and act as his own trustee; or one person could create the trust for his own benefit and have someone else be his trustee.
"WHO" HOLDS LEGAL TITLE TO THE TRUST PROPERTY?
So to summarize, a trust is just a legal document expressing the terms of a relationship (a stack of papers that include a bunch of [important] legal mumbo jumbo). You would go to an attorney to draft this legal document for you. Once the legal document is drafted, the trust will only come to life after it is properly "funded" with the trust property.
You actually have to change "title" of the property to the name of the trust. For example, if someone tells you that some real estate is in trust, that means that the actual deed of that real estate has to be "in the name of" the trust. When you put property into a trust, you are giving up your legal interest in the property itself. It is no longer owned by you in your individual capacity but rather it is owned by the trustee for the benefit of another person, the beneficiary.
Hearing that, you might wonder why you'd want to give up your legal interest in some property that you own? Well, it is because trusts can have benefits under the law that may be advantageous for some people's needs.
BASICS- WHEN ARE THEY CREATED? ARE THEY REVOCABLE?
TESTAMENTARY TRUSTS vs. INTER VIVOS TRUSTS
A testamentary trust is a trust that is created upon the grantor's death. It is typically included as part of the provisions of a person's will.
An inter vivos trust is a trust that is created during the grantor's lifetime. It can be created for the grantor's own benefit or for the benefit of others. Such a trust can be funded either during the grantor's lifetime or at the grantor's death.
Inter Vivos trusts can be created as a Revocable Trust or an Irrevocable Trust. A Revocable 'Inter Vivos' Trust is commonly referred to as a Revocable Living Trust.
REVOCABLE TRUSTS vs. IRREVOCABLE TRUSTS
There are Revocable Trusts and Irrevocable Trusts.
A revocable trust is a trust which the grantor can revoke, amend or cancel at
any time (before his/her death). On the other hand, an Irrevocable
Trust cannot be revoked, cancelled or even amended after it is created.
(Irrevocable Trusts are often used in estate planning in an attempt to
minimize or defer Estate Taxes.)
DIFFERENT KINDS, DIFFERENT PURPOSES
PURPOSES, in general
Trusts are used for various purposes. Estate planners often use trusts in planning for reasons such as: holding property for a person (the beneficiary) until he is mature enough to manage it; holding property for a beneficiary so that it can only to be used for specific purposes; holding property for a beneficiary to protect it from the claims of creditors; holding property so that it can be managed for a beneficiary's long term support; providing [estate] tax reduction or deferment benefits; etc.
REVOCABLE LIVING TRUSTS
Revocable Living Trusts can have several benefits
for certain planning needs but unfortunately have been marketed by non-legal professionals (or those outside of Texas) who do not understand the true nature of when or why they are truly beneficial. Although I could essentially make more money by having a client believe that they are "necessary", my goal is to explain to my clients the pros and cons of such legal planning and allow them to decide for themselves. (In most cases, for the younger client, the benefits for having a revocable living trust do not outweigh the cost analysis nor realities of actually living with funded revocable living trust.)
One Common Misconception
Many people have the
misconception that the true, primary advantage of a Revocable Living Trust is that it
will 'reduce or eliminate thousands of dollars in taxes and probate costs'.
Going back to the concept discussed above about "who" owns legal title to the trust property, remember that you no longer own that property if it is funded into the trust. When you die, that means that since you no longer personally own that property, it is not an asset that is probated (e.g., distributed) by the terms of your will but rather it is distributed according to the terms of the trust. That is what keeps property held in a Revocable Living Trust from going through the probate process.
With that said, the misconception stated in paragraph one is is more hype than truth due to the simple fact that the probate process in Texas is relatively inexpensive and does not include as many
cumbersome court restrictions as compared to several other states (which is primarily how that misconception originally came about, not to mention marketers of living trusts).
Inexpensive and Straightforward Probate in Texas
Texas, we have an independent administration process which means that if an
Independent Executor is properly named in your will and appointed by the Court, such Executor can often
act to administer your estate without having to obtain constant court approval.
Therefore, "avoiding probate" in Texas involves much less economic advantage than
in other states and should not be the only reason for creating and funding a
Revocable Living Trust during your lifetime.
With that said though, Revocable Living Trusts can be beneficial in
situations including but not limited to the following instances:
If your will is probated in Texas and you have
assets that pass under your will, a listing of your assets (and the
beneficiaries named in your will) are kept in the court records, which are
public. Having such assets funded into your Revocable Living
Trust during your life will be governed by the trust agreement at your
death and will not pass through probate (which means that your trust will NOT be in this same public record).
Additionally, if you want your
holdings to be kept private while you are alive, a Revocable Living
Trust may appeal to you for these reasons.
Real Estate Owned Outside of Texas
If you are domiciled in Texas when you die but
have real estate in another state, it is most likely that your family will have
to go through probate in the state where that real estate is located. You can potentially avoid this with the creation and funding of a Revocable Living Trust, and therefore such real property will be controlled by the terms of your Texas Revocable Living Trust (if the real property is properly deeded into the Trust).
Will Contest Anticipated or Likely
If you anticipate that members of your family would attempt to contest your Will on grounds such as undue influence, etc., you can deflect some of these legal arguments by creating and funding a Revocable Living Trust during your life.
Mental or Physical Incompetency
Unlike most of the situations listed above that
provide benefits after your death, this benefit would protect you while you are
In the event you become incompetent and prefer to name a trustee to
manage your assets, as opposed to potentially having an [Adult] Guardianship (over your assets), a Revocable Living Trust may be able to protect you from
having an expensive and cumbersome court supervised Guardianship over your
assets (referred to as Guardianship of the Estate). For this type of goal, you can even have a Revocable Living Trust drafted for you but have it act as a "stand-by" trust in the event you do become incapacitated.
Bottom line for Revocable Living Trusts, if you do not have one of the goals or reasons listed directly above, you are most likely not a good candidate for a Revocable Living Trust.
Many irrevocable trusts are created in conjunction with estate planning in an attempt to defer or minimize [estate] taxes. In general, when people refer to 'taxes at death', they are speaking of estate taxes.
Estate tax is not the same as income tax. As you are probably already familiar, income tax is a direct tax that you pay on income you earn annually while you are alive. Estate tax is different in that it is an excise tax. That means that it is essentially a tax that is assessed on the amount of property a person owns at their death and therefore passing on to others as a privilege. The tax is based on the value of the goods you are passing. [In estate planning speak, we say that the taxable amount is based on the value of the gross estate of decedent's assets on his date of death.]
Why is this important in regards to irrevocable trusts?
Many of the ways in which people can reduce the ultimate amount of the value of the goods they are passing at their death is to either give it away or give up control over it. Sometimes, property owned by a trust is not considered owned by you at your death if certain federal tax rules are followed in drafting the trust. True estate planners that engage in tax planning must be familiar with the federal tax rules (i.e., the Internal Revenue Code) because there are essential language requirements that must be followed to obtain these certain benefits.
This type of planning typically includes testamentary trusts (such as a Bypass Trust) but oftentimes this type of planning also includes different types of Irrevocable Trusts.
Why is it important that some of these trusts be irrevocable?
The reason comes from the idea that you can't hold onto that property in a Revocable Trust and later change your mind and get it back. Therefore, Irrevocable Trusts in this type of planning coincide with the theory that you can't have your cake and eat it too.
MISCELLANEOUS TRUSTS USED IN ESTATE PLANNING
Irrevocable Life Insurance Trusts ("ILITs"),
Grantor Retained Annuity Trusts ("GRATs", also "GRITs" and "GRUTs"),
Qualified Personal Residence Trusts ("QPRTs"),
Charitable Remainder Annuity Trusts ("CRATs", also CRUTs"),
Defective Grantor Trusts,
Marital Trusts, Bypass Trusts, Exemption Trusts, Generation Skipping Trusts,
various other irrevocable trusts, etc.
The above listed irrevocable trusts involve not only precise and extensive drafting but also ongoing transactional procedures that you must keep up with in addition to the initial creation of the trust. Most of these types of trusts are not typically needed or encouraged if you are a person who would not die with a taxable estate.