Trusts 101: The 5 "Ws" - Who, What, Where, When, and Why
This article contains an overview of some of the basics concerning Trusts. This article is by no means comprehensive. Your review of these materials, and use of the information contained herein, is subject to the "Disclaimer" included at the bottom of this article, as well as the Terms of Use on the EPM website. While this article discusses some types of trusts at a very basic level, EPM does not provide tools for estate plans involving any type of trust other than a revocable Living Trust, which is not intended for tax purposes.
W #1 - “What” is a Trust?
Trusts, at a basic level, are contractual arrangements that allow one party to give property to a second party, which then holds the property for a third party. The terms of the “trust agreement” define and describe the rights and duties of the parties involved in the transaction. As is true of most contracts, a Trust is flexible and can be adapted to many varying situations. One of the primary uses for a Trust is estate planning. There are numerous types of trusts that fall into a few general categories and types (for example testamentary, living, revocable, and irrevocable trusts). The best use of a given type of Trust is situational and dependent upon the facts and circumstances involved. When the correct type of Trust or set of trusts are used properly, they can help protect an individual’s assets, account for the allocation of property upon the creator’s death, and aid in tax planning.
A Living Trust and Living Will are both used in estate planning. However, a Trust is intended to secure assets, and control property, whereas a Living Will is a document used to spell out your medical wishes for your family and health care representatives if you suddenly become incapacitated.
Trusts can be employed in a number of ways to plan one’s estate, protect assets and even create wealth. A number of techniques are available to limit and restrict assets and their disposition during life and at death which can be of great benefit to asset holders.
W #2 - “Who” is involved in the Trust?
There are generally three separate parties involved in a trust agreement. First, the “grantor” or “trustor” is the party that transfers his or her property to the trust. Second, the “trustee” is the person or entity responsible for holding the Trust property. Third, the “beneficiary” is the person on whose behalf the Trust property is being held. Nothing prevents a single individual or entity from acting in all three capacities. When such an occurrence takes place, the Trust is said to be a “grantor trust”. Generally, each of the three parties to a Trust transaction will have different rights and duties with regard to the Trust. These rights and duties are spelled out in the trust agreement and further by state law.
W #3 - “When” is a Trust Applicable - During and/or After Life?
A Trust can be created at any time, but proper planning is required. As to when a Trust can come into effect, it can come into effect during life (called “Living” or “inter vivos”) or at death (“Testamentary” or “causa mortis.”)
A Living Trust is created through a trust agreement executed while the grantor is living. The Living Trust is revocable if it contains provisions that allow the grantor to change the terms of the Trust at will during the grantor’s lifetime. This is distinguished from an “irrevocable” Trust which cannot generally be amended by the grantor. Much like a Last Will and Testament, a Living Trust usually specifies the distribution of certain property at the time of a beneficiary’s death. In such cases, the property contained in the Trust can avoid probate. It is common that a Trust will not contain all of a grantor's property. For example, people often choose not to include personal vehicles in the Trust because it may be difficult to get insurance on the vehicle if it is placed in Trust. When a grantor dies, something needs to happen with the property that is not already in the Trust. For this reason, a Living Trust is often accompanied by a Pour-over Will, which will transfer into the Trust, most of the property not held in Trust at the time of the grantor's death. Although probate in Illinois (and most other states) cannot always be avoided, and in many cases is no more inconvenient than a post-death administration of the terms of a Trust, many situations exist where a Trust can avoid a burdensome probate administration. Additionally, because a Trust is a private document, it is not subject to public display in the way that a Will might be publicly disclosed. Even when the creator of a Trust is no longer able or willing to act as trustee, the assets in a Trust remain the property of the Trust and remain for the benefit of the beneficiary (or beneficiaries) of the trust. A pre-determined successor trustee then takes over the administration of the Trust on behalf of the now incapacitated beneficiary without court intervention or supervision.
A Testamentary Trust, arises upon the death of the testator of a Will, when the Will specifies that a Testamentary Trust be created. One of the most common examples of a Testamentary Trust is called a Spendthrift Trust which is set up to handle property on behalf of a minor beneficiary (often a child or grandchild of the testator).
W #4 - “Why” do People Choose to Use Trusts?
When an individual dies without a valid estate plan, the applicable state’s default rules (called “intestacy” statutes) apply. These default rules often don't align with the wishes of an individual, which is one of many reasons why individuals rely upon their own estate plan rather than to simply allow for the application of the state’s default intestacy laws. (For a more detailed discussion, See Wills 101: The 5 “W”s - Who, What, Where When, and Why).
There are a number of reasons why someone would want a Trust. In the event that a person without a Trust is adjudged to be incompetent, that person’s loved ones must go to the probate court to establish a guardian of the estate of the incapacitated person. This is a costly procedure and requires strict court intervention, budgeting and accounting on a regular basis. Probate is not generally considered a preferred process and many people wish to avoid the time, expense, and complexities of stress associated with the probate process. Additionally, upon death, the contents of a Will are generally become available as part of public record, which is avoided through the use of a Trust.
A Trust, by itself, does not automatically avoid the burden of estate taxation. The Trust tool offered by EPM is NOT INTENDED for the purpose of tax planning and/or estate tax avoidance, and is not suitable for that purpose. The tax considerations are highly complex and should never be attempted without the advice and guidance of a licensed attorney.
W #5 - “Who” can Create a Trust?
A trust can generally be created at any time by a person of legal age, of sound mind and memory, and creates the will under his or her own free will (without undue influence or coercion).
Conclusion
While most people understand that having an estate plan is important, many people fail to take action before it’s too late. In so doing, they generally bring about a result that is not in the best interests of their loves ones as compared to the result available through active estate planning. The basic information included in this article is intended to provide you with an initial primer on some of the most basic estate planning considerations.
Disclaimer - This article is provided for educational purposes only. Nothing contained herein should be considered "legal advice", and this information should not be relied upon by any reader as such. The information presented herein is not necessarily presented based upon the laws within any specific state, and such laws vary from state to state. The provision of this discussion shall not be deemed to create an attorney-client relationship between the reader and EPM and/or any other third party. This discussion was not provided as a "legal advertisement" and the readers have no duty or obligation to provide any compensation for the information provided herein. The determination of the need for legal services and the choice of a lawyer are extremely important decisions that should not be based solely upon advertisements, endorsements, or self-proclaimed expertise.