Introduction
Estate planning involves many considerations and various
legal devices to make sure your heirs (beneficiaries) receive your
property according to your wishes. This pamphlet is intended to provide
you with general information about trusts, a popular-but sometimes
complex-estate planning tool. The contents are based on trust statutes
of the state of Washington, which were modified in 1984, and on the
Tax Reform Act of 1986. (Other estate planning subjects are discussed
in State Bar pamphlets on 'Wills' and "Probate."See back
panel for ordering information.)
What is a trust?
A trust is an agreement under which money or other assets
are held and managed by one person for the benefit of another.
Different types of trusts may be created to accomplish specific
goals. Each kind may vary in the degree of flexibility and control
it offers.
Among the common benefits that trust arrangements offer are:
- Providing personal and financial safeguards for family and other
beneficiaries;
- Postponing or avoiding unnecessary taxes;
- Establishing a means of controlling or administering property;
and
- Meeting other social or commercial goals.
How Is a trust created?
Certain elements are necessary to create a legal trust,
including a trustor, trustee, beneficiary, trust property and trust
agreement.
The person who provides property and creates a trust is called a
trustor. This person may also be referred to as the "grantor," "donor," or "settlor."
The trustee is the individual, institution or organization that
holds legal title to the trust property and is responsible for managing
and administering those assets. If not designated by name, a trustee
will be appointed by the court. In some cases, a trustor can serve
as the trustee. It is also possible for two or more trustees to serve
together, or for both an individual and an organization to act as
co-trustees. Separate trustees may also be named to manage different
parts of a trust estate.
The beneficiary is the person who is to receive the benefits or
advantages (such as income) of a trust. In general, any person or
entity may be a beneficiary, including individuals, corporations,
associations or units of government.
The general duties and obligations of the beneficiary, the trustee
and the trustor are summarized elsewhere in this pamphlet.
To be valid, a trust must hold some property to be administered,
The trust property may be any asset, such as stocks, real estate,
cash, a business or insurance. In other words, either "real" or "personal" property
may comprise trust property (which may also be called the "trust
corpus," "trust res," "trust estate," or "trust
principal). Trust property may also include some future interest
or right to future ownership, such as the right to receive proceeds
under a life insurance policy when the insured dies (discussed under
'What is a life insurance trust'?). Property is made subject to the
trust by transfer to the trustee, commonly called a "gift in
trust."
The trust agreement is a contract that formally expresses the understanding
between the trustor and trustee. It generally contains a set of instructions
to describe the manner in which the trust property is to be held
and invested, the purposes for which its benefits (such as income
or principal) are to be used, and the duration of the agreement.
Trust agreements may be expressed in writing, by oral agreement
or may be implied, and the trustor usually has considerable latitude
in setting the terms of the trust. To be enforceable, a trust involving
an interest in land must be in writing.
What types of trusts are there?
Many kinds of trusts are available. Trusts may be classified
by their purposes, by the ways in which they are created, by the
nature of the property they contain, and by their duration. One
common way to describe trusts is by their relationship to the trustor's
life. In this regard, trusts are generally classified as either
living trusts ("inter vivos" trusts), or testamentary
trusts.
Living trusts are created during the lifetime of the trustor. Property
held in a living trust is not normally subject to probate (the court-supervised
process to validate a will and transfer property on the death of
the trustor). In Washington, because such property is not subject
to probate, it need not be disclosed in the court record and confidentiality
may be maintained. Such trusts are widely used because they allow
the trustor to designate a trustee to provide professional management.
Under some circumstances, living trusts will allow income to be
taxed to a beneficiary and result in income tax savings to the trustor.
However, it should be noted that income earned by a trust established
for a beneficiary under the age of 14 may be taxed at the beneficiary's
parent's tax rate. The transfer of property to a living trust may
also be subject to a gift tax.
Testamentary trusts are created as part of a will and must conform
to the statutory requirements that govern wills. This type of trust
becomes effective upon the death of the person making the will (the "decedent")
and is commonly used to conserve or transfer wealth. The will provides
that part or all of the decedent's estate will go to a trustee who
is charged with administering the trust property and making distributions
to designated beneficiaries according to the provisions of the trust.
Before the trust property becomes subject to the testamentary trust,
it will normally pass through the decedent's estate. When the estate
is probated, those trust assets will be subject to probate. The assets,
which will form the Corpus of a testamentary trust, also are potentially
subject to an estate and generation-skipping transfer tax at the
time of the decedent's death.
A testamentary trust gives the trustor substantial control over
his or her estate distribution. It also may be used to achieve significant
savings in the future. For example, by using a testamentary trust,
a trustor can provide for a child's education or can delay the receipt
of property by a child until the child gains financial maturity.
Moreover, given the proper form of trust, property may be exempted
from death taxation on the later death of a trust beneficiary. However,
a generation-skipping transfer tax may still apply.
How can I establish a trust?
Depending on a number of circumstances, trusts may be established
orally, in writing or by conduct. Most trusts involve a number
of technical legal concepts relating to ownership, taxes and control.
A lawyer can assist in explaining options, considering contingencies
and preparing documents.
In creating a trust, you should consider several factors and obligations,
including:
- Your personal situation, including age, health and financial status.
- Your family relationships and you family's financial circumstances.
- Personal financial data: personal property, real estate
holding, securities, and other property-as well as your tax situation
and any debts of obligations,
- The purpose of the trust: your goals, or what you hope
to accomplish by the arrangement.
- The type of trust, and how versatile or flexible your plans
are,
- The amount and type of property it will contain.
- The duration, or how long the trust will last.
- The beneficiaries and their specific needs.
- Any conditions that must be met by a beneficiary to receive
benefits (such as attaining a certain age).
- Alternatives for disposing of assets in case the trust
conditions are not met or circumstances change, and
- The trustee, and the conditions or guidelines under which
he or she will function.
Dependency exemptions, capital gains and losses, income,
gift, estate and generation-skipping transfer taxes also should be
considered when planning certain types of trusts. Likewise, you may
want to go about naming alternative or contingent beneficiaries and
trustees.
Once a trust has been established, a period review of the status
of the trust is advisable; you may want to obtain professional assistance
appropriate to the requirements of the trust.
What are a trustees duties and obligations?
A trustee-whether an individual or institution--holds legal
title to the trust property and is given broad powers over maintenance
and investment. To ensure that these duties are properly carried
out, the law requires that the trustee act in a certain manner,
in general a trustee must:
- Act in accord with the express terms of the trust instrument.
- Act impartially, administering the trust for the benefit
of all trust beneficiaries.
- Administer the trust property with reasonable care and
skill, considering both its safety and the amount of income it produces.
- Maintain complete accounts and records, and
- Perform taxpayer duties, such as filing tax returns for
the trust -and paying required taxes.
The trustee must administer the trust property only for
the designated beneficiaries and may not use trust principal or income
for his or her own benefit. In other words, a trustee is usually
prohibited from borrowing or buying from the trust, from selling
his or her own property to it, and from using the trust assets as
collateral for a personal debt.
In selecting a trustee you should consider the potential trustee's
competence and experience in managing business of financial matters
and the potential trustee's competence and experience in managing
business or financial matters and the potential trustee's availability
and willingness to serve.
Individuals and certain corporations (or a combination of both)
may serve as trustee. Each selection offers distinct advantages and
drawbacks that should be considered. For example, and institution,
such as a bank, usually offers specially trained managers to provide
administrative, counseling and tax services. Other typical advantages
include the institution's continuity and reliability of service,
and its ready availability. Most banks will charge a fee for trust
services, and some may not want to manage small trusts, so you may
want to compare options.
As an alternative, an individual, such as a relative, family friend
or business associate, may serve as trustee. An individual, unlike
an institution, may be willing to serve for little or no fee. Furthermore,
this person could add a more personal touch for special understanding
to the needs of the beneficiaries. However, you will want to be certain
that any nominated individual has the skill and experience necessary
to properly manage the trust property.
Where should a trust be established?
The location of the trust is usually determined by the
residence of either the trustor or trustee. In deciding where to
establish the trust, it must be remembered that each state has
different laws governing the operation of trusts and trustees" powers.
Circumstances may sometimes warrant moving the trust location. Relocation,
called a "change of situs," may be desirable or necessary
for either tax or nontax reasons (e.g., the trustee moves to another
state). Whether or not a move can be made, and how the move is accomplished
will be dictated by each state's laws.
Can a trust be altered or revoked?
Living trusts can be "revocable" or "irrevocable." The
trustor may change the terms or cancel a revocable living trust.
Upon revocation, the trustor resumes ownership of the trust property.
In general, a revocable living trust is used when the trustor does
not want to lose permanent control of the trust property, is unsure
of how well the trust will be administered, or is uncertain of the
proper duration for the trust. With a properly drafted revocable
trust, you: (1) may add or withdraw some assets from the trust during
your lifetime; (2) may change the terms and the manner of administration
of the trust; and (3) may retain the right to make the trust irrevocable
at some future time. The assets in this type of trust will generally
be includable in the trustor's taxable estate, but may not be subject
to probate.
An irrevocable living trust may not be altered or terminated by
the trustor once the agreement is signed. Two distinct advantages
of irrevocable trusts are: (1) the income may not be taxable to the
trustor; and (2) the trust assets may not be subject to death taxes
in the trustor's estates. However, these benefits will be lost if
the trustor is entitled to (1) receive any income (2) use the trust
assets; or (3) otherwise control the administration of the trust
in a manner that is inconsistent with the requirements of the Internal
Revenue Code.
Since a will may be revoked or amended at any time prior to death,
a testamentary trust may be changed or canceled. Revisions can be
made by drafting a new will or by using a simple document called
a "codicil" to make changes or additions to your will.
However, to be effective, any such modifications must be executed
in the same manner required for wills.
The trust instruments should be explicit regarding revocability
or irrevocability. If it is not, the trust will be considered irrevocable.
What Is an "Insurance trust"?
Insurance trusts may take various forms, such as business
insurance trusts (which may be used to protect the "key men," proprietor
or partners of a business), or personal insurance trusts (which
involve no business interests). These types of trusts are usually
intended to provide assistance in the management of insurance proceeds
from estate taxation. Insurance trusts may be revocable or irrevocable,
and various types of agreements are available to accommodate an
individual's circumstances and desires, or the requirements of
a business.
What Is a "life Insurance trust"?
Another form of insurance trust is the life insurance trust.
This trust, similar to a living trust, is created to receive proceeds
payable under a life insurance policy. It is normally established
to exclude those proceeds from taxation in the decedent's estate.
A life insurance trust can also be used to provide a vehicle for
continued management and distribution of insurance proceeds for
a beneficiary who may need assistance in those matters.
To obtain the tax benefits of having the proceeds excluded from
the decedent's estate, it is imperative that the insured divest himself
or herself of all interest in the policy, and place those rights
in the hands of the trustee. For this reason, it is preferable to
have an individual other than the insured act as trustee.
This type of trust cannot be revocable, and the insured cannot retain
any right to trust income. To ensure the tax advantages are retained,
it is important that the document be properly drafted. The tax rules
in this area are quite complex, so professional legal assistance
may be helpful in the preparation of such a document.
What Is a "charitable trust"?
A charitable trust is also called a "public trust" because
through charitable means it benefits, immediately or eventually-members
of the general public. It can offer many tax advantages to the trustor
not available to other "private" trusts. Unlike private
trusts, it can be established to last indefinitely.
Although sometimes complicated in their arrangement, charitable
trusts off offer considerable flexibility in providing benefits from
the trustor or other trust beneficiaries, while at the same time
meeting charitable goals. Charitable trusts must be carefully drafted,
however, to ensure advantageous tax treatment. A commonly used charitable
trust is the "charitable remainder trust."
What Is a "charitable remainder trust"?
This type of trust allows you to give a future interest
in an asset to charity, while keeping an income stream for yourself
or for another beneficiary.
A trustor may specify that a certain portion of the trust income
be distributed to a non-charitable beneficiary for a certain period
of time, with the charity to receive the money or property thereafter
(e.g., upon the death of the on-charitable beneficiary).
In addition to offering an immediate tax deduction for the charitable
contribution, the charitable remainder trust can no help lower your
estate taxes. To qualify for a charitable deduction, specific formats
must be followed, and the charitable beneficiary must meet standards
set by the Internal Revenue Service.
The amount of the charitable deduction is base on complex tax laws
that consider such factors as the age of the beneficiary, the value
of the property, and the expected income from the trust. Because
of the detailed legal concepts and changing IRS regulations , it
is advisable to consult a lawyer when considering such arrangements.
How long does a trust last?
There is no specified time during which a trust must remain
in effect. Each situation must be evaluated separately. In general,
however, Washington state law will not allow a private trust to
continue longer than 21 years after the death of a person living
at the time the trust was established. Charitable trusts, on the
other hand, may continue indefinitely.
What about taxes?
The use of a trust may help you achieve certain goals,
such as reduction of taxes. However, while trusts can offer a number
of tax advantages, tax avoidance should not be the sole motivation
for using this estate planning tool.
It also should be recognized that the laws governing trusts and
their taxation are complex and subject to change. As an example,
under the Tax Reform Act of 1986, income earned in a trust which
has a beneficiary under the age of 14 will be taxed at that beneficiary's
marginal tax rate. This is a significant departure from prior tax
law, which provided that such income be taxed to the child at his
or her own tax rate, often resulting in little or no tax being due.
Because of the new tax rules, an individual contemplating a trust
for tax purposes should consult with his or her accountant or attorney
to determine if the trust can be structured in a way to meet one's
tax objectives. By carefully choosing the proper type of investments
within a trust, it may still be possible to accomplish tax goals,
but careful planning and drafting are required. These facts, coupled
with the numerous financial consideration involved in estate planning,
suggest that professional legal and financial assistance may be necessary
to help you make informed decision.
How much does It cost to establish and maintain a trust?
The cost of creating and administering a trust can vary
considerably, depending on its type and duration. A lawyer's fees
to create a trust, for example, will usually be based on the time
involved in consulting with you, and in planning and preparing
documents. Therefore, before you hire a lawyer, you should discuss
fees (for example, whether hourly or flat fees are charged). Ask
for an estimate or arrange a written fee agreement.
A trustee's fee may vary with the skill and expertise the trustee
offers. Charges may also be influenced by the size and complexity
of the trust estate. This affects the nature and amount of services
required, such as record-keeping, asset management and tax planning.
In addition to legal and trustee expenses, there may be accounting,
real estate management or other service fees. Other common charges
include annual, minimum, withdrawal and termination fees.
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