Irrevocable vs Revocable Trusts, What's the Difference

As we previously discussed, there are different kinds of Trusts that serve different client needs. It is common to have a Living Trust as part of an estate plan because such trusts give the Grantors versatility to adapt their planning as life circumstances change to protect family members and avoid probate. There are other forms of Trusts that provide less flexibility to the Grantor, but they are useful in the right circumstances. Every Living Trust executed as part of an estate plan is revocable (changeable) during lifetime, but at the death of the Grantor becomes an Irrevocable Trust (unchangeable) administered by the Successor Trustee pursuant to the terms set by the Grantor during lifetime. 

This transition from Living to Irrevocable Trust at the death of a Grantor is the most common instance of irrevocable trusts in an estate plan. Generally the terms of the Living Trust provide that at the death of the Grantor no changes may be made to the terms of the trust, and that the successor Trustees have a duty to administer the Trust as a separate legal entity. This duty requires the successor Trustees to apply for a Tax ID number from the IRS, inform the institutions that hold the trust’s assets of the change in status, and provide the Beneficiaries of the trust with sufficient information to allow them to enforce their rights under the trust. The Trustees are charged with following the Grantor’s instructions with respect to administering and distributing assets to trust beneficiaries until the assets of the trust are exhausted or distributed outright to a beneficiary. 

While the “Irrevocable Living Trust” is the most common instance of an irrevocable trust in an estate plan, other forms of irrevocable trusts are available depending upon the need of the client. While clients like the Living Trust because it is changeable, they can control it during lifetime, and they can receive the benefits of the assets in the Living Trust, those benefits can be detrimental in certain tax and printer liability circumstances. Irrevocable trusts are beneficial as part of an estate plan because an irrevocable trust, if properly drafted, is a separate legal entity from the person who created it and therefore is treated differently in a number of respects. If properly drafted, irrevocable trust assets and income are not considered as owned by the Grantor, therefore taxable income is not included in the Grantor’s income nor can creditors up of the Grantor generally reach irrevocable trust assets. The drawbacks of an irrevocable trust generally require that the Grantor cannot be a beneficiary or trustee of an irrevocable trust, prevents the Grantor from changing the terms of the trust and prevents the Grantor from enjoying the benefits of the assets. In addition, income earn by a trust is taxed at a higher rate than that earned by an individual if income is not distributed to beneficiaries.

Even with these downsides, creating an irrevocable trust can address a variety of complex planning circumstances. The Irrevocable Trust can be used to own insurance policies provide cash to pay estate tax on the death of the Grantor, or be used to provide proceeds used to fund a business buyout, while not being includable in the Grantor’s estate. An Irrevocable Trust can also be used to hold funds to care for the needs of children with disabilities and not be subject to the requirement of state agencies that such funds be used in lieu of state funds instead of in addition to any straight funds. A recent change in Michigan law also allows the creation of an irrevocable trust that allows the Grantor to have substantial use of trust assets while shielding those assets from creditors in the event of a lawsuit. These techniques tend to involve individuals with more complex planning situations and significant assets, but can assist in addressing concerns about careers with higher than average liability or to address concerns regarding assets and second marriages. Other sophisticated estate planning strategies also use different types of Irrevocable Trust, but a discussion of these is beyond the scope of this blog.

Care should be taken when considering irrevocable trust strategies because, as with all good planning ideas, some may be taken to a ridiculous and untenable level. While properly executed and administered irrevocable trusts comply with legal provisions, the IRS is always looking for situations where trust are not properly drafted or administered, opening up the client to taxes and penalties Always consult with an attorney experienced in estate planning before signing any documents.

Matt and Al

Estate Planning for a Second Marriage

     Recently a colleague asked for information about the use of trusts in estate planning following a divorce and remarriage. Since we have not addressed this topic yet, a post on the subject seemed appropriate. It is important for client to consider estate planning issues following a divorce and remarriage to avoid inadvertently disinheriting either the new spouse or children of the first marriage. Clients (husband and wife) in their first marriage usually have common goals, such as providing for the surviving spouse during their lifetime and leaving any remaining assets to their children equally. This makes estate planning relatively simple, because a living trust holds the assets to limit tax liability, avoid probate, and ensure the assets pass to the surviving spouse for use during the spouse's lifetime and then on to the couple's children.

     Clients in second marriages, whether because of divorce or death, usually have a more complex situation with which to deal. In those circumstances there are concerns regarding the surviving spouse, children from the first marriage, the surviving spouse's children, and possibly children from the second marriage. Clients wish to ensure the surviving spouse has sufficient assets during lifetime, while also ensuring that the assets they brought into the marriage eventually pass to their children.

     A frequent concern of clients in their second marriage is ensuring that both their second spouse and their children receive gifts following the client's death. A common technique used to achieve this goal provides the surviving spouse with a regular stream of income from the trust assets, while reserving distributions of principal for the client’s children following the death of the surviving spouse. When using this technique, it is also common to provide the trustee with the discretion to make distributions of principal to the surviving spouse, under a limited set of circumstances, to ensure that the surviving spouse has sufficient assets to live on following the first spouse's death. It is important in these circumstances that the trustee understand that part of their responsibility is to balance the best interests of both the spouse and children from the first marriage in making distributions. It is a good idea for the client to discuss these issues with the named trustee.

     Alternatively, some clients opt to address this issue by distributing different assets to their surviving spouse and their children. For example, a trust might provide that the client’s children receive immediate distributions from the trust assets equal to the payout from a life insurance policy. The client may also provide that the children are beneficiaries of the client’s IRA or other retirement accounts. The trust then provides that the client's surviving spouse receive all income from the remaining trust assets, and gives the trustee broad discretion to make distributions of principal for the surviving spouse's needs. Any trust assets that remain following the death of the second spouse are distributed to the client’s children. This technique ensures that that the client’s children receive an immediate gift as well as the potential for additional assets should any remain after ensuring that the surviving spouse has sufficient assets during the their lifetime.

     A well-drafted trust is required to make use of these techniques because you need an entity maintain the trust assets instead of passing those assets directly to the surviving spouse. During a first marriage, a common technique for probate avoidance is to own property jointly with rights of survivorship. This allows the surviving spouse to remain the sole owner of the property following the first spouse's death without the property passing through probate. If this same technique is used following a second marriage, the surviving spouse becomes the sole owner of the property or bank account and then is free to do with that property whatever he or she chooses. This means that property the client intended for children to inherit following the second spouse's death could pass directly to the second spouse's children or family and completely disinherit the client's children from the first marriage.

     There is not always controversy about who inherits which assets. In many second marriages, spouses and their children from first marriages live in perfect harmony. Even in these circumstances, the spouses may wish to ensure that particular assets, such as vacation homes or collectibles, that each has brought into their second marriage are eventually inherited by their own children. With proper planning, it is possible to maintain these separate assets for both spouses’ use while ensuring that after the second death the assets will go to each spouse’s children, while assets earned jointly during the marriage are split equally amongst all the children.

     It is clear that the circumstances that exist when contemplating estate planning for a second marriage involve a level of complexity that generally does not exist when planning during a first marriage. These circumstances can become even more complex if either spouse’s children has special needs, dependency issues, creditor problems, or if there are significant personal conflicts between children and second spouses.  You may actually have a case where the new spouse has his or her own issues, which need to be addressed. An example of this occurs if the new spouse has an unpaid federal income tax liability and the spouse transfers a residence originally owned individually to the other spouse as joint tenants. Now the IRS can attach a lien to the residence. It is important to speak with an experienced attorney to ensure that the estate plan meets the goals of both spouses and is implemented with a minimum of conflict.

Insurance as Part of an Estate Plan

When clients are in their early career years, working hard to establish themselves and starting a family, not enough time and effort is placed on setting assets aside to protect the family for the future. The thought process usually is that with hard work, we will be able to save sufficient assets for putting our children through school and providing a nice nest egg for our retirement years. However, what happens if plans go awry and the client dies unexpectedly? The family loses someone who was previously contributing to the payment of day-to-day living expenses. This can have a significant adverse effect on the lifestyle or future plans of the surviving spouse and children. This is the perfect time to consider the need for life insurance to provide that protection.

Life insurance can provide protection for a spouse and children in the event a client dies prematurely. A life insurance policy can provide funds to pay family living expenses and college education costs. It can replace the income stream lost when one spouse passes away unexpectedly, and allows the family to maintain a standard of living is otherwise lost because of that death. At this stage in a client's life, term life insurance is probably the most economical way of funding this family protection. The relatively low cost of term insurance at young ages makes it affordable for families on a limited budget. The policy can be designed to protect for a finite number of years, (for example 10, 15, 20 or 30), depending on the length of the term insurance contract chosen. If the client dies at a young age, funds are available so a family's lifestyle can be maintained and dreams of college for children can be met. If the client lives to middle age and beyond, he builds a significant estate to protect the client and family in retirement years. In that case, the client lets the policy lapse or terminates it because it is no longer necessary.

Sometimes clients have targets for what they would like to leave to their children at their death. Clients often use life insurance to fund the difference between actual assets and the theoretical target set by the client. For example, if a client has five children and wants to pass on $500,000 each of death, a client needs $2,500,000. If the client only has $1,500,000 in assets, the difference can be funded with a life insurance policy at a much smaller cost on an annual basis than hoping to save the difference before the client dies.

Some of my clients have used life insurance fund a bequest to a child while giving a specific asset to another child that values that asset. For example, the largest asset of a client’s estate may be a business in which only one of the children are active. The client desires to leave the business to that child, yet does not want to be unfair to any other children. By purchasing a life insurance policy of equal value to the business, the client can assure that there will be sufficient assets to provide an equal split of value between us children.

On occasion, a client has used a life insurance policy to fund a special needs trust for a particular child, leaving the remainder of assets to other children in order to make certain that none of the estate is required to be used for the special needs child in lieu of government benefits.

Clients who are fortunate enough to have assets in excess of lifetime exclusion of $5,000,000 can use life insurance to replace the amount of the estate loss to estate taxes. These amounts can be replaced on a leveraged basis using life insurance because the cost of a life insurance policy, whether a term policy or a permanent policy will never exceed the face value of the policy. The replacement of the assets using life insurance policy is funded at a fraction of the cost. In a situation such as this, where a life insurance will always be useful, it may be more appropriate to use a permanent policy and continue to pay premiums, because a term policy has a finite existence and may lapse or terminate or become too expensive at a time when it would be most needed. While many clients worry about the costs reducing their livestock, the reality generally is that the life insurance premiums will be paid from excess assets, not assets being currently used to support the client's lifestyle that the payment of premiums will come from excess assets, not assets otherwise used to support a client's lifestyle.

For many years, the funding of a retirement benefit or savings using a permanent life insurance policy has been out of favor for a number of reasons. Some commentators are now suggesting that because of the income tax changes in the most recent tax law, which raise income tax rates on investment income, and dividends for some taxpayers, using a life insurance policy as an estate builder can be valuable because of the tax-deferred buildup of the value of the policy. While this remains to be seen, at least make sense to consider this as a possible planning option.

Whether a term policy or permanent policy makes sense will depend upon the intended use for the proceeds. Whatever type of policy is purchased, it will usually make sense to purchase it sooner than later because life insurance is less expensive for younger, healthier clients, resulting in smaller premiums. Using life insurance, goals can be met even if an unexpected death or other event occurs for a family. Clients should always discuss the purchase of life insurance with an experienced life insurance professional and their estate planning attorney.

Selecting People to Administer your Estate Plan

An important part of developing an estate plan is selecting people to help administer the plan at your death or incapacity. This includes Personal Representatives to administer the Will under Michigan probate, Guardians to see to the physical well-being of your minor children, and Successor Trustees to administer the assets of the Living Trust for the benefit of your beneficiaries. Sometimes selecting people to serve in these capacities is not an easy task because there may not be family members or friends you trust enough to select for those positions. Alternately, there may also be a concern that you will offend some people by not naming them to certain positions. This should not deter you from making decisions that you think are the best ones, because, after all, you will not be around to listen to their complaints.

Guardians are obviously important because you want to select people whose child-rearing philosophies are similar to your own. That may actually be a sibling and his or her spouse, but it may actually be another relative or a close friend. Another common concern when selecting guardians is geographic location. While a family member who lives in another state may be more than capable of caring for your children is important to consider whether such a drastic move is good for your children. The thing to focus on is "what is the best for my children?"

Nearly as important as the Guardian, the Successor Trustee administers trusts, pursuant to their terms, when the initial trustee (who is usually the trust maker) becomes incapacitated or dies. Naming a successor trustee is not a decision made lightly. It is possible to name a family member, a friend or colleague, a corporate trustee, or a combination of them as trustee or co-trustees. Each of these alternatives has positive and negative aspects.

Family Member

Pro: They have family experience with the beneficiaries, are empathetic, and are personally involved.

Con: They are probably unskilled in business, there is no record of accomplishment in maintaining or growing assets, or they can become too emotionally involved.

Friends or Colleagues

Pro: They likely have a personal knowledge about the beneficiary's, and are trained professionals or have good business sense

Con: They may not have enough time to do a good job, may themselves pass away, or may have a conflict of interest when it comes to a business asset of the trust.

Professional or Corporate Trustee

Pro: Corporate trustees have the benefit of being professional, experienced, and objective, regulated and will not die.

Con: Corporate trustees are dispassionate, possibly ignorant of family dynamics, may be too conservative, and may have a high turnover of corporate trust officers.

Some clients use a team approach, considering that "two heads may be better than one,” or that they want a combination of professional and personal co-trustees. Unfortunately this tactic may only give the illusion of safety because it creates a trust that may be clumsy to administer.

What ultimately is important is selecting the person or persons you feel will be able to make good decisions. It is not necessary that they have significant expertise or experience with administration and investments, as long as they are capable of retaining qualified people to assist them. You want someone who has a similar philosophy and values as yourself, because they will be administering the trust for your loved ones.

I often use the story of how I selected my own trustee when my children were small. I have two brothers who I was considering as successor trustee. I asked myself what my brothers would say if one of my children came to the successor trustee and asked for a Porsche to drive down to Wayne State University for college classes. One of my brothers would have said "sure.” The other brother would have said, "You do need a car, but your dad would have bought you an Escort.” I of course chose the brother who took into consideration what I would have done in that situation.

Once you have selected successor trustees, the decision regarding whom to name as a personal representative under the will becomes much easier. Since the successor trustee and the personal representative will work closely with one another during the initial probate process many clients opt to name the same individual in both positions so there is no conflict.

Finally we do not want to forget that during the planning process you will also name individuals to make decisions on your behalf should you become incapacitated. You want to consider carefully whom you are naming under your Patient Advocate Designation to make medical decisions in the event you are incapacitated and whom you are naming under your Durable Power of Attorney to make legal decisions in the event you are incapacitated.  Again, it is important that those people you name have an understanding of your philosophy and values when it comes to making medical decisions, especially those "pull the plug decisions". You want to make sure that the person or persons you name will be able to make those decisions when the time comes, yet will not make them too quickly.

As you can see, naming people to administer your documents for your benefit and the benefit of your beneficiaries is as important as determining where you want your assets to go. If in the estate planning process, you find yourself unable to decide whom to name to these important positions your estate planning professional should be able to assist you in making these important decisions.

Using your "Imagination" in Designing a Living Trust

My clients will often ask if they can provide for certain events in their Living Trust documents. The usual answer is that "the only limit on what you can put in your estate planning documents is your imagination." However, I do temper that with the statement that you should not let your imagination run wild.

     While it is true there is almost no legal limit on what you do in your Living Trust, it may lead to bigger issues later. While we are all concerned that our beneficiaries may not have the maturity or good sense we have developed after a lifetime of experiences, we should be careful not to be so restrictive that it makes it difficult to administer the trust.

     For example, I had a client who wanted to place restrictions on distributions for young children in the event he predeceased them. He wanted to require that they received no inheritance unless they earn a degree from a specific college. While it was a worthy desire, it did not take into consideration that the children might have no interest in attending that college, for any number of reasons unrelated to their desire for a college education. An alternative college might better suit the child's interest and skills. Alternatively, the child might be better suited to entering into a trade rather than going to college for which there is no interest.

     Another client had three daughters and at any given time was at odds with one of them, although not always the same one. Over the course of ten years, one of the three was always excluded from the Trust. I cautioned the client that trying to use her estate to control her children might not be the best way to establish a good relationship, but every twelve to eighteen months, she revised her trust to remove one daughter and provided only for the other two. I did not look forward to the day I had to explain to the three daughters that only two of them were beneficiaries of her trust. Eventually, my client concluded that it was counterproductive to try to control her children with her money and asked that I revise her trust to provide for all three daughters equally. She died unexpectedly a few months later, but the daughters shared equally because of the last trust amendment.

     A third client had three sons, all in their 30s. One son was the "good son" and was to receive a share of the trust immediately upon the death of his parents. The client did not speak with his second son because of a business arrangement gone awry. That son borrowed money from his father to go into business, then grew bored with the business, and left it to his father to clean up the mess. This lead my client to provided that this second son was not to receive any of his inheritance until he reached age 65. The third son was also not to receive his inheritance until age 65, unless "he was not married to that woman." Including provisions such as these (and some even more imaginative) in the trust is the client’s prerogative but, as you can imagine, may cause serious problems and possibly create sibling disharmony when the parents die.

     Many clients desire to promote their own value system to their beneficiaries and discourage unproductive behavior. Trust provisions for this purpose include:

1. Allowing a Trustee to make distributions to assist in the purchase of an automobile at certain ages and upon achieving a specific grade point average.
2. Providing for a distribution to a beneficiary upon enrolling in college.
3. Distributing an annual award for academic performance.
4. Distributing an award upon receiving a Bachelor's degree, especially within a designated period of time
5. Providing an award for receiving an advanced degree.
6. Making a distribution to match the beneficiary's earned income, up to a certain maximum amount.
7. Allowing distributions to assist in the purchase of a residence.
8. Allowing distributions to assist in starting a business.
9. Requiring financial training to assist beneficiaries in managing distributions
10. Providing for distributions for the cost of traveling to visit family members in an attempt to encourage and maintain relationships among children and grandchildren.
11. Preventing distributions to those not engage in productive activities or who are substance abusers

     These and many other incentive provisions are possible, but should not be added to a document without serious thought of the consequences as well as possible drawbacks or traps created because circumstances may change in the future.

One of the great freedoms of a Living Trust is the ability to dictate the exact distribution of your assets after you are gone. It is important to temper that freedom with common sense and to engage an experienced attorney to seek out potential problems with your distribution instructions. The trust is a tool that can assist in protecting your loved ones from potential problems in life, but just as it is nearly impossible to use a hammer on a screw, tools have limits. Attempting to work outside of those limits can have unexpected and sometimes disastrous consequences.

Protecting Four-Legged Loved Ones

The subject of today's blog started as a joke over the holidays as I discussed with a number of friends my desire to expose more people to the information in our blog. Those friends informed me that the most successful blogs they know of deal primarily with pictures of cute animals and/or celebrity gossip. In honor of that discussion, I start today's blog with this adorable photo.

While we do not intend to make a habit of luring readership to our site with adorable puppy pictures, we are not opposed to an occasional cute picture in order to educate people about the estate planning process.

-Matt

For most people, the process of estate planning revolves around ensuring that their assets go to the people they care for and that sufficient protections are in place so that those assets are put to the greatest possible use. For some people this means establishing 529 Education Savings Plans to ensure that funds are available for children or grandchildren to attend college. For others it means limitations on the distribution of trust principal to ensure that beneficiaries with spending issues or other personal issues have a source of income over their lifetimes. Often forgotten in the estate planning process is the fact that a person's loved ones sometimes include nonhuman companions that will also require care after their owner has died. While it is certainly possible to nominate an individual to care for a loved pet and leave that person funds for that purpose, the use of a pet trust ensures that those funds are used only for the benefit of the pet and the new owner does not skimp on the pet’s care to supplement their own income.

Currently forty-eight states, including Michigan, allow for the creation of a trust for the benefit of animals. These trusts, commonly known as Pet Trusts, allow people to ensure that assets are available to provide for their furry friends after they are gone. In Michigan, Pet Trusts are governed by MCL 700.2722. This statute formalizes the principle that the care of a pet is a lawful, noncharitable purpose, for which the trust can be created. Furthermore, the statute creates a presumption against construing a bequest for the benefit of the pet as merely precatory or honorary, thus discouraging courts from refusing to enforce such bequests.

The Michigan statute does however place certain limitations on the use of Pet Trusts. First, the statute limits the term of a Pet Trust to the lifetime of the animal or animals named as beneficiaries. However, the statute recognizes that certain animals have extremely long lifespans and therefore exempts trusts created under the statute from the uniform statutory rule against perpetuities, which would otherwise cause such trusts to fail and be unenforceable. It is possible for a pet trust to provide for multiple generations of animals or for multiple animals of varying ages. Second, the statute specifically allows the probate court to reduce the amount of property transferred to the trust if the court determines that the amount designated substantially exceeds the amount required to care for the animal. When a court makes this determination, the amount of reduction passes pursuant to the terms of trust as if those assets were not expended caring for the animal. This means that as in the case of Leona Helmsley, who attempted to leave her dog, "Trouble", $12,000,000 in the trust fund, the probate court is free to determine the amount of assets needed to care for a pet over its remaining expected lifespan. In the case of Trouble, it is worth noting that the probate court determined that a reasonable sum to provide care for the rest of his lifetime was only $2,000,000.

For those people who are not real estate moguls with the desire to keep their Maltese in handmade dog food and fur coats for the rest of their lives, a pet trust still provides an excellent resource for ensuring care of their animal companions and encouraging a two legged loved one to take the pet into their home. When creating a pet trust it is important to remember three things. First, as discussed, it is important to determine how much to leave in trust for the pet’s care. You should also determine what happens to any amount left in trust at the death of the pet. As with any other residuary distribution from a trust, the grantor can determine how such funds are distributed. In the simplest case, any remaining funds are distributed to the other beneficiaries. Alternately, if the grantor is charitably inclined, remaining funds could be used to benefit charitable organizations including the ASPCA, Humane Society, or World Wildlife Fund. In addition, it is important to name individuals who you wish to care for your pets. A pet trust does very little good if there is not a human alive to expend the trust assets for the pet’s benefit. From a common sense perspective, it is preferable to name someone other than the Trustee of the trust as the guardian for the pet, thus ensuring that there is supervision over the use of the assets. Lastly, it is important to remember that pet trusts are not limited to dogs and cats. The statute allows the creation of the trust for any animal, thus it is possible to ensure that funds are available to care for large animals such as horses or long-lived animals such as turtles long after the original owner has passed away.

As with any other form of trust is important to work with a knowledgeable and licensed attorney to ensure the observation of the legal formalities of creating a trust and that the trust is enforceable. Planning for the long-term care of an animal is as complex as planning for the long-term care of any other loved one, but with the proper assistance it is possible to ensure that all of our friends and family, on two legs or four, receive the best possible care even after we are gone.

Trust Funding—Filling the Trust-Bucket to Avoid Probate

As we have previously discussed, executing a Trust creates a legal entity that can own property. However unless steps are taken to transfer property to that entity, even the best-drafted Trust will provide very little value. I have previously referred to a newly executed Living Trust as an empty bucket. The Grantor/Initial Trustee carries the trust-bucket around during their life and makes use of its contents. If the trust-bucket does not have any assets in it, then the bucket is not doing its job. Thankfully, the process of funding a Trust, though sometimes complex, can be completed and provide protection.  Examples of  items to place into the trust-bucket are:

Tangible Personal Property Tangible personal property includes all the property a person owns that is movable; this includes clothing, furniture, and other household goods. Tangible personal property also includes items such as artwork, unique collectibles, firearms, and jewelry. These items are added to the bucket (and thus funded to the trust) through the execution of an Assignment of Personal Property. In our office, when we draft a Living Trust we automatically draft an Assignment of Personal Property. This ensures that before the client leaves we know that their Trust is the owner of their tangible personal property.

Real Estate.  The next item commonly funded to a Living Trust is real estate, such as a residence or vacation home. In order to fund real estate to the Living Trust the Grantor executes a quitclaim deed transferring the property to the Trust. Upon signing the deed, the Trust becomes the owner of the property. State law then requires recording of the deed with the county to ensure a complete record of property ownership exists. It is worth noting that in some circumstance it is more advantageous, primarily for creditor protection, not to fund real estate to a Living Trust. The decision to fund real estate to a Trust is a discussion that each individual needs to have with their attorney to determine what the best course of action is in their particular set of circumstances.

Investment Accounts   The third type of asset to place in the trust-bucket is accounts with financial institutions. Funding these assets to a Living Trust ensures that not only do those accounts pass directly to the beneficiaries without the delay of probate, but also that the Successor Trustee has access to those assets upon the death of the Grantor in order to make any payments that need to be made prior to making distributions to the beneficiaries. A subset of financial account assets frequently handled by banks and financial advisers is life insurance policies, IRAs, and other retirement accounts. These accounts are not funded to the Living Trust during the owner’s life but instead the Living Trust is one of the designated beneficiaries of the accounts at the owner’s death. In the case of life insurance policies, we recommend that the Living Trust be the primary beneficiary for the policy. This ensures this ensures that at the death of the insured party the proceeds from the insurance policy are distributed directly to the Living Trust. As for IRAs, if our clients are married we recommend that they designate their spouse as the primary beneficiary of the IRA, because spouses enjoy preferential distribution treatment, and then name the Living Trust as a contingent beneficiary.

Business Entities.  The final assets commonly funded into a Living Trust are interests in Business Entities such as Companies, Corporations, and Partnerships. The funding of these interests to a Living Trust is completed with an Assignment. This Assignment can occur any time after the signing of the Living Trust, and if the Entity issues stock certificates those certificates need to be updated to reflect that the Living Trust is the owner of the interest. When funding a business interest to a Living Trust it is important to review the Operating Agreement for the business entity to ensure that there is no restriction on transfer of stock to a living trust.

After all this funding is complete, the trust-bucket now contains bank accounts, investment accounts, deeds to real estate, and interests in business entities. Insurance policies and IRAs designate that they pay out directly to the Living Trust and thus those assets drop into the bucket at the death of the owner. All of this ensures that when the Grantor/Initial Trustee passes away and the Successor Trustee comes along to pick up the bucket and follows the instructions written inside it, all of the Grantor’s assets are in the bucket and there is little to no need to deal with the Probate Court.

In the event that a Grantor has not funded an asset to the Living Trust prior to the Grantors death, a properly drafted estate plan will include a Will that designates the Living Trust as the sole beneficiary of the entire probate estate. This means that any asset that needs to pass through the probate process will end up as a Trust asset for the Trustee to distribute pursuant to the terms of the trust. While this will act as a safety net, catching anything that happens to be missed in the initial planning process, like all other circumstances involving a safety net the intention is to never need to make use of that net.

Each individual's circumstances are unique and due to those unique circumstances, it may not benefit an individual to transfer an asset into the name of the trust. These circumstances are one of many reasons that it is important to consult a licensed attorney to assist you with estate planning and to share information openly with that attorney.

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.

How a Living Trust Protects your Loved Ones

               There are many types of trusts and each of them is beneficial in the right circumstances. Today I want to talk about the commonest form of trust, the “Revocable Trust”, also sometimes called the “Living Trust”. 

The first benefit of the Living Trust is that it is revocable—you can change it as many times as you like for any reason, or no reason, as long as you are alive and competent. 

               As your financial situation or family situation changes, your Living Trust can change with it to provide your loved ones with the protection you desire. Living Trusts are particularly useful for the following three reasons:

1. AVOIDING PROBATE: In Michigan, any asset titled in your name alone, must pass through the probate process at your death. The probate process can be expensive, time consuming and very public. If you transfer assets to your Living Trust, you control them because you are the initial Trustee and only beneficiary during your lifetime, and your successor Trustee administers the assets for your loved ones following your death, without any probate required. 
2. REDUCING OR ELIMINATING FEDERAL ESTATE TAXES: If your estate exceeds the current exemption from estate taxation (currently $5,000,000 per person but scheduled to be reduced to $1,000,000 in 2013), the Living Trust can be drafted to insure both spouses’ exemptions are used and estate taxes are eliminated or at least delayed until after the death of the second spouse to die. 
3. PROTECTING YOUR SPOUSE AND OTHER FAMILY MEMBERS: Perhaps the most valuable benefit of a Living Trust is the ability to protect your family by stating in advance how your loved ones receive your assets after your death. Some examples are: 

• Provide funds to maintain the spouse’s accustomed standard of living, but limit access by creditors or impatient children. 
• Place limits on distributions in the event the surviving spouse remarries, to insure children of the first marriage will have their inheritance protected. 
• Place limits on how distributions can be used or when distributions occur for gifts to children and grandchildren. Restrictions can be placed on the use of income and/or principal, such as: 
• Spreading out distributions over time or at specific ages, such as 1/3 distributions at ages 25, 30 and 35 
• Distributing specific amounts after reaching certain educational milestones 
• Allowing distributions only to pay for education expenses, or only partial payment of expenses if child pays the other portion. 
• Providing for any educational need, purchase of a home, or starting a business, if the independent trustee approves. 
• Restrictions to insure creditors or divorcing spouses are unable to reach trust assets until actually distributed to children. 
• Restrictions to protect immature children from spending funds unwisely 
• Restrictions for children with dependencies to protect them from a worse condition 
• Provide "special needs beneficiaries” who are entitled to benefits through state and federal programs with funds to provide for additional assistance while protecting them from losing eligibility for government funds because of a sudden influx of assets or income. 
• Protect elderly relatives relying on you for support by providing a fund for their use if needed. 
• Allow you to fulfill any charitable inclinations you may have with donations at your death. 

               You have built a legacy of which you can be proud. Let a properly drafted Living Trust allow you to use and distribute it as you see fit.

What is a Trust and Why do I Need One?

What is a trust? 

Why do I need one? 

Aren’t trusts just for rich people? 

Aren’t trusts expensive?

           These are typical questions clients ask when we are discussing estate planning. Let’s start with the easy questions: 

What is a trust? 

           A trust is a written document that creates an entity and provides a set of rules for administering assets owned by that entity, during your lifetime and after your death. It is important to note that executing a trust without funding assets to it is a waste of money. The trust is an “empty bucket” when signed, but if you do not fill the “bucket” with assets the trust is of little use to you. Fortunately, transferring assets to trusts is relatively simple 

Why do I need a trust? 

           The trust states your instructions for how assets transferred to the trust are used. It contains your specific desires about how assets are invested, how income and principal are distributed during your lifetime and how your spouse and children are taken care of after your death. 

Aren’t trusts just for rich people? 

           Many people believe that they do not have sufficient assets to require a trust. While some aspects of a trust are more beneficial to a wealthier client, a benefit of a trust that is useful to everyone is the additional control you have over when your heirs receive their share of your estate. 

           If you have children, minors or otherwise, are you comfortable with the idea they will receive their share of your estate immediately at your death (or when they reach age 18 in the case of minors)? Using a trust to spread out distributions and help them control their assets is a useful tool even if you aren’t “rich”. 

           People with large amounts of assets aren’t the only ones who need trusts. Take a moment to add up your assets. Do you have any of the following? 

• Home 
• Cottage 
• Investments 
• IRAs 
• Company retirement plans 
• Life insurance 
• Potential inheritances 

           Surprisingly, the value of your assets begins to add up quickly. By placing these assets into a trust, you ensure that when you pass away all your assets are in one place and pass to your loved ones in an orderly fashion according to your instructions. 

Aren’t trusts expensive? 

           The benefits of having a well-drafted estate plan do not come without a cost. However, creating a trust is more than just a one-time transaction with an attorney. The time and money spent creating a trust are an investment in your and your family’s future. A trust can: 

1. Control your wealth during your lifetime 
2. Protect your legacy 
3. Help avoid Michigan Probate 
4. Protect your loved ones after you are gone 
5. Protect minors and special needs children 
6. Help reduce or eliminate estate taxes. 

           A trust can save far more in probate costs and estate taxes, while providing security and protection for your loved ones, than it costs to prepare. 

     

           If you are not sure you need a trust, or any other estate planning documents, make an appointment with an estate planning attorney. Many attorneys are willing to meet with you, explain estate planning and, after determining your needs, quote you a fee before you have to make any commitment.