The most common Trust used for estate planning purposes is referred to as a “Revocable Trust”.
A Grantor (or Settlor) is the person creating the Trust. When a Revocable Trust is established, a Trustee must be appointed to manage and later distribute the Trust assets to the beneficiaries or to legacy Trusts for beneficiaries. The Trustee appointment occurs upon the creation of the Trust. The Grantor may appoint him or herself as Trustee and often joins their spouse as Co-Trustee. The Revocable Trust instrument (document) instructs the Trustee on how to manage the assets during the Grantor’s lifetime. The Trust instrument also tells the Trustee when and how to address incapacity, and how and when to distribute the assets to the beneficiaries named in the Trust.
If the Grantor is named as the Trustee of his or her Revocable Trust, a Successor Trustee is normally named in the Trust to manage and distribute the Trust assets if the Grantor is subsequently incapable of serving as Trustee as a result of the Grantor’s disability, incapacity, or death.
Only assets transferred into the name of the Trust (this is often called “funding” the Trust) can be administered by the Trustee who then manages the Trust assets for the benefit of the beneficiaries. The Grantor must convey real property (real estate) to the Trust by a properly executed deed in order for the real property to be an asset of the Trust. Likewise, personal property must be transferred to the Trustee by a properly executed Bill of Sale. Bank accounts, stock certificates, certificates of deposits, and other intangible assets must be re-titled (“funded”) in the name of the Trust. Trust funding, especially when retirement accounts are concerned, is easy to mismanage. Consulting with The Miller Elder Law Firm’s Funding Specialist before transferring assets into a Trust is strongly recommended.
Assets that are not conveyed or transferred to the Trust prior to or at death, will be subject to the probate process. A pour-over will is normally used to distribute assets not owned by the Trust when the Grantor dies. These assets are then administered and poured into the Trust and then distributed pursuant to the terms of the Trust, if there are assets remaining after all estate/probate creditors have been paid and claims are satisfied. Proper funding of the Trust may avoid this probate process.
A Trust established during the lifetime of the Grantor/Settlor can be either revocable or irrevocable. A Revocable Trust permits the Grantor to revoke the Trust, alter the terms of the Trust, or withdraw some or all of the assets from the Trust. A Revocable Trust becomes irrevocable, by operation of law, upon the death of the Grantor. Since the Grantor of a Revocable Trust retains control of assets through his or her power to revoke or alter the Trust, there are no gift, income, and estate tax consequences when assets are conveyed to a Revocable Trust. The Grantor continues to report the earnings of the Trust assets on his or her personal income tax return if the Grantor is the Trustee and he uses his or her own social security number to report the income.
A Revocable Trust is an excellent tool to plan for the administration of assets in the event of a disability. A Successor Trustee can be named to administer the Trust assets if the Grantor’s incapacity occurs. The Trust instrument normally states that when the written opinion of a licensed physician (normally the Grantor’s physician) along with trusted family members, either by majority or unanimity, certifies that the Grantor is incapable of managing his or her property, the Grantor’s Trustee authority is suspended and a Successor Trustee takes over.
The assets placed in a Trust are not typically subject to a probate proceeding; however, these assets must be administered pursuant to a Trust Administration. The Successor Trustee must collect the Trust assets, pay the Grantor’s final bills, be responsible for the federal estate tax apportioned to the Trust, and make distribution of the remaining assets according to the Trust’s instructions. Creditors in a probate proceeding must file claims in order to be paid. It is often advised that an Estate Tax return be filed, in order to capture the deceased spouse’s remaining credit on their estate tax coupon.
Irrevocable Trust Based Planning
A less common type of Trust is an Irrevocable Trust. An Irrevocable Trust cannot be amended or altered in most circumstances. The assets conveyed to an Irrevocable Trust cannot be withdrawn or returned to the Grantor (except in certain circumstances). An Irrevocable Trust is normally created to avoid estate taxes. A person may transfer assets to an Irrevocable Trust to avoid having to include the increase in value of these assets in his or her taxable estate at death. It is important to remember that a transfer of an asset to an Irrevocable Trust constitutes a gift. Accordingly, the fair market value of the asset on the date of the transfer to the Trust must be reported to the Internal Revenue Service. The advantage of transferring assets to an Irrevocable Trust is that the appreciation in the value of these assets will not be subject to federal estate taxes upon the taxpayer’s death.
Another use of the Irrevocable Trust is to exclude the value of life insurance from the taxable estate calculation. This Trust is known as an ILIT, or Irrevocable Life Insurance Trust. Since the life insurance policy is owned by the Trust and not the taxpayer, the proceeds paid on the taxpayer’s death are not included in his or her gross estate for calculation of estate taxes. The payment of the premium for the life insurance during the taxpayer’s life is normally made from annual contributions by the taxpayer to the Trustee of the Irrevocable Trust.