What Are Trusts? Why Should We Use Them?
Trusts avoid the need for a conservatorship in the event someone suffers substantial disability and prevents the need for a probate estate administration upon death. Think of a trust as a wagon. The purpose of the wagon is to carry your assets past the probate court upon disability or death so that you don’t have to enter the probate court which has a very expensive cost of admission. The concept of how a trust operates is like a triangle. The points of a triangle are the positions inherent in every trust. The grantors or settlors are the people who create the trust. The trustees are the people who manage the assets that are placed in the trust. And, the beneficiaries are the people for whom the trust has been created, who receive the benefits of the trust. When a trust is created, you hold all three positions. You create the trust. You have exclusive control of your assets once they’re in the trust. As a result, you and your family members are the exclusive beneficiaries of that trust once it’s created.
The reason every state has probate courts is to solve an incredibly simple problem; because the substantially disabled or deceased title owner cannot sign his/her name, nothing can be done with the title owner’s assets because he or she cannot sign his or her name. By virtue of the fact that a title owner can’t sign his or her name, the assets lock up. The only way to unlock those assets, absent proper planning, is to visit the probate court. In the context of disability, it’s a conservatorship estate. In the context of death, it’s a decedent estate. A trust provides a mechanism to avoid having to go to probate because when an asset is placed in a well-crafted trust, the asset never becomes locked up. This is because a well drafted trust always provides that successively serving designated trustees have the legal ability to sign the trust’s name. For example, when the trust is created, you’re the initial trustee or co-trustee with your spouse. Each has the ability to individually sign the trust’s name to deal with trust assets. A well-crafted trust also provides for alternate successor trustees. For instance, if someone becomes disabled, upon proof of that disability, the chosen designee or successor trustee of the creator of the trust steps up to take control of the trust and administer the assets according to the trust’s terms for the benefit of the disabled person. In the event of death, the chosen designee or successor trustee will also step up to administer the trust to wind up the decedent’s financial affairs and administer the trust assets for the beneficiaries named in the trust. If there are no designated trustees left, a well drafted trust will have a mechanism by which beneficiaries, or a trusted advisor, can designate a new trustee to administer the assets. By virtue of these facts, a trust always has an identified or an identifiable trustee who has the legal ability to sign the trust name and control the trust assets according to the terms of the trust. That way, no one has to go to probate in the event of disability or death.
What are some of the specific types of trusts?
The most common type of trust is a probate avoidance trust. The goal of the trust is to avoid probate in the event of death or disability. The trust allows you to maintain control of it. You can change its terms as life circumstances change by replacing trustees, changing the rules of administration, or, in certain instances, changing the identity of beneficiaries or the manner by which they receive inheritance.
A second popular type of trust is a Medicaid qualification trust. People of modest means often are concerned about what would happen if they became substantially disabled. The cost of nursing homes in Missouri, on the low end, runs around $4,000 a month. On the high end, it can cost as much as $10,000 or more each month. A family does not have to completely spend all of the wealth that they have in order to maintain a disabled spouse. With Medicaid qualification planning, you can secure family assets and allow an individual to qualify for governmental subsidies. For example, Medicaid subsidies for nursing home care, without having to expend down every penny of family wealth, can be accomplished through the use of an irrevocable trust. A well drafted irrevocable trust allows the maintenance of an individual’s assets for the benefit of one’s family while still allowing a disabled person to qualify for Medicaid for nursing home or stay at home care. Now, an irrevocable trust can’t be changed once it’s put in place, and with certain limited exceptions, it must be created five years before the onset of disability. So, if you’re concerned about disability down the road, or are already diagnosed with a condition that is encroaching over time, you can protect family assets in that manner.
Several trusts that were popular in the past, and are still popular with extremely wealthy people, are for the purpose of estate tax avoidance. There are trusts that allow you to invest in life insurance to take advantage of the death benefit of the policy to help avoid estate taxation. There are trusts that could be utilized if you have a substantially valued home. You could place your home in a trust to protect its value from estate taxation. We don’t really see too many of those trusts because under existing law, estate tax doesn’t come into play unless a deceased person has an asset value in excess of $11,500,000. Although we used to draft them quite commonly when the taxation levels started at $1 million.
The most common trusts are probate avoidance trusts, Medicaid qualification trusts, and one other trust that is used for qualified retirement benefits to protect possible inheritors who are children.
Do I need to have multiple trusts?
You can have multiple trusts depending upon your situation and what you’re trying to accomplish. For example, sometimes we create a primary probate avoidance trust and a separate trust to deal with retirement benefits. Now, you can put retirement benefit planning into the same trust as your other asset planning. But I have found over time that if you’re designating a financially unsophisticated trustee when you put two different distribution provisions in a single trust, the trustee gets confused. They mix up the terms and create horrible tax consequences. So, in a situation where there are either young children or adult children with varying financial responsibility levels or substantial disabilities, I create a second trust to handle qualified retirement plan benefits. The purpose of that trust is to allow a financially sophisticated trustee to manage the investment and distribution of the retirement benefits for death beneficiaries. Under the existing income tax laws, it takes a financially smart individual to balance the economic needs of the unknowledgeable, irresponsible or disabled beneficiaries, versus the tax cost involved in the administration of the trust.
I recently created a special needs trust for an adult disabled child, that could typically be incorporated into a basic plan, but the parents of the adult disabled child wanted to earmark specific assets while they’re alive for the benefit of their adult disabled child. They wanted to secure the quality of life for their child beyond their subsidies by Medicaid qualification. Medicaid will pay for basic room and board, but not much beyond that. So, parents create special needs trusts to enhance the quality of life by allowing a trustee to invest in managed funds, and use those funds to pay for things that basic Medicaid qualification will not.
Another example is life insurance trust. Oftentimes, parents want to particularly benefit younger adults by providing life insurance benefits for them on their own lives because life insurance can be used as an investment vehicle as well as a method to increase inheritance. In those situations, the parent creates an irrevocable trust, which pays the premiums for a cash value life insurance policy and controls the investments during the parent’s life. Then, upon death when the policy blossoms by virtue of the death benefit value, they can transfer that value to the adult child and still provide ongoing financial management until the child is financially responsible to manage the increased benefit for himself or herself.
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