From the perspective of estate planning, what is a trust? We will answer that question by exploring these trust concepts: the purpose of a trust, the grantor, funding a trust, the beneficiary of a trust, the beneficiary’s beneficial interest, and the trustee.
Purposes of a Trust
We’ll start with the purposes of a trust.
A trust can accomplish many purposes. A primary goal of most people who form trusts is to enable a smooth transition of their property to their loved ones when they die. With a trust, probate can be avoided entirely – which means no court proceedings with their related delays and expenses. While probate proceedings are public, trusts are private. With a trust, you can appoint someone you know and trust to manage your affairs if you become incapacitated. Without a trust, someone may have to file a guardianship proceeding to help you if you become incapacitated. With a trust, you determine who receives – or doesn’t receive — what property, and in what proportions when you’re gone. A Grantor can also use a trust to promote family goals and values, for example by encouraging certain behaviors or through charitable distributions.
Carefully constructed trusts can provide immense tax savings. They can be arranged to reduce income tax, estate tax, gift tax, and Generation Skipping Transfer taxes. A trust also can protect assets from creditors, predators, and potential divorcing spouses, and from the indiscretion or youthful whims of the beneficiaries themselves. Above all, a solid trust-centered estate plan can give you peace of mind that your affairs are arranged well in case something happens to you.
The Grantor
The Grantor creates the trust and funds it by transferring property into it.
Other terms for Grantor are Trustor and Settlor. The trust is revocable if the grantor can entirely change the trust. The Trust is irrevocable if the Grantor cannot change it. The Grantor determines how the trust works, and the Grantor’s intent should control the administration of the trust.
Funding a Trust
Think of funding as the process by which a Grantor pours assets into a trust.
The Grantor funds the trust by transferring property into it. A Grantor may place any type of property into a trust – cash accounts, stock, real estate, intellectual property. A Grantor funds an inter vivos trust while the Grantor is alive. A Grantor funds a Testamentary Trust through a will when the Grantor dies.
Beware of the empty trust! If you never transfer property into your trust, it is empty or unfunded. Because a trust controls only property that has been transferred into the trust, an empty trust is all but useless. I’ve met many clients who have had trusts for years but never funded them. Happily, we caught the problem and corrected it before they experienced death or incapacity.
Beneficiary of a Trust
The beneficiary benefits from the property in the trust and income on that property.
A beneficiary is a person or charity named in a trust to receive some sort of property through the trust. A trust may have one or many beneficiaries. Anyone can be a beneficiary. Beneficiaries do not have to be related to the grantor, although they often are. Organizations including charities may be beneficiaries as well. Beneficiaries do not have to exist when the trust is created. For example, a donor can leave property to “my children” or “my grandchildren,” including children and grandchildren not yet born.
Life Tenants receive property during their lifetime, while remaindermen receive property in the future. For example, a trust may distribute property to the grantor’s children during their lifetime, and to the grantor’s grandchildren after the children die. This means that some gifts are contingent, or depend upon other events. For example, if all property in the trust is distributed to the children before they die, then the grandchildren may not receive anything – despite the fact that they are named as beneficiaries in the trust.
Beneficial Interest
What’s in the box? What does the trust give the beneficiary? Different beneficiaries have different beneficial interests.
A beneficial interest is a beneficiary’s right to benefit from trust assets. People with a beneficial interest do not own title to property in the trust but have some right to benefit from the property. If an interest is mandatory, then distributions must be made to the beneficiary. If it is discretionary, then distributions may be made, perhaps based on some guidelines. Beneficial interests often distinguish between rights to principal and interest. Principal indicates the property that funded the trust. Income indicates the interest or income earned on the principal. Trusts often distinguish between beneficiaries’ rights to distributions of principal and income.
The Trustee
The trustee holds the key to the trust and is in the drivers seat.
The trustee administers the trust for the beneficiaries. An adult or a corporation can serve as trustee. A trust can have one or many trustees, although administration tends to be easier when there is only one. The trustee has the ability to control and distribute assets in the trust according to the terms of the trust. The trustee’s duties include implementing the terms of the trust, protecting trust property, investing trust property, keeping records and preparing accountings, and filing tax returns. The trustee must be careful about taxes: a trustee who distributes trust assets before paying taxes will be personally liable for those taxes.
A trustee should be selected very carefully, given that the trustee will have control over property in the trust. A good trustee will be honest, competent, understanding, and prudent. Being a trustee is also a great responsibility. The trustee will be upheld to the standards of how a prudent person should behave. The Prudent Man Rule demands that a trustee behave as a reasonable prudent person managing his own affairs. The Prudent Investor Rule demands that a trustee invest for the benefit of income beneficiaries and principal beneficiaries.
The same person can be grantor, beneficiary, and trustee. This is often the case with revocable living trusts while the grantors are alive and well.