Estate Planning with Trusts
For most people, there are six major considerations in deciding how to handling their estate plans:
- Avoiding probate
- Minimizing taxes (estate taxes and income taxes, including capital gains taxes)
- Controlling the future uses of the assets
- Costs and other practical considerations
- Protecting against future incapacity as well as death
- Providing protections for heirs
At one time, the first two concerns were the primary motivation for most estate plans. Today control of assets, during lifetime due to concerns about incapacity, and protection of assets for the benefit of remainder beneficiaries are becoming much more common concerns.
"Living" ("Inter-Vivos") Trusts
One of the most popular and enduring options for sophisticated estate planning is the revocable living trust. This instrument creates a separate entity with specific and very individualized rules for its operation. Normally, it is completely revocable or amendable by its creator (referred to as the "trustor,” “grantor, ” or "settlor") during his or her lifetime, and the trustee may be virtually any person, entity or combination of persons and entities. While usually the trust is established and funded by one person, it is possible, and sometimes advantageous, to have a “joint trust” that is established by a married couple. Advantages of the living trust include:
- Tax savings
Estate taxes are no longer an important reason for establishing living trust for most people, since currently the personal exemption for federal estate tax is $5,490,000 for an individual. Tennessee estate tax has been eliminated, and while some other states still have estate taxes, most have been repealed.Other taxes may still affect remainder beneficiaries:
- Income Taxes. The remainder beneficiary of IRAs, qualified retirement plans, and tax-deferred annuities will be subject to income tax on the distributions that had been sheltered from taxes during the owner’s lifetime.
- Capital Gains Taxes. Because inherited property normally gets a “step-up” tax basis for capital gains purposes, the property wouldn’t be subject to capital gains tax unless the sales price later was greater than the value at date of death. However, property held between spouses as joint tenants (or in a conventional joint living trust) normally only qualifies for the "stepped-up" basis for half of the jointly owned property on the death of the first spouse. Use of a joint living trust that is written as a “community property trust” may take advantage of a little-understood capital gains tax break for married couples in Tennessee and some other states. By holding their joint interests in the trust as community property, married couples can eliminate the tax on capital gains accruing between the original purchase of the assets and the death of the first spouse, while still enjoying most of the benefits of the joint tenancy arrangement usually utilized to avoid probate.
Only persons with an interest in the living trust need be notified of the proceedings, the assets held in trust, or their values or ultimate disposition. No publication of notices, no court filings, or public hearings would then be required.
- Avoiding Probate
Assets that had been transferred to the living trust before the death of the trustor do not need to be taken through the probate process. In addition to the time saving (even a simple probate will normally take six months or longer), this may save considerable expense to the successors. A living trust is particularly advantageous where the trustors own real property in more than one state, since a separate ancillary probate proceeding may be required in each state where real property is located.In the event assets were missed and not contributed to the trust during the trustor’s lifetime or otherwise distributed by beneficiary designation, a back-up will, sometimes called a “pour-over will” is executed along with the trust and held in reserve. The provisions of the pour-over will direct the executor to distribute the probate assets to the living trust to be handled in accordance with the trust’s provisions.
When a trustor dies, the living trust continues to function as planned, with no probate process. Assets in the living trust normally are handled exactly as they were prior to the trustor's death, and the trustee may be directed to make the income available to a surviving spouse or others, to divide the trust into sub-trusts for remainder beneficiaries, or to distribute the assets outright and end the trust.
- Protection during Illness or Incapacity
The living trust can be constructed to provide for management of assets during any period of illness or incapacity of the trustor. A successor trustee chosen by the trustee can take over, or the trustor might appoint a co-trustee who could be authorized to serve alone in the event of the incapacity or death of the primary trustee (usually be the trustor). This flexibility will normally avoid the necessity of conservatorship proceedings in the future, and will provide for the smooth transition of control from the trustor to a trusted, successor trustee or co-trustee, whether an individual or entity.
- Management of Assets
Options for management of a living trust include having the trustor act as the initial trustee or co-trustee. The trust could provide that a trusted family member act as trustee or co-trustee or selecting a corporate trustee to manage the trust property after the incapacity or death of the trustor. Continuity of management in a trust may be particularly useful where the trustor owns rental properties or has other investment requiring management. The idea of professional asset management by a corporate trustee or co-trustee is attractive to many individuals.
- Flexibility and Control
The living trust offers the trustor the maximum control over his or her assets in the present and in the predictable future. The trust instrument provides the opportunity for directing the general uses of the trust assets after the death of a trustor, whether for a surviving spouse or other remainder beneficiaries. A living trust can be designed around the specific needs of the trustor's family. A trust can be a way to ensure that money is available for the education of children or grandchildren, or for extraordinary care required for a disabled child or spouse.
- Security Against Challenges (Before and After Death)
Since the living trust usually will have been in place for a considerable period of time before the death of the trustor, and since there is no court proceeding initiated to determine the validity of the trust document, it is normally much more difficult for disinherited relatives to challenge the estate plan after the death of the trustor.A living trust is usually "funded" by transferring most or all the trustor's assets into the name of the trust. The trustee is then directed to utilize the income from those assets exclusively for the benefit of the trustor during the trustor's life, but even these common provisions may be altered to provide for each trustor's unique circumstances.A revocable living trust does not protect the trustor’s assets from claims of the trustor’s own creditors. In general, a trustor who retains control of distribution of the trust’s assets will still be treated as the owner of the trust property for both income tax and creditor protection purposes. Tennessee law does recognize “asset protection trusts” under certain circumstances (Tennessee’s statute is called the “Tennessee Investment Services Trust Act”), but these trusts are irrevocable trusts with significant restrictions.Many types of trusts are popular, under a variety of names, for estate planning. Some of the most common terms used to describe specific trust instruments include "supplemental needs” trusts, "spendthrift" trusts, and "asset protection" trusts. Some of these instruments, such as Tennessee’s asset protection trusts, are designed to deal with specific problems that require the trust to be irrevocable and unamendable, even during the lifetime of the trustor, in order to achieve their desired purpose.Though often irrevocable, supplemental needs trusts for the benefit of a disabled beneficiary (other than the trustor or his spouse) may be established as a revocable trust. The trustor may reserve the power to make it irrevocable during his lifetime, but it would automatically become irrevocable upon the death of the trustor. So long as none of the disabled beneficiary’s own assets are used to fund the trust, there would be no “Medicaid payback” upon the beneficiary’s death, so the trustor would be free to direct any remaining trust assets to other beneficiaries.Finally, federal law has just recently been amended to permit a disabled person under age 65 to establish a special needs trust to protect his own assets and allow him to be eligible for SSI and/or Medicaid. Before the recent establishment of the “Special Needs Trust Fairness Act” a trust containing assets belonging to a disabled person could only be established by a “parent, grandparent, court or a guardian,” and not by the competent disabled person directly. These trusts must comply with the provisions of 42 U.S.C. Sec. 1396p(d)(4)(A), including the requirement that the trustee repay Medicaid for any medical benefits received prior to distribution to remainder beneficiaries after the beneficiary’s death. While trusts established with a beneficiary’s own assets are normally subject to the claims of creditors, Tennessee law is unusual in that the trust assets are protected from claims of the beneficiary’s creditors created after the funding of the trust.
A trust may be created in a will, rather than during the lifetime of the trustor. Such a trust is normally called a testamentary trust, and does not go into effect until the probate of the decedent's will. While a testamentary trust will not be useful in avoiding probate (since the will must be admitted to probate in order to set up the trust), it may nonetheless be a valuable estate planning tool. Testamentary trusts are especially useful for providing for the continuing care of spouses, disabled children, or other relatives, where there is some reason not to establish a living trust. An individual cannot establish a supplemental needs trust for the benefit of his or her spouse except as a testamentary trust. For some individuals (especially professionals with potential lingering malpractice exposure) it may actually be desirable to go through the probate process so that potential creditor's claims may be cut off; for such a person, the testamentary trust may be a viable option.
While testamentary trusts obviously will not avoid the probate process, most of what has been said about living trusts applies as well to testamentary trusts. Whether living or testamentary, a trust is a marvelously flexible way to provide for control over the use of assets, even after the death of the original owner.
This content was adapted by William King Self, Jr., CELA, with permission, from materials developed by Robert Fleming, CELA, well-known and respected elder and special needs planning lawyer in Tucson, Arizona. See his website, www.elder-law.com for further useful information.