Nov 22, 2009

In prior months we have discussed a number of the “Tools” which comprise a well rounded Estate Plan. While I have opined that the Durable Power of Attorney is perhaps the all-important “hub” of a good plan, the Revocable Living Trust is–perhaps–equally important.

Often referred to as a “Will-substitute,” the Revocable Trust functions, like a Will, to distribute assets to heirs (known as “beneficiaries”) after death. However, it is the additional things that can be done with a Trust that make it “shine” in the Estate Planning arena. A Trust allows the maker (known as a “grantor”) to provide for ongoing management of assets and controlled distributions for beneficiaries who may be minors, incapacitated, or simply not ready for unfettered receipt of assets in the mind of the grantor. And, during the continued lifetime of the grantor, the Trust can be an important asset management tool in the event of the grantor’s own incapacity.

In most states, a Trust is not subject to the same “formalities of execution” that a Will must have. Trusts are generally governed by contract law (with some modification by modern state Trust Codes), which can allow for more flexibility in drafting for the wishes of the grantor.

The “magic” of the a Trust is that it is recognized as a “legal person” and therefore, “lives on” after the death of the Grantor. This means that there is essentially uninterrupted management and control of assets within the Trust and (usually) no need for court-supervised administration of the estate.

Like many legal concepts, there are some common misconceptions about Trusts:

Trusts do not save or avoid taxes. Trusts, themselves are simply tools. Avoidance or reduction of taxes requires active planning, and often involves the use of Trusts. Many times over my 25 years of practice, I have seen persons relying on the existence of a Trust as a tax savings, only to be rudely surprised after it was too late.

ou don’t have to hire a third party Trustee. There often seems to be this vague notion that you must put all your assets in a box, take it down to the bank or brokerage, and entrust it to some third party who then tells you how and when you can use them. This is followed by a similar vague thought about the expense involved.

In reality, you may–and usually should (and the substantial majority of my clients do) be your own Trustee. Indeed, most of these Trusts are known as “Grantor-Revocable Trusts” (which has a technical tax meaning). Michigan’s Trust Code actually provides that the grantor of such a Trust remains and is treated as the owner of the Trust assets in all respects. There is no independent tax reporting or filing under a grantor-revocable Trust. Nor is there any duty to “account” (it just wouldn’t make sense to require you to account to yourself).

On the death or incapacity of the grantor, a successor trustee can be a family member or close personal friend or advisor. With married couples, we usually appoint spouses as co-trustees, with the surviving spouse continuing in that role. This doesn’t mean there is never a time when a third party Trustee might be advised. There are professional trustees who are well versed in trust and asset management and set up to fulfill the formal requirements of trust administration. Most often this arises after the grantor’s death.

You don’t have to have be a millionaire for a Trust to be advised. I would like to have $10 for every time in my career that I have heard a client (and sometimes a colleague) say the estate wasn’t large enough for the estate tax and therefore a trust wasn’t necessary. This misconception goes hand-in-hand with the notion that Trusts somehow eliminate or reduce taxes. The primary function of a Trust is orderly, managed, asset distribution without the need of Probate. Any client who owns a home, has life insurance and some other assets is at least a candidate for a Revocable Living Trust.

There are certain crucial steps in setting up an Effective Trust:

Trusts must be Funded! One critical error we see regarding Trusts is that they often fail to be funded. I like to describe a Trust as a box. The document itself is the box.

We can make a pretty nice box, with lots of proverbial bells and whistles. But by itself, it is still just a box–an empty box.

The trust will only cover assets that are titled in the trust, or are designated to automatically pay into the trust at some point (often on death). Other assets will still be subject to probate (or may, whether intended or not, pass directly to a beneficiary or joint owner).

Careful attention must be paid to each type of asset in this process. There are even some assets which in most circumstances, should probably not be put into a Trust (most notably, many retirement plan assets).

Regular Monitoring is Critical. Another factor contributing to the failure of Trusts in Estate Planning is the failure to periodically and consistently review the plan. This relates not just to the document itself, but to the process of funding. The one true constant in our lives is change. I am consistently impressed with how often clients change their asset mix. CD’s become due. Accounts are changed to “better” investments. Products are exchanged and rolled over. And banks seem to change names so often these days that often the paint isn’t even dry on the new signs between name changes. All these factors contribute to the crucial need to undertake periodic review. While I am hesitant to set a “rule of thumb,” if it has been more than two years between reviews, that is too long! The reality of the situation is that your own particular circumstances will dictate the frequency.

We recommend Revocable Living Trusts for the majority or our Estate Planning clients, not because it is a “favored product,” but because it truly fits the needs and goals of most clients in our experience. In upcoming posts, I will address some variations of Trust Agreements that may be recommended for clients with particular circumstances.


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