Tuesday, October 23, 2012

How a Trust Works

Over the past few posts, we have done our best to give you an idea of what a Living Trust can do and how such a Trust can be advantageous to a wide variety of people. For many of our clients, having this information is all they need to make the decision to move forward with the Estate Planning process. However for other clients, learning that a Trust can provide these advantages leads them to the inevitable question of how does a Trust make these things happen.
Trusts have been in use for hundreds of years and the law that controls their use is substantial and complex. In Michigan, where we practice, the Michigan Trust Code (part of the Estates and Protected Individuals Code (EPIC)) governs the use of Trusts. Each state has their own law governing Trusts and it is important to consult an attorney who is familiar with that law before engaging in any planning. Today however, we will discuss the broad concepts that allow a Trust to provide benefits to those who include one in their Estate Plan.
Owning Assets
The law allows for the creation of a number of different types of Entities, including Trusts, Corporations, and Companies that have rights and privileges similar to those of Individuals. One of these rights is the ownership of property. Business Entities use this ownership option to spread the cost, liability, and profits of their ventures amongst investors. A properly drafted Living Trust uses this ownership option to create an Entity that owns the property for purposes of control and transfer while subjecting the property to be taxed as if an Individual owned it. This dual natured ownership creates one of the largest advantages of including a Trust in an estate plan, the ability to avoid probate.
Avoiding Probate
Assets owned by a Trust avoid the probate process because the only assets regulated by Probate Courts are those owned by Individuals when they die. Since a Trust is not an Individual and cannot die, it is not subject to the probate process.
The concept that the Trust Grantor may use all of the Trust assets as they see fit during their lifetime yet not be treated as the owner of the assets at death is often one that confuses clients. It is helpful to think of the Living Trust as a bucket containing the Grantor’s assets that the Grantor/Initial Trustee carries around during lifetime. The trust-bucket contains a list of instructions that says that the Grantor/Initial Trustee may use the assets contained in the bucket as he or she sees fit. When the Grantor/Initial Trustee passes away, the Successor Trustee picks up the trust-bucket and uses the assets according to the Grantor’s instructions.
An additional benefit of avoiding the probate process, besides the time and cost involved, is the ability of the Trustee, and not court, to control distributions to Beneficiaries who may be unprepared to handle an influx of assets. While the probate courts can provide a measure of protection for minor children, that protection ends at age 18. For adult beneficiaries in need of additional assistance due to addiction, disability, or other difficult circumstance, the probate courts only have the extreme option of imposing a guardianship or conservatorship if circumstances warrant it.
Enforcing the Grantors Wishes after Death
Legally, the Trust is a contractual arrangement between the Grantor and the Trustee. Upon the death of the Grantor/Initial Trustee, the contract provides the Successor Trustee with the authority to take actions on behalf of the Trust needed to comply with the Grantor’s instructions. This authority is not limitless and the Successor Trustee owes a fiduciary duty to the Beneficiaries (those people who the Trust says will receive the Trust assets).
A fiduciary duty requires the Trustee to act solely for the benefit of the Beneficiaries in taking actions in relation to the Trust and avoid any conflict of interest between the Trustee and the Beneficiaries. A fiduciary duty is the strictest duty of care recognized by the legal system and a Trustee who breaches this duty is subject to removal and a civil lawsuit. A Beneficiary who proves that a Trustee has violated their fiduciary duty may recover profits made by the Trustee, even if the Beneficiary has not suffered any actual harm.
Additionally it is illegal for a Trustee to conceal the existence of a Trust from a Beneficiary of that Trust. While the terms of the Trust may limit the amount of information the Trustee must provide to a Beneficiary, certain information must be provided to a Beneficiary and a court may always order a Trustee to provide information to the Beneficiary or to the court. This requirement ensures that a Beneficiary has the information required to protect their interest in the Trust assets.
The complexity of trust law in the wide variety of trusts in existence make it understandable that an individual would not want to blindly accept that a Trust is able to provide them and their loved ones with all of the promised benefits. As attorneys, we strive to provide our clients with all the information they need to be understand how the documents we draft for them are able to protect them and their loved ones. If you have specific questions regarding how part of a Trust works, please leave us a comment or e-mail us and we will be happy to address that in later posts.

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