Estate Planning for Beginners: Part Three

Previously we have looked at what makes up a will and how assets can be transferred when the time comes. In this article we'll talk more in-depth about certain trusts that can be useful when making your estate plans.

In the process of estate planning, one of the key decisions to be made is between establishing a revocable trust or a will, which provides for a fairly simple disposition of assets of a deceased person after the payment of all debts and taxes, if applicable. But what exactly is a trust, which in the simplest of terms also, like a will, lays out instructions for the distributions of assets? 

In my experience, the most common use of a trust is for minor children followed by a spouse and lineal descendants. When minor children are involved or where there may be some assets including life insurance proceeds, the testator may want to include a trust for the benefit of their minor children. In addition, a trust can be used for other individuals, whether they be a spouse and/or aging parents.

One of the primary purposes of most trusts is to provide a time table for the distributions of the assets of the trust where, for any number of reasons, an outright distribution at the death of the testator (you) may not be warranted. (For more, see: Estate Planning for Beginners, Part One.)

The Testamentary Trust

When the use of a trust is warranted, the testator has two choices. The first is to include a trust or trusts within the body of the will. If this is the approach to be taken, the trust(s) are referred to as testamentary trusts or, stated another way, coming from within the will.  

When the trust is within the will, the probate court/judge will have jurisdiction over the assets of the trust after your death, as well as all actions of any trustee until the trust terminates by its terms. The oversight by the court/judge may last anywhere from one year to 70 years or more and the court will most often require formal accountings each year, annual fees for its oversight and may even question the actions of the then-serving trustee.

Before we go any further, note that it is very rare where we will recommend the use of a testamentary trust with the exception of young singles and married couples with few assets.

The Living Trusts

The second option is the use of a living trust. The primary types of living trusts consist of the revocable trust and/or the irrevocable trust. Although there are a number of other forms of living trusts, they are highly specialized. Our discussion today will be limited to the revocable trust. 

Unlike placing the terms of the trust within the body of the will as in a testamentary trust, a revocable trust is a separate standalone document independent of the will. A revocable trust does not eliminate the need for a will; it serves with the will to complete the estate plan. The revocable trust will have two major sections. The first happens during the life of the settlor (you) and the second occurs after the death of the settlor.

During your lifetime, you typically name yourself as trustee and possibly your spouse as co-trustee. Since the trust is revocable, anything you place in the trust can be taken out at any time during your lifetime. But suppose you are in an accident and cannot act on your own behalf. Your named co-trustee or successor trustee can step in. The trust allows for distributions to you during your lifetime for your care and support and is much more flexible than if you depend upon a durable power of attorney or if a court were to appoint a conservator of your assets.

Because you took the time to establish a standalone trust when you were competent, your chosen co-trustee or successor trustee steps in to manage the trust and pay your bills. (A testamentary trust has none of these advantages since it only comes into existence at your death.) Also unlike a testamentary trust, at the death of the testator (you again), the assets in the trust plus any assets it receives from the will are no longer subject to probate court oversight or jurisdiction. Mandatory accountings are not required although they are recommended to be presented to the beneficiaries or their representatives (assuming they are minors) rather than any court. We refer to this as the ability to avoid probate and although many attorneys do not place a significant value on this issue, I believe that whenever possible, the elimination of the probate court is desirable and worth the effort to avoid. In the rare situation where the family expects trouble among the beneficiaries after the death of the parents, probate court jurisdiction may be warranted. (For more, see: Estate Planning for Beginners, Part Two.)

For many people, privacy is very important. When all of the provisions are included in a will, all of the accountings are available to the general public for all to see—including the will itself. On the other hand, if all of your assets are in your revocable trust at the time of your death or come over from your will, there is no need for any formal accounting and your assets and the terms of the trust never become public.

As far as the selection of trustees are concerned, you can name an individual or a corporate trustee or both. If you name an individual or two individuals as trustees, at least one of them should be a family member. You might even consider naming the guardian of your children if applicable as one of the trustees. The other should have some background in finances or investments. You then have to consider that a trustee(s) is entitled to a fee which is typically charged quarterly or annually. Typically, a fee of up to 1% annually is considered reasonable for individual trustees. You may want to limit the fees (be careful here) by stating that the individual trustee may charge no more than 1% plus any out-of-pocket expenses. If there is more than one trustee, be sure to settle if they are to share the fee or if they are both entitled to a full fee.

If a corporate trustee is desirable, then I would also name a family trustee with financial experience to serve as co-trustee. The advantage of a corporate trustee, such as a bank or independent trust company, is that they do not die and will likely always be there. The disadvantage is that you will never know who (which trust officer) will be assigned to the trust at the time of your death. In the alternative, you can give your individual or family trustee the power to appoint a corporate trustee, which I believe may be a better option than naming one today.

Regardless of who or what is named a trustee, you want to provide the individual co-trustee or a special trustee with the power to remove and replace the corporate trustee if necessary or desirable.

Terms of the Trust

Depending on the amount of money involved, I typically recommend split distributions from the trust. As an example, the terms may read as follows (and this is merely an example for illustration; it's not meant to be legal advice). “The trustee may pay to or for the benefit of the children, in equal or unequal shares, as much of the income and/or principal as the trustee shall determine in its discretion for the maintenance, education, support and health of the children until such time as the youngest child reaches the age 25. When the youngest child reaches the age of 25 or has completed four years of post-secondary education, whichever comes first, the trust is to be split into as many shares as there are children surviving plus one share for any child who has died leaving children surviving. For any child who has reached the age of 25, they shall 'vest' in an amount equal to 20% and the remaining 80% shall vest at age 30.”  You can pick whatever ages and percentages that you like.

Most attorneys that I deal with are still using outright distributions rather than vesting. Vesting allows for the beneficiary to defer taking funds out of the trust if all is going well knowing full well she/he can access the vested funds at any time. Another major advantage is that you as the grantor of the trust provided for a line of succession by stating that if the beneficiary were to die with assets in the trust, the assets shall go as you previously directed.

Why split distributions you may ask? This is to cover the possibility that if the child blows through the distribution at age 25, then they have another chance at age 30 when they are hopefully better prepared to handle the remaining funds. 

An example may help. Suppose there is a car accident and a husband and his wife are killed leaving two minor children, Tommy who is 7, and Barbara who is 4 years old. We discover that the parents had received some good advice and had a testamentary trust in their wills leaving everything to each other or in trust for their children. If any child is under the age of 25, the assets are to be held in trust until the youngest child has reaches the age of 25. When the youngest gets there, the assets are to be split into as many equal shares as there are children surviving, plus one share for any child who has died leaving children surviving, otherwise to the surviving children of the grantor, per stirpes. (For related reading, see: Life Insurance vs. Irrevocable Trust: Which Is Better.)