A trust is created when a person (settlor) transfers assets to himself or herself or another person or trust company (trustee) to hold for his or her benefit or the benefit of others (beneficiaries).
I. THE PLAYERS
A.Settlor - Sometimes referred to as a grantor or trustor, the settlor is the individual who establishes the trust.
B. Corpus - The corpus, often called principal, is the asset held by the trust. When a trust is established, it may or may not be funded immediately with the corpus. A settlor is often permitted to make additions to the corpus of a trust.
C. Trustee - A trustee, which can be an individual or a corporate entity or both, is the fiduciary responsible for managing the corpus and carrying out the intentions of the settlor in accordance with the terms of the trust document.
D. Beneficiary - The beneficiary or beneficiaries reap the benefits of the trust. A beneficiary can be an income beneficiary or a remainderman or both. The income beneficiary is entitled to the income, and sometimes part of the principal, from the trust either absolutely or at the discretion of the trustee. The remainderman is entitled to the principal of the trust, usually upon a specified date or the death of the income beneficiary.
II. TESTAMENTARY VS. INTER VIVOS
The only difference between a testamentary and an inter vivos (“living”) trust is that the former is a trust created by one’s will and the latter is a trust created during one’s lifetime. Often, the same tax planning and distribution schemes can be accomplished by either document.
III. REVOCABLE VS. IRREVOCABLE
A revocable trust is a trust which the settlor has specifically reserved the right to revoke or amend during his or her lifetime. By definition, a revocable trust may not be a testamentary trust. Revocable trusts are always inter vivos, or “living” trusts, a detailed description of which is provided below. The revocable trust can also be made irrevocable. Usually this occurs by act or death of the settlor/beneficiary. Of course, all testamentary trusts, having been created by will after one’s death, are irrevocable.
An irrevocable trust may be created initially as such by its terms. Typically, a settlor creates an irrevocable trust during his or her lifetime to achieve a death tax savings or protect assets. Assets in a qualified irrevocable trust can escape death taxes at the settlor’s death. An irrevocable trust is “qualified” if the settlor does not retain any incidents of ownership over the trust, such as the right to revoke or amend the trust, remove or replace the trustee, demand distributions of income or principal from the trust or borrow against the principal. Irrevocable trusts may be used to purchase insurance covering the life of the settlor, or the joint lives of the settlor and his or her spouse, the proceeds of which can be totally insulated from death taxation when distributed, typically, to the children. Irrevocable trusts can also be used to shelter assets from creditors. Of course, the settlor’s own ability to benefit from such asset protection trusts must be considerably curtailed.
IV. THE “LIVING TRUST” IS OVERSOLD
Living trusts, which as noted above are also called revocable inter vivos trusts, have many fine features, however, advertisements and “product” sales persons tend to overstate their advantages. In some instances the advertisements, particularly those offering self-help products, are plainly misleading. There are four good reasons for establishing a living trust: First, some people may want their assets managed by a corporate fiduciary or other party to relieve them of the burden, or to consolidate real estate owned in numerous jurisdictions. However, a durable power of attorney is also effective for this purpose. Second, the trusts can eliminate the need to probate a will in more than one state when real estate is owned in a number of states. Third, such trusts can eliminate the need for, or at least reduce the cost and headaches of, probate in those states such as California or South Carolina where the proceedings are costly, complicated and protracted (that is not the case in Pennsylvania and New Jersey). Fourth, wills are subject to public scrutiny the moment they are probated, but living trusts sit privately in the hands of the trustee until an account must be filed for court adjudication, or some other court action becomes necessary. Only at that time does the trust become a public document. Too often, though, living trusts are recommended for the wrong reasons. First, any trust that one creates for his or her own benefit will not save any death taxes. Second, as noted above, there is no compelling reason for Pennsylvania or New Jersey residents to create a trust simply to avoid probate. The horror stories about probate originate in states where probate and the estate administration procedures are quite different and complex. However, probate is fast, easy and inexpensive in Pennsylvania and New Jersey. An experienced lawyer with properly prepared papers can probate a will in these states in less than ten minutes. No prior notices or appraisals are required and no judicial proceeding is involved. Living trusts may certainly permit the distribution of funds to the surviving family members on an expedited basis, however, there is usually no reason the executor of the will of a decedent domiciled in Pennsylvania or New Jersey cannot provide the same service.
V. THE “FAMILY”, “BY-PASS” OR RESIDUARY TRUST IS A VALID AND USEFUL DEATH TAX SAVINGS TECHNIQUE
For those who are married and have combined estates valued in excess of $675,000, we frequently recommend dividing the estate so that assets valued up to $675,000 (the value of the federal estate and gift tax exemption for 2000) are titled in the name of each spouse. A trust to hold this amount is established either under the will or as part of an inter vivos trust for each spouse. This important trust which holds the exemption-equivalent amount is also variously called a residuary, by-pass, credit-shelter and family trust. Rather than allowing all of the assets to end up in the hands of the surviving spouse (which would result if all assets were jointly owned) to be totally exposed to death taxation when he or she dies, the trust effectively “holds out” the maximum amount without exposing it to federal estate taxation at the death of the first spouse so that at the death of the surviving spouse, at least that amount, including any appreciation, will not be needlessly added to his or her estate. Of course, the $675,000 exemption is also applicable to whatever assets are in the surviving spouse’s name. In effect, the combination of the two exemptions this year totals $1.35 million.