Q: A friend of mine said he recently had his attorney prepare a trust for his grandchildren. He was really excited about taking care of their college education, but he did not explain how the trust would work. Can you give me an explanation?
A: A trust involves placing legal title with one person or institution for the benefit of one or more beneficiaries. It can be revocable and changeable, or it can be irrevocable. The person creating the trust is usually referred to as the trustor or settlor. The trustee is the person or entity selected to take legal title and administer the trust assets.
Trusts are often an important part of estate planning. Most estate planning trusts do not become effective or funded until the person creating the trust dies. If established by the person’s last will and testament, the trust does not even come into existence until the person dies. When the trust is established by a will, it is termed a testamentary trust. The remainder of this article we will discuss some of the uses for testamentary trusts.
Believe it or not, some families have what could be affectionately termed a “black sheep.” This person is not good with money, addicted to gambling, alcohol or drugs, frequently married and divorced or just not good with finances. If the black sheep is a beneficiary of the will, he or she may spend or lose their inheritance quickly.
Instead of giving the black sheep an inheritance, his or her portion can be left to a trustee in trust. Terms of the trust can provide for distribution of income, payment of medical bills, rent, emergency expenses and such other items as the person creating the trust deems appropriate. The trust can also include provisions prohibiting assignment by the beneficiary and prohibiting attachment by creditors of the beneficiary.
Protection from creditors is done by including a “spend thrift” provision. This provision prohibits assignment or anticipation by the beneficiary, which means a creditor can not reach the beneficiaries interest in the trust. This feature can be attractive even where a black sheep is not involved, as the funds in the trust can provide a safety net for the beneficiary, free from unforeseen creditors. I frequently refer to the unexpected car accident as creating an unforeseen creditor.
Trusts are often used to provide for minor children. Funds are placed in trust until such time as the beneficiary, or beneficiaries, attain a certain age. Funds in the trust can be used for the health, welfare and education of the beneficiary, with the remaining assets not distributed until the minor has reached the age that the person creating the trust felt would be sufficiently mature to deal with a large financial gift.
Grandparents often create educational trusts for grandchildren. Such trusts usually limit use of the monies to post high school education and provide for final distribution of any remaining funds at the time the beneficiary reaches a certain age.
Estate tax savings may also be realized by creating what is known as a credit shelter trust in the will. Under current estate tax law, each person may give two million ($2,000,000) dollars to beneficiaries other than the person’s spouse, free of estate tax. There is generally no estate tax due on a gift to a spouse. However, when the spouse dies, the spouse will be limited to the two million ($2,000,000) dollar exemption from estate tax when assets pass to children, grandchildren or others. The IRS allows tax payers to have most of their cake and eat it too, if a credit shelter trust is utilized.
A maximally funded credit shelter trust will involve a decedent leaving two million ($2,000,000) dollars in trust when he or she dies. In simplest terms, the income from the trust can be automatically paid to the surviving spouse and the trustee can have power to invade principal if needed by the surviving spouse. Assets in the trust when the surviving spouse dies pass to children, grandchildren or others free of estate tax, so that the ability of both spouses to give two million ($2,000,000.00) dollars at death free of estate tax is preserved. Better yet, if the credit shelter trust assets increase in value between death of the first spouse and final distribution, that increase also escapes estate tax. Since the estate tax rate on the non-exempt portion of an estate is 49 percent, fully funding the credit shelter trust can save $780,800 dollars in taxes.
Even without tax savings, a trust might be created for benefit of a surviving spouse. This is often done in a second marriage situation, where the first spouse to die sets up a trust for benefit of the surviving spouse. At death of the surviving spouse, the assets remaining in the trust are distributed to children from a previous marriage.
A trust is a flexible instrument that can be applied to almost any situation. Creating a trust should be discussed with your estate planning attorney.
William G. Morris is a lawyer with offices at 247 N. Collier Blvd., Marco Island. The column is not intended to be legal advice for specific circumstances. General questions can be sent by e-mail to firstname.lastname@example.org or by fax to (239) 642-0722. Read other columns at http://www.wgmorris.com.