Trusts and Estates – An Overview
The basic concept of the trust is to set aside certain assets to be managed by an entrusted person for the benefit of others. This concept has, however, evolved over the years to encompass all manner of circumstances and to satisfy a variety of needs.
In attempting to understand the concept of a trust, it is first and foremost important to note that when you create a trust, you are creating a legally distinct person. A trust can hold title to property, manage assets,
Today, trusts can be used for estate planning, asset protection, investments and a host of other purposes. While some people still have the mistaken notion that trusts are something used by rich people to hide their assets, the fact is that trusts have become a pervasive part of our society.
The most common form of trust used today is the Revocable Living Trust (also sometimes just referred to as a “Living Trust”). This form of trust is typically used as a means of estate planning, allowing the creator of the trust to avoid the costs and complications of the probate process. This common form of trust is discussed in more detail below.
The following overview of trust law is NOT intended as, and shall NOT constitute legal advice. Instead, this overview is provided as a generalized discussion of the subject for informational purposes. If you are contemplating whether to form a trust, whether for estate planning, investment or asset protection purposes, you should always first speak with a legal professional.
The Basic Concept
A trust generally consists of three persons: the grantor (also sometimes referred to as the “settlor”), the trustee and the beneficiary. The grantor is the person setting aside certain assets for the benefit of the beneficiary. Meanwhile, the trustee is the person charged with managing those assets for the benefit of the beneficiary.
A Basic Example:
To better understand this basic construction of a trust, we sometimes use the example of orphan Annie. Imagine that Daddy Warbucks wishes to set aside a few million dollars for the benefit, welfare and education of little orphan Annie. However, Daddy Warbucks is a very busy man. He doesn’t have time to properly manage those assets for Annie’s benefit. Moreover, he wants to ensure that, in the event of his death, the assets will continue to be properly managed for the health, welfare and education of little orphan Annie. So, Daddy Warbucks establishes a trust for Annie’s benefit, naming a trusted third party (such as a close friend or relative or perhaps a professional trustee) to manage the trust for Annie’s benefit.
To create a trust of this kind, Daddy Warbucks would likely meet with a lawyer, who would draw up a trust agreement, or what is also referred to as a “Declaration of Trust”. The Trust Agreement would set out the basic terms of the trust: It would identify Daddy Warbucks as the grantor; It would name Annie as the beneficiary; and it would set out the rules that govern how money flows in and out of the Trust. Depending on the terms of the trust agreement, the person managing the trust (the “trustee”) could have very broad discretion or a very narrowly defined role. It really depends on the intent of the grantor.
Once the trust agreement is finalized, then the trust officially exists. Depending on certain characteristics of the trust, there may be some further formalities that the parties must undergo, but generally speaking, once the trust agreement is signed, the trust becomes a legally distinct entity. At that point the grantor, Daddy Warbucks, can start transferring assets into the trust, to be managed by the trustee for the benefit of the beneficiary, Little Orphan Annie.
This is the classic example of a trust: a family patron setting aside assets for the benefit of a young child, requiring a trusted third party to manage those assets.
The Historic Origins of Trusts
This classic example of the Trust dates back many hundreds of years, possibly even dating back several millennia. While we have yet to come across a definitive historical account of the origin of trust law, it is clear that this concept of setting money aside to be managed by a trusted third party, for the benefit of one’s family is quite old.
During the English Crusades, it was common that a knight would be forced to leave on a quest for many years or even decades without seeing his family. During this time, a knight would typically assign his estate to a trusted third party during his absence. The knight would enter into some sort of underlying agreement with a friend or a relative (a “trustee”), whereby the knight would assign his lands (and the proceeds associated with those lands) to the trustee, with the understanding that the trustee would, in turn, take care of the knight’s family during his absence then return the lands to the knight when he returned from his quest.
As you can imagine, this system was deeply flawed. Often knights would return to find that the “trustee” was less than his word, discovering that his family was not well taken care of in his absence, or that the lands were not properly maintained. In fact, there are many recorded instances when the trustee would simply outright refuse to return the knight’s land. However, as the Court of Chancery dealt with these various disputes, it developed a body of case law that governed these trust relationships and eventually evolved into the legal framework that we use today.
While the English Common Law is typically credited with the creation and development of what we refer to today as the Law of Trusts, this is not to suggest that the concept of the Trust was uniquely English. On the contrary, similar concepts existed in other cultures. For instance, early Islamic culture developed the concept of the waqf, which allowed a person to similarly set aside certain property for charitable purposes. Likewise, Roman law included a concept referred to as Fideicommissum, which contemplated the notion of testamentary trusts; that is, trusts created upon the death of the grantor for the benefit of one or more descendants.
Modern Uses of the Trust
Today, trusts are used for a variety of purposes: estate planning, asset protection, investment vehicles, charitable giving and numerous other objectives.
Using Trusts for Estate Planning Purposes
Estate planning is perhaps the most common purpose for which trusts are applied. Trusts provide a number of distinct advantages over simply having your wishes stated in a last will and testament. Unlike assets bequeathed by will, assets transferred pursuant to a trust are typically exempt from probate. Furthermore, if properly constructed, a trust can provide tax advantages to the grantor’s heirs, such as increasing the exemption for federal estate tax.
The term “estate planning” refers to the process of anticipating and making arrangements related to the disposal of an estate. In its most basic form, estate planning is about planning for your own death. Who will have control of your property when you die? Who gets the car? Who gets the house? What about your bank accounts, 401(k), retirement funds, insurance policies? Will your assets be distributed to your children? What if your children are still minors at the time of your death? Who will take care of your children? These are just a few of the questions that people must ask themselves as they make the necessary preparation for there estate plan.
The most basic form of estate planning is the Will; also referred to as the “Last Will and Testament.” Your will is basically a set of instructions, informing the world who your heirs are and how your estate is to be disposed of upon your death. One of the great myths of wills is the notion that a properly drafted will allows you to avoid probate. This is not true. While a properly drafted trust can avoid probate, a will does not avoid probate. A will must be probated.
What is probate? Well, the probate court is the division of the local court system that deals with the estates of deceased persons. The probate court typically issues orders as to the proper transfer of assets formerly belonging to the deceased. In some cases, the probate process can be very smooth and somewhat inexpensive. However, more often than not, probate is a costly and even counterproductive process, where legal fees can run in the thousands, tens of thousands or even hundreds of thousands of dollars.
Consequently, most people wish to avoid probate. This is where the trust comes in. You can create a self-settled revocable living trust (also referred to as a living trust).
Using Trusts for Asset Protection Purposes