3 Concepts That You Need to Know When Setting Up an Estate Plan Trust

Posted By: Ken Russell | April 24th, 2017

Trusts are one of the cornerstones of Estate Planning.  Trusts are a very flexible concept with multiple uses which are developed and tailored to each family and their respective needs.

Here are 3 concepts that will help you to determine what kind of Trust would work best for you.

#1 – The Different Parties to a Trust

A Trust is a contractual arrangement between three parties: the Grantor(s), the Trustee(s), and the Beneficiary(ies).

  • The Grantor – the person or persons who create the trust – that is you. The Grantor(s) selects the Trustees and Beneficiaries and then set forth the terms of the management of the Trust and how it operates in the Trust document.
  • The Trustee – the person or persons who takes title to and manages the Trust’s assets for the benefit of the Beneficiaries in accordance with the instructions that the Grantor(s) sets forth in the Trust.
  • The Beneficiaries – the persons for whom the Trust is established and benefits. In your case, the natural beneficiaries would be your children or others whom you name.

#2 – A Revocable Trust vs. an Irrevocable Trust

A Trust can be drafted as either “revocable” or “irrevocable.”  The differences between a Revocable Trust and Irrevocable Trust are as follows:

  • A Revocable Trust – you can set it up, terminate it; put money in, take it out; name a trustee, change the trustee; or change the language in the Trust. You have full control over a Revocable Trust.
  • An Irrevocable Trust – the opposite of a Revocable Trust. Once you set up an Irrevocable Trust, you can’t terminate it; put money in, you can’t withdrawal the money; name the trustee, you can’t change the trustee; and, with very few exceptions, you can’t change the terms of the Trust.  Once established, you have no control over an Irrevocable Trust.

Why would anyone use a Revocable Trust if you have no control over the Trust once you set it up?  Generally, any asset that you have “control” over for IRS purposes is considered in your estate and taxable.  Any asset that you don’t have “control” over is outside of your taxable estate and is not taxed. For persons with significant assets, ensuring that the assets placed in the Trust will not be taxed (at the federal level) is important to the growth of the Trust for the Trust’s Beneficiaries.  There may be other reasons why one type of Trust is preferable over another.

Aside from the tax benefits of an Irrevocable Trust, an Irrevocable Trust also has asset protection features derived from its design.  This design ensures that neither creditors nor divorcing spouses can access funds contained in the Trust.

#3 – Trust Design

Our trusts are drafted so that every Beneficiary will have their own separate Trust. The design of each Beneficiary’s Trust has almost unlimited options.  Here are some examples of standard designs:

  • Standard Option

Typically, Trusts are drafted such that the Trustee may distribute to a Beneficiary all or a portion of the income and principal of that Beneficiary’s separate trust  – as the Trustee deems necessary or advisable for the education, health, maintenance, and/or support of such beneficiary (those terms are defined in the document).

This is a broad “invasion” provision definition that allows the Trustee to distribute Trust assets to a Beneficiary for most necessary expenses during the course of the year.

  • Alternative 1 – Restricted Distributions until Predetermined Age

In this design, the Trustee(s) may distribute to a Beneficiary all or a portion of the income and principal of that Beneficiary’s separate trust as the Trustee deems necessary or advisable for the health and education of such Beneficiary until that Beneficiary attains a certain age, such as forty (40).  Once the Beneficiary turns the required age, the Trustee(s) could also distribute income and/or principal for said Beneficiary’s maintenance, support, and best interest.  This design is to limit a Beneficiary living off of the Trust assets during his or her younger working years, thereby ensuring the Beneficiary needs to work during that time, with the Trustee’s discretion expanding once the Beneficiary attains an older, and, hopefully, wiser age.

  • Alternative 2 – 10% Yearly Limitation on Principal Distributions

In this design, the Trustee(s) may distribute to a Beneficiary for the reasons that you choose, but such distributions are limited to all of the income and a maximum of ten percent (10%) of the principal value of that Beneficiary’s separate trust (valued typically at the beginning of the year).  The reasons can, again, be for the Beneficiary’s education, health, maintenance, support, but the 10% limitation ensures the long-term viability of the Trust assets.

  • Alternative 3 – Incentive Trust

If this alternative is selected, your Trust would impose fixed conditions on distributions to encourage or discourage certain behaviors by using distributions of Trust’s income and/or principal as an incentive.

Some of the types of activities and incentives might include: paying for college and giving a lump sum distribution upon graduation; providing funds for a down payment to purchase a home; making a loan to enable a child to start or buy a business; or providing living expenses to allow a child to undertake non-profit, religious, or charitable work.

The goal of these restrictions is to encourage the responsible use of the funds and the encouragement of the Beneficiary’s responsible behavior. The Trustee(s) may also be instructed to withhold funds from any Beneficiary that exhibits irresponsible or abusive behavior in any manner that you direct.  The options with this kind of Trust are endless.

  • Other Considerations Regarding Trust Design

When will your Beneficiary receive income?

  • Immediately
  • Monthly
  • Quarterly
  • Annually
  • For Health, Education, Maintenance, and Support (“HEMS”)
  • None – added to principal

When will your Beneficiary receive principal?

  • HEMS or only an individual element of HEMS
  • HEMS + Best Interest
  • Limitation on the percent that can be withdrawn.

Upon the death of a Beneficiary, what happens?

  • As Grantor, will you designate everything in the Trust without the Beneficiary having a right to change who receives Trust assets after his or her death?
  • Do you permit some discretion though a “Power of Appointment,” which permits the Beneficiary to designate different percentages to their children?
  • Do you permit the Beneficiary to leave his or her Trust to charity as well as his or her descendants?
  • Do you permit the Beneficiary to leave the Trust to his or her spouse (typically not)?
  • What is the default provision when no one that you have designated is able to inherit?
  • Can a Trustee resign?
  • If a Trustee resigns or no longer wishes to act, what happens?
  • Can a Corporate Trustee be named or act as Trustee?
  • Can the Trustee select a successor?

These constitute some of the basic concepts behind a Trust and also some basic Trust design options.  Baratta, Russell & Baratta is able to discuss your individual situation, determine whether a Trust is appropriate for your planning, and then discuss detailed options on the design of your Trust.

About the Author

Ken Russell is the principal attorney in Baratta, Russell & Baratta Trusts & Estates department. Ken has been providing estate planning and administration legal advice for over 20 years. Ken understands the importance of your legacy and ensuring your loved-ones receive the fruits of your lifetime of effort.

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