The Trust was developed more than a thousand years ago by the English nobility to ensure that their property passed the way they wanted without interference by the government. For that reason, the Trust has always been associated with the rich. Even today, many people believe that the Trust is a planning technique used only by the very wealthy. Others believe that establishing and managing a Trust is costly and beyond their means, requiring a team of attorneys, accountants and trust officers to administer the trust. These perceptions are wrong. The Trust is a planning tool that can benefit anyone who owns a home or has a few bank accounts or investments. While establishing a Trust will add to the cost of establishing an estate plan, the additional expense is a very cost effective investment. The legal fee for setting up a Trust is a fraction of the cost of probating a Will or commencing Guardianship proceedings in Probate Court. The savings are not just monetary. All Probate Court proceedings take place in open court. They are commenced by a notice in the local newspaper. Children may argue over who should be appointed as legal Guardian of a parent. Family members who are not happy with the terms of the Will can easily hold up probate for months, while the assets in the estate are frozen. Probate records contain detailed information about family members and the estate assets and are available to anyone who asks for them. In contrast, the administration of a Trust does not invade your family’s privacy. The Trust can be a private family agreement, with the terms of the Trust and information about the trust assets known only to those individuals involved with the Trust. It is not necessary to hire experts to administer your Trust. You, your spouse, and your children can act as Trustees. If your children are not old enough to be named as Trustees, a parent, sibling or close friend can act as Trustee. It is not necessary to obtain the approval of a Probate Court Judge to start the administration of the Trust, so there is no outside interference with the management of your affairs. With a Trust, the family is spared not only the expense, frustrations and the delays of probate, but also the invasion of the family’s privacy. Following is a comparison of Wills versus Trusts:
Wills Versus Trusts
- A TRUST AVOIDS PROBATE
With a Trust, your assets can be distributed directly to your beneficiaries after your death without time delays and without the need to obtain the approval of a Probate Court Judge or anyone else. Your Trust takes effect on the day that you sign it; it does not have to be “allowed” by a Probate Court Judge after your death. The person named to take over as Trustee after your death can immediately take over the management of the trust assets, paying your final bills and funeral expenses, and then distributing the remaining funds as directed by you in the Trust Agreement. There will be significant savings of attorney’s fees and your family’s privacy will be protected. In contrast, a Will must be allowed by a Probate Court Judge before it takes effect. In Massachusetts, this takes at least three months. In the meantime, the estate assets are frozen and bills cannot be paid. Even after the Will is allowed, the Executor must obtain the Court’s permission to sell real estate, to make distributions to the beneficiaries, and for other routine tasks. The Executor must provide detailed information to the Probate Court, including the names and addresses of your beneficiaries, the value of every asset included in your estate, and the exact amount distributed to each beneficiary. All of this information is public and available to anyone who asks for it. The Executor must hire an attorney to get the Will allowed and must pay the attorney for multiple court appearances and for the preparation of the documents and accounts required by the Probate Court.
- TRUSTS CAN REDUCE OR ELIMINATE ESTATE TAXES
With two properly drafted and funded Trusts, a married couple can pass on $2,000,000 free of Massachusetts estate taxes and $10,000,000 free of federal estate taxes to their children and other beneficiaries. With simple Wills, the couple can shelter only $1,000,000 from Massachusetts estate taxes. Under recent federal laws, there are new “portability provisions” that enable a couple to shelter up to $10,000,000 from federal estate taxes without funding two Trusts, but these provisions are new and apply only to 2011 and 2012. Because federal estate tax laws change so frequently, the more conservative course of action is to have each spouse establish a Trust and fund the two Trusts, more or less equally, with the couple’s combined assets. This planning is required if the couple wants to make full use of the Massachusetts estate tax exemption, to shelter up to $2,000,000 from Massachusetts estate taxes. For a couple with an estate worth $2,000,000, the use of Trusts can eliminate Massachusetts estate taxes. With simple Wills or one Trust holding the couple’s combined assets, the couple’s children will have to pay the Commonwealth of Massachusetts $100,000 in estate taxes before distributions can be made from the estate of the surviving spouse.
- A TRUST ELIMINATES THE NEED FOR GUARDIANSHIP
A properly drafted Trust includes instructions about the administration of the Trust in the event of your incapacity. If you become disabled or are unable to manage your assets, the person named by you as successor Trustee (your spouse, child, or close friend) can immediately take over the management of the trust assets for your benefit, following your instructions in the Trust. This can be accomplished privately, without the need to obtain the permission of a Probate Court Judge or anyone else and without the need to retain an attorney for Guardianship proceedings. A Will cannot accomplish this because the Will takes effect only after your death. Without a Trust, your family may have to commence Guardianship proceedings in the Probate Court if you become incapacitated. Like the allowance of a Will, Guardianship proceedings are public proceedings, started by paperwork filed in the Probate Court and a notice in the local newspaper. After your Guardian is appointed, he or she must file yearly accountings, with detailed information about your assets, income, and expenses. Each bill paid by your Guardian must be listed on a yearly account. Your Guardian must obtain the Court’s permission to sell real estate and undertake other routine tasks. An attorney must be retained to represent the Guardian throughout the Guardianship proceedings. Guardianship proceedings are costly, can go on for many years and truly violate your family’s privacy. Your Guardian and your family doctor must disclose detailed information about your medical status, declaring you to be “mentally ill”, as well as providing information about your finances and expenses.
- A TRUST ALLOWS YOU TO RESTRICT HOW YOUR ESTATE IS MANAGED AND SPENT AFTER YOUR DEATH
A Trust can provide for the care, support and education of your spouse, children, grandchildren and other beneficiaries for several generations after your death. There are many reasons to continue the administration of your Trust after your death. You may want to provide for a second spouse, but ensure that your children by your first marriage will inherit a significant portion of your estate after your spouse’s death. Your children or grandchildren may be too young to manage a large inheritance or you may have a child or grandchild with special needs or problems. Some people believe that their children or grandchildren should establish themselves in a career before they inherit and others want their estate spent for the benefit of their heirs in a specific way (i.e., college expenses). Whatever your reason, the Trust is the best way to provide future benefits for family members. A Will cannot accomplish this. After your Will is allowed, your Executor is required by law to make distributions to your beneficiaries within nine months from your date of death.
- A TRUST CAN PROTECT CHILDREN FROM EARLIER MARRIAGES, WHILE PROVIDING FOR YOUR SPOUSE
You can provide for both a surviving spouse and children from a previous marriage with a Trust that stays in effect during the lifetime of your spouse, with the Trustee spending the trust funds for your spouse as directed by you in the Trust Agreement. After your spouse’s death, the Trustee will distribute the remaining funds to your children. For a larger estate, the Trust can provide for the distribution of some funds to your children, with the balance held in Trust for your spouse. When the spouse dies, the Trustee can distribute the remaining funds to your children or other beneficiaries. This cannot be accomplished with a Will. Your surviving spouse is free to make use of any distribution made to him or her under the terms of your Will (unless their share of the estate is distributed to a Trust.) The same is true of jointly owned assets or life insurance proceeds collected by your surviving spouse. Without a Trust, you cannot direct how your spouse can spend his or her inheritance or how it will be distributed after your spouse’s death. Even if you and your spouse draft Wills together, with the provisions of your spouse’s Will consistent with your wishes, your spouse can draft a new Will after your death, leaving the money inherited from you to a new spouse, his or her children by another marriage, or to a favorite charity.
- A TRUST CAN ENSURE THAT YOUR WISHES ARE CARRIED OUT AND ARE NOT SUBJECT TO PUBLIC ATTACK
The allowance of a Will begins with the issuance of a citation, which is a public invitation to contest the Will. It is extremely easy for an unhappy beneficiary to hold up the allowance of a Will for months, even without hiring an attorney or having valid grounds to contest the validity of the Will. Many Executors give in and pay a settlement to an unhappy beneficiary to avoid a lengthy, costly and public Will contest. By contrast, it is very difficult for a Trust beneficiary to overturn an established Trust. If you are concerned that a child or other beneficiary is going to be unhappy with their inheritance, it is far safer to leave your estate to your beneficiaries under the provisions of an established Trust, rather than under the terms of a Will.
A Trust is a written document that gives one or more Trustees the legal authority to manage the property transferred to the Trust. The Trust contains instructions about how the trust property should be managed and distributed to the Beneficiaries of the Trust. The “Trustee” is an individual, a bank, or trust company, to whom property is transferred for the purpose of managing the property for the benefit of one or more individuals, known as “beneficiaries.” The “Trust” usually includes the following provisions:
- The name of the “Settlor” or the “Grantor“. The Settlor is the person who establishes the trust and who usually reserves certain powers or control over the property transferred to the Trust. If the trust is revocable, the Settlor may amend or terminate the trust at any time. If the trust is irrevocable, the Settlor does not have the power to amend or terminate the trust. In most cases, the Settlor is the person who funds the trust by transferring property owned by him or her to the trust. Other individuals may add property to the trust if the terms of the trust allow this.
- The name or names of the original Trustee or Trustees (there may be more than one Trustee). The Settlor of the trust may also be a Trustee of the trust. The Trustee is responsible for managing and investing the property transferred to the trust, and for paying the expenses necessary to maintain and preserve the trust property, including the payment of any taxes due, Trustee’s fee, and legal and accounting expenses. The Trustee must also follow the instructions in the Trust regarding the distribution of the trust income and assets to the beneficiaries.
- The name of a successor Trustee or Trustees, who will take the place of the original Trustee upon the resignation or death of the original Trustee, or under other circumstances stated in the trust.
- The names of the original beneficiaries. The trust property is managed and invested for the benefit of the beneficiary or beneficiaries. The terms of the trust direct when and if distributions of trust income and trust principal should be made to the beneficiaries. The Settlor of the trust may name himself or herself as a beneficiary of the trust.
- The names of contingent or future beneficiaries, who will become the beneficiaries of the Trust upon the occurrence of a certain event or condition, such as the death of the original beneficiary.
- Instructions regarding the investment, management, and sale of any property (cash, stock, bonds, mutual funds, real estate, or any other asset other type of investment) transferred to the Trustees.
- Instructions regarding the distribution of trust income and principal to the beneficiaries. Trust principal is the property (cash, stock, bonds, mutual funds, real estate, or any other asset) that is originally transferred to the Trustee, property that is purchased by the Trustee with the funds originally transferred to the Trustee or property that is purchased by the Trustee with funds produced by the sale of other principal assets held in the Trust. Trust income is interest and dividend income, and in some cases, capital gains distributions, produced by the principal assets held in the trust. The instructions regarding the distribution of trust income and principal can be extremely detailed, or can give the Trustee wide discretion to determine how the trust income and principal should be managed and distributed.
Different Types of Trusts
The Living Trust. The most popular and versatile version of the Trust is the Living (Revocable) Trust. In simple terms, the Living Trust is a private family agreement that provides for the management of the family’s property. The person who establishes the Trust, referred to as the “Settlor“, may manage the Trust property, naming himself or herself as the original Trustee. The Trust may also be managed by other family members or by a professional Trustee. It is up to the Settlor to decide who will serve as original and successor Trustees. The Settlor also gives the Trustee instructions to cover all of the expected events that may occur during his or her lifetime and the lifetime of the future trust beneficiaries. The Living Trust is revocable. This means that the Settlor of the Trust may change the instructions contained in the Trust Agreement, as the family situation changes. The Settlor may also remove a Trustee and appoint a new Trustee. The Living Trust is more than a substitute for a Will. A Will takes effect only after the death of its maker, after it is “allowed” by a Probate Court Judge. The Living Trust takes effect on the day that it is signed. The most important feature of the Living Trust is that it has the ability to take care of its maker, known as the “Settlor“, during his or her lifetime. If the Settlor becomes incapacitated, the original Trustee (or Successor Trustee) of the Living Trust can care for the Settlor, without having to commence Guardianship proceedings in the Probate Court. After the Settlor’s death, the Trust does not have to terminate. The Trust can continue for the benefit of several generations of family members, managed by the persons chosen by the Settlor to serve as successor Trustees. After the Settlor’s death, the Living Trust becomes irrevocable. This means that the successor Trustees and the future beneficiaries cannot change or set aside the Settlor’s instructions. Because it is extremely difficult to contest an established Trust, the Settlor of the Trust can have peace of mind that his or her wishes and instructions contained in the Trust Agreement will be honored after his or her death.
Trusts to Minimize Estate Taxes. Trusts are a critical component of an estate plan that is designed to minimize liability for estate taxes. A married couple can eliminate, or significantly reduce, Massachusetts and federal estate taxes by establishing and funding two Living Trusts. With this type of estate plan, a husband and wife each establish a Living Trust with additional provisions that allow both of them to make full use of the Massachusetts and federal estate tax exemptions. Their Trusts are administered as standard Living Trusts during their lifetime. When the first spouse dies, the assets held in his or her Trust are divided into two subtrusts, known as a “Marital Q-TIP Trust” and a “Family Trust“. These subtrusts are created by the terms of the Trust Agreement. The two subtrusts are funded with the trust property in a way that takes advantage of the federal and State estate tax exemptions available to the deceased spouse’s estate. A married couple with a smaller estate ($2,000,000 or less) can eliminate liability for both federal and Massachusetts estate taxes. For a larger estate, federal and Massachusetts estate taxes can be decreased substantially. The end result in both situations is the distribution of more assets to the couple’s children and other beneficiaries and less to the IRS and the Massachusetts Department of Revenue. A single person can also minimize liability for estate taxes by establishing a Trust and making tax-exempt gifts to the Trust each year. Under current laws, an individual can make yearly tax-exempt gifts of $13,000 to any number of individuals. An individual with five children can gift $65,000 each year to a Trust established for the benefit of his or her children. If the Trust is drafted properly, the yearly gift of $65,000 to the Trust is deemed to be five tax-exempt gifts of $13,000 to each of the trust beneficiaries. There is no need to file a Gift Tax Return and no gift taxes will be due from the parent or the children. With this type of Trust, the parent is able to shift $65,000 each year from his or her taxable estate to the five children without any tax liability. Making gifts to this Trust is advisable when the parent’s estate exceeds $1,000,000 (the current Massachusetts estate tax exemption). If the parent in this example has an estate valued at $1,300,000, he or she can reduce his or her taxable estate to $1,000,000 in five years by making five yearly gifts of $65,000 to the Trust established for the benefit of the five children. No gift taxes will be due from the parent or the children and liability for Massachusetts estate taxes will be eliminated. If the parent does not make any gifts and dies with an estate of $1,300,000, the Massachusetts estate tax that his or her children must pay will be $51,600.
Irrevocable Income Trust is an irrevocable Trust that is established for the primary purpose of protecting an older parent’s assets from being eroded by nursing home costs. In this part of the country, nursing home care averages about $335 per day or about $122,000 a year. With advance planning, an older individual can prevent nursing home costs from totally eroding their life savings. This Trust is appropriate when a parent has sufficient income (including investment income) to pay for his or her living expenses. The Trust is funded by the parent, who gifts his or her life savings and investments to the Trust. As long as the amount transferred to the trust does not exceed $5,000,000, no gift taxes will be due from the parent or the trust beneficiaries. The parent usually names his or her children and/or grandchildren as the beneficiaries of the Trust. The parent can be a Trustee of the Trust, although at least one child should serve as a Co-Trustee of the Trust. If the parent is not able to manage their finances, one or more children should be named as the original Trustee. The funds gifted to the Trust by the parent are invested and the parent is entitled to the distribution of the income generated by these investments. The net income can be paid monthly, quarterly, or annually, whichever is most convenient for the person paying the parent’s bills. The Trust will name at least one beneficiary who will be entitled to the distributions of trust principal (the trust investments) during the parent’s lifetime. This provision ensures that the trust principal will be available to pay for the parent’s care if the parent’s income (including the investment income from the Trust) is not sufficient to pay for the parent’s living expenses. If the parent needs funds in addition to their income, trust principal can be distributed to one or more of the trust beneficiaries, who will use the funds to pay the parent’s expenses or purchase something that the parent needs. If the parent is admitted to a nursing home in the future, the trust investments are not deemed to be available assets to pay for the parent’s nursing home care, as long as five years have passed after the funds have been gifted to the Trust. In this way, the parent’s life savings are protected. After the parent’s death, the trust principal and any undistributed net income will be distributed in a manner consistent with the parent’s instructions contained in the Trust Agreement. Obviously, advance planning is required to protect the funds transferred to this type of Trust. If five years has not passed after the parent has gifted the funds to the Trust, some or all of the funds must be used to pay for the parent’s nursing home care. However, the Trust can be structured so that the trust funds will be available to pay for the parent’s care if five years has not passed since funds were gifted to the Trust. Because there is only one governmental program that pays for long term nursing home care (the Medicaid program) and this program does not pay benefits until a nursing home resident has reduced his or her assets to $2,000, it is usually worth the expense and effort of establishing this type of Trust. The Trust can also be structured to reduce, or eliminate, liability for estate taxes.
Irrevocable Life Insurance Trust (ILIT). The Irrevocable Life Insurance Trust (ILIT) is another tool for minimizing liability for estate taxes and providing funds to pay for estate taxes. The Trustee of the ILIT holds title to one or more life insurance policies. These can be new policies purchased by the Settlor of the Trust or existing policies that the Settlor transfers to the Trust after it is established. The Settlor continues to pay the premiums for the insurance policies by making tax-exempt gifts to the Trust when the premiums are due. The Settlor usually names his or her spouse, children and/or grandchildren as the beneficiaries of the Trust. After the Settlor’s death, the Trustee collects the life insurance proceeds and pays the estate taxes due from the Settlor’s estate. Because the Trust owns the life insurance policies, the death benefits are not included in the Settlor’s taxable estate. Any funds left after estate taxes are paid can be distributed to the beneficiaries named by the Settlor. It is sometimes appropriate for the Trust to continue after the Settlor’s death. If the Settlor’s spouse has a substantial estate, the Trust can continue to be administered for the benefit of the spouse and children. If the Trust is drafted properly, the funds remaining in the Trust after the spouse’s death will not be included in the spouse’s taxable estate. If the beneficiaries are younger, the Trust can continue to be administered for their benefit until they reach the age designated by the Settlor, at which time they will receive an outright distribution of their share of the trust property. This ILIT is appropriate for individuals with life insurance policies that will pay out significant death benefits. Removing the death benefits from the individual’s taxable estate can reduce or eliminate liability for estate taxes. The Trust is also appropriate for an individual who owns a business, a farm, or commercial properties that the family would like to continue to operate for one or more generations. The life insurance policies held in the ILIT will pay the estate taxes due after the death of the owner of the family business, the farm, or the commercial properties. The children will not be forced to borrow money, or even worse, sell the business, the farm, or the commercial properties to pay the estate taxes that are due.
Special Needs Trust
The Special Needs Trust, which is also referred to as a Supplemental Needs Trust, is a Trust established by a parent or sibling for the benefit of a child or sibling with special needs or medical problems. This type of trust is appropriate when the child or sibling is receiving governmental benefits based on financial need. These benefits include SSI, Medicaid, food stamps, and benefits for housing. If the parent gives money outright to the child, the child will no longer meet the financial requirements of the programs and will lose all of their benefits. To deal with this problem, the federal government created the Supplemental Needs Trust. If the Trust meets the federal guidelines, a parent or sibling may make unlimited gifts or leave a child’s inheritance to the Supplemental Needs Trust established for the child’s benefit without disqualifying the child from receiving these benefits. The Trust must be irrevocable and the Trustee must be directed to make expenditures of the trust funds to supplement the governmental benefits for which the child is eligible. When the child dies, the Trustee must repay any lien imposed by the federal of State agency that granted the child’s benefits. At the current time, the only program that imposes a lien is the Medicaid program, which is administered in Massachusetts as the MassHealth program. In many cases, leaving a child’s inheritance to a Supplemental Needs Trust is also necessary because the child is not able to manage their own finances.
Conclusion. Attorney Roberta A. Schreiber has more than thirty years of experience in Estate Planning, assisting clients in choosing, drafting, and administering the Trust or Trusts that are appropriate for their situation. If you need assistance in establishing or administering a Trust, please contact usfor legal representation.