Trusts

A trust is a legal arrangement through which one person (or an institution, such as a bank trust department), called a "trustee," holds legal title to property for another person, called a "beneficiary."  The person creating the trust is referred to as the “Grantor” or “Settlor.”  Typically, when you establish a Trust, you hold all three roles at the same time:  Settlor, Trustee, and Beneficiary. The rules or instructions under which the trustee operates are set out in the trust instrument. Trusts have one set of beneficiaries during their lives and another set, often their children, who begin to benefit only after the first group has died. The first are often called "life beneficiaries" and the second "remaindermen." (For an overview of a trustee's duties, click here.)

Uses of Trusts

There can be several advantages to establishing a trust, depending on your situation. The best known is the advantage of avoiding probate. In a trust that terminates with the death of the Settlor, any property registered in the trust prior to the Settlor's death passes immediately to the beneficiaries by the terms of the trust without requiring probate. This can save time and money for the beneficiaries. Certain trusts can also result in tax advantages both for the Settlor and the beneficiary. These are often referred to as "credit shelter" or "life insurance" trusts. Other trusts may be used to protect property from creditors or to help the Settlor qualify for Medicaid nursing home benefits. Unlike Wills, trusts are private documents and only those individuals with a direct interest in the trust need know of trust assets and distribution. Provided they are well-drafted, another advantage of trusts is their continuing effectiveness even if the Settlor dies or becomes incapacitated.

Types of Trusts

Trusts fall into two basic categories: testamentary and inter vivos.

A testamentary trust is one created by your Will, and it does not come into existence until you die. In contrast, an inter vivos trust starts during your lifetime. You create it now and it exists during your life.

There are two kinds of inter vivos trusts: revocable and irrevocable.

Revocable Trusts

Revocable trusts are often referred to as "living" trusts. With a revocable trust, the Settlor maintains complete control over the trust and may amend, revoke or terminate the trust at any time. This means that you, the Settlor, can take back the funds you put in the trust or change the trust's terms. Thus, the Settlor is able to reap the benefits of the trust arrangement while maintaining the ability to change the trust at any time prior to death.

Revocable trusts are generally used for the following purposes:

     1.  Asset management. They permit the named trustee to administer and invest the trust property for the benefit of one or more beneficiaries.

     2.  Probate avoidance. At the death of the person who created the trust, the "grantor" or "Settlor," the trust property passes to whoever is named in the trust. It does not come under the jurisdiction of the probate court and its distribution need not be held up by the probate process. However, the property of a revocable trust will be included in the grantor's estate for federal estate tax purposes.  Note, Michigan does not have a state estate tax.

     3.  Tax planning. While the assets of a revocable trust will be included in the grantor's taxable estate, the trust can be drafted so that the assets will not be included in the estates of the beneficiaries, thus avoiding taxes when the beneficiaries die.

     4.  Long-term care planning.  Married couples can establish certain revocable trusts that provide that the assets left to the surviving spouse by the first spouse to die, are available for the survivor’s needs, but are protected from the Medicaid spend down requirement if the surviving spouse should later need long-term care in a nursing home.

Irrevocable Trusts

An irrevocable trust cannot be changed or amended by the Settlor. Any property placed into the trust may only be distributed by the trustee as provided for in the trust document itself. For instance, the Settlor may set up a trust under which he or she will receive income earned on the trust property, but that bars access to the trust principal. This type of irrevocable trust is a popular tool for Medicaid planning.

Testamentary Trusts

As noted above, a testamentary trust is a trust created by a Will. Such a trust has no power or effect until the Will of the Settlor is probated. Although a testamentary trust will not avoid the need for probate and will become a public document as it is a part of the Will, it can be useful in accomplishing other estate planning goals. For instance, the testamentary trust can be used to reduce estate taxes on the death of a spouse or provide for the care of a disabled child.

Supplemental Needs Trusts

The purpose of a supplemental needs trust is to enable the Settlor to provide for the continuing care of a disabled spouse, child, relative or friend. The beneficiary of a well-drafted supplemental needs trust will have access to the trust assets for purposes other than those provided by public benefits programs. In this way, the beneficiary will not lose eligibility for benefits such as Supplemental Security Income, Medicaid and low-income housing. A supplemental needs trust can be created by the Settlor during life or be part of a Will.

Credit Shelter Trusts

Credit shelter trusts are a way to take full advantage of the estate tax exemption. The first $3.5 million (in 2009) of an estate is exempt from estate taxes, so theoretically a husband and wife would have no estate tax if their estate is less than $7 million. However, if one spouse dies and leaves everything to the surviving spouse, the surviving spouse may have an estate that is greater than $3.5 million. When the surviving spouse dies, any part of the estate over $3.5 million will be subject to estate tax.

To avoid this problem, the spouses can create a credit shelter trust as part of their estate plan. When one spouse passes away, the first $3.5 million of that spouse's estate is put in to a trust. The surviving spouse can receive income from the trust, but as long as he or she does not own the principal, the money will not be included in the surviving spouse's estate when he or she passes away. The principal continues to be owned by the trust.

Asset Protection

In addition to protecting against long-term care costs and estate taxes, married couples can establish trusts with provisions that protect the surviving spouse from elder abuse/financial exploitation and lawsuits and creditors.  Moreover, the trust can also be drafted so that if the serving spouse remarries, the assets in the trust are not lost if the marriage later ends in divorce or the person the surviving spouse married turns out to be a gold digger or gigolo.  This ensures that the assets stay in the family tree instead of passing to the new spouse.