Trusts, Pt. 2: When should they be used?
By F Hale Stewart, JD, LLM, CAM, CWM, CTEP
The Law Office of Hale Stewart
In my first article on trusts, I looked at some of the nuts and bolts. Today, I'll finish up with some basics and then talk about more advanced terminology and concepts.
In addition, I’d like to add this cautionary word: In these articles I am discussing the very basics of trusts to give the reader the appropriate tools to talk with clients and potential clients. If you have further questions, please contact an attorney regarding your specific situation.
First, a few more preliminary points.
It is possible to have a non-written trust. At least it is on a law school final. Here’s my advice regarding verbal trusts: don’t. Always — always — have a written document that explains the basic terms. Verbal trusts are a litigation nightmare waiting to happen.
A revocable trust is a trust that can (obviously) be revoked. This also means the terms of the trust can be changed. For example, it allows the grantor the opportunity to add or subtract a beneficiary, change a disbursement scheme, or make any other change he wants to make, including dissolving the trust.
The benefit with a revocable trust is that it prevents application of the gift tax rules because a revocable trust is an incomplete gift.
In contrast, an irrevocable trust is a trust that can’t be changed by the grantor. Additionally, once a trust becomes irrevocable, the grantor has made a completed gift, meaning we must how take the gift tax rules into consideration.
So, now that we have some of the basics down, when should we use trusts?
Trusts are very good at one thing: segregating property, placing it under professional management and controlling its manner of investment and disbursement.
For example, suppose a client wants to make sure a spouse is taken care of when they (the client) die. The client can establish a trust as part of their estate plan and make the spouse the primary beneficiary. The spouse can receive all the income from the trust on at least an annual basis and also have the right to dip into the trust’s principal for their “health, education and welfare.” After the spouse dies, the money can be distributed to their children (the grantor’s children).
The client can also write an investment policy directing the trustee to only invest in certain types of assets (for example, single “A” and above securities) and only in certain percentages (no investment can account for more than 5 percent of total trust assets).
The above stated possibilities are just that: one available possibility. The total number of possibilities are endless, depending only on creativity.
Another very common trust is an irrevocable life insurance trust, or ILIT. Life insurance is often sold as part of an estate plan. However, under the estate tax rules, the value of the life insurance policy will be included in the gross estate if “the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person.”
To prevent this rule from applying, estate lawyers write and fund an ILIT, placing the life insurance policy in the trust and taking the “incidents of ownership” out of the grantors hands. This effectively removes the face value of the policy out of the grantor’s estate.
These are but two of the most common applications of trusts. In the next topic, I’ll touch on the more advanced concepts such asset protection trusts, GRATs and intentionally defective grantor trusts.