Trusts are a topic that seem to be often discussed but seldom understood among the general public. This is not an indictment of a misinformed public, but a commentary on the wealth of information and various channels through which it flows. Your Google search results, your local banker or even a co-worker may claim to have all the insight on how to plan your estate and “get your affairs in order.”
Clients often tell me they “need a living trust.” When I ask why they need one, they are unsure how to answer. I do not ask the question to interrogate their understanding of their own legal needs as I, of course, seek to help all my clients, but a good estate planner should always start with assessing a client’s goals before implementing an estate plan. While everyone needs an estate plan, there is not a “one size fits all” approach to estate planning. A client’s interest in a “living trust” gives an attorney little to go on as far as providing competent estate planning the client deserves.
So, what is a trust? For one, it is a very broad concept. It is as broad as saying “a corporation,” which gives no indication as to the businesses operations and its mission statement. A trust is a legal fiction if you will, a placeholder to own property for a wide variety of purposes. On the esoteric side, it is an agreement to split the legal and equitable title to property. A trust involves three parties, to wit: the “Grantor or Settlor” who establishes and funds the trust; the Trustee or Co-Trustees who agree to hold and are given legal title to trust property; and one or more beneficiaries who are given equitable title to trust property. In simpler terms, the trustee holds property based on the Settlors terms and conditions for the benefit of a beneficiary or beneficiaries.
What is a “living” trust, you ask? Is it alive? Well, sort of, but you must be alive when yours is created. A living trust is simply a trust created during the life of the Settlor of the trust, as opposed to a trust created after death through a Will which is known as a testamentary trust. With such a broad definition, knowing you “need a living trust” leaves many open-ended questions.
There are many types of living trusts which can achieve a variety of different goals from tax planning, to probate avoidance, to asset protection. The broadest subset of, and possibly the most important way to categorize, living trusts is into that of revocable and irrevocable living trusts.
A revocable trust is one in which the Settlor retains an unfettered right to revoke the trust. Because of this distinct trait, a revocable living trust acts as an alter ego of the Settlor and is typically identified by the Settlor’s social security number for tax purposes. Accordingly, a revocable living trust generally offers no asset protection benefits during the Settlor’s lifetime. The most prominent benefit of a revocable living trust is the avoidance of probate for any assets actually transferred to the trust. A revocable living trust has many other benefits such as avoidance of public record, potential asset protection for your beneficiaries upon your death by the use of spend thrift or special needs provisions (note: a revocable trust almost always becomes irrevocable upon the death of the Settlor), ease of distribution for beneficiaries and greater long-term control over your legacy.
An irrevocable living trust is one in which cannot be revoked at the whim of the Settlor. An irrevocable living trust is commonly used in Medicaid planning and can aid in protecting the Settlor’s assets. Even though the Settlor cannot revoke the trust altogether, an astute estate planner can include mechanisms which allow the Settlor to retain significant control over the ultimate disposition of the trust assets and income. While typically irrevocable trusts are a separate tax entity from the Settlor and pay income taxes at the trust tax rate, certain language from the Internal Revenue Code can be included to create an irrevocable “grantor” trust, where all tax liability is allocated back to the Settlor’s personal tax returns and, therefore, taxed at the individual income tax rate.
While clients are sometimes frightened by stark words like “irrevocable” or are told to avoid irrevocable trust by financial planners, carefully designed irrevocable trusts can allow clients to have the best of both worlds of asset protection and control over the protected assets.
Contact one of our estate planning attorneys to learn more about the benefits and flexibility of an irrevocable grantor trust.