Trust Law and Estate Planning: A Complete Guide

Introduction to Trusts and Estate Planning

A trust is a valuable tool in the process of organizing an estate plan. It is a legally created entity established for the expressed purpose of holding assets that are managed in accordance with the terms dictated by the trust document. The individual creating the trust—the grantor—describes how the trust assets are to be managed and distributed. In creating the trust, an individual or institution is designated as the trustee. The trustee is empowered to manage the trust in accordance with its written terms. Trusts are ordinarily created for the benefit of designated beneficiaries.

There are several general forms of trusts. One form is a revocable trust, which allows the grantor to change his mind and withdraw assets from the trust. Irrevocable trusts, on the other hand, require that the grantor surrender permanent control over the assets unless the terms of the trust dictate otherwise. The creation of a trust can be a simple matter, but some trusts are extremely complicated and require the expertise of an individual thoroughly trained in trust law, as the tax implications can be highly confusing.

Essential Elements and Creation of Trusts

Elements of a Valid Trust

There are essential elements that must be satisfied in order for a valid trust to be created. First, there must be a trustee. This individual holds legal title to the trust property on behalf of the beneficiaries, who hold equitable title. The second element is that there must be property in the trust—property that is capable of being owned. Typically, such property takes the form of land or stocks. Items such as pension funds cannot form the corpus of a trust. Every trust must also have a beneficiary, who must be either an individual or a charity capable of benefiting from the trust. A trust that does not have a designated beneficiary is unenforceable. The final element is that the trustee must handle the trust property for the benefit of the beneficiaries and in accordance with the terms of the trust.

Creation of Express Trusts

In creating an express trust there must exist a stated intent to create a trust. No specific language is required to express this intent, but the intent must be clearly understood. In most cases, allowing the beneficiary to know that the trust exists aids in establishing intent. At the time the trust is created, the individual creating it must have the legal capacity to do so—meaning he or she must be able to understand the effect of the trust. Additionally, the designated trustee, whether an individual or institution, must also have the capacity to serve in that position.

As a third element of trust creation, the terms of the trust must in most circumstances be in writing in order to comply with the Statute of Frauds. Trusts may be created for nearly any purpose as long as that purpose is neither illegal nor against public policy. A trust created, for example, to avoid the payment of creditors would be against public policy and, therefore, invalid and unenforceable. There must be at least one beneficiary designated to receive the benefits of the trust; if no individual or charity is designated, the trust is deemed unenforceable and no one can compel the trustee to carry out its terms.

Once the trust is created and property is transferred to the management of the trustee, the trust holds legal title to the trust property while the beneficiary holds equitable title. In drafting trust agreements, careful attention must be paid to the Rule against Perpetuities and Restraints on Alienation. These two ancient legal concepts are applied differently depending on the jurisdiction, but their application can frustrate the intent of the grantor, and special attention must be afforded both.

Beneficiary Interests and Charitable Trusts

Transfer of a Beneficiary's Interest

Under normal circumstances, the beneficiary of a legal trust owns an equitable interest in the property that forms the corpus of the trust—that is, he or she is entitled to the benefits the property generates in accordance with the trust's terms. This equitable interest can be sold, transferred, or assigned just like any other property interest. The terms of the trust, however, may limit the ability of a beneficiary to dispose of that interest. For example, the trust may stipulate that any attempt by a beneficiary to sell, transfer, or otherwise dispose of the interest may result in the equitable interest reverting to someone else. Many trusts include a special provision known as a spendthrift clause that further restricts the beneficiary's use of trust proceeds. Such provisions are commonly used in situations where the beneficiary has a history of poor money management.

Charitable Trusts

Often the beneficiary of a trust is a charity. Like all trusts, the designated charitable beneficiary can be of any legal form so long as it is legally recognized as such. Charitable trusts can take on several forms. A grantor can designate the charity as a beneficiary without any limitations, but there is also a hybrid form known as a charitable remainder trust (CRT), which allows the grantor to make a gift to charity while still reserving some benefit for himself or herself. This type of trust is particularly useful in situations where the trust involves property that has appreciated significantly in value and an outright sale would generate substantial capital gains taxes. In effect, the charity becomes the owner of the property but the grantor retains the income generated by the property. Once the grantor dies or terminates the trust, the property reverts entirely to the charity.

There are three specific forms of CRTs, each involving different benefits for the charity and the grantor. Under a charitable remainder annuity trust, the grantor receives a fixed percentage of the original trust property. The second form, the charitable remainder unitrust, provides the grantor with a fixed percentage of the fair market value of the property—as opposed to the value at the time the trust was created—allowing the grantor to benefit from any subsequent appreciation. The third form is the charitable lead trust, under which the grantor retains title to the property while the charity receives all income from the property during the life of the trust; once the trust is terminated, the property reverts to the grantor or his heirs. All charitable remainder trusts must be irrevocable in order to be enforceable. The grantor, however, does retain the authority to change the designated beneficiary, assuming that power was reserved at the time the trust was created.

Conclusion: Practical Considerations in Trust Planning

A trust is a legal creation wherein a right in property—either real or personal—is held by a fiduciary for the benefit of another. The individual in the fiduciary position is the trustee, who actually holds legal title to the property, while the person to whom the benefits flow is the beneficiary, who holds equitable title to the property contained in the trust.

The purposes for creating trusts are numerous and can incorporate nearly every condition imaginable. Until recently, the law supporting trust creation was governed largely by the state laws of the jurisdiction in which the trust was created, but the adoption of the Uniform Probate Code has had considerable impact on trust law, and many jurisdictions have adopted its provisions.

The advantages connected to the use of trusts include minimizing one's tax liability through devices such as the marital deduction trust, a Crummey trust, or irrevocable life insurance trusts. Each of these trusts has unique features tailored to specific needs, but they all share the common goal of reducing estate tax liability. Trusts can also be used to avoid the need to probate one's estate upon death. Through a trust, arrangements can be made to provide for one's family without interruption, as the trustee is immediately empowered upon the grantor's death to continue operation of a business. The use of a trust also protects the deceased's family from public exposure and scrutiny that might result from the public disclosure of estate assets at the time of death. Probate court records are public and subject to inspection by anyone with an interest; trust documents are not public record and do not have to be probated, so the contents of a trust are typically never disclosed to the public.

The selection of a reputable trustee is an important feature of trust creation. The chosen trustee should be not only trustworthy but should also possess some measure of professional expertise in law, accounting, or finance. It has become increasingly popular to choose an institutional trustee, such as a bank with a dedicated trust department accustomed to the intricate administration of trusts. Institutional trustees provide a measure of detachment that is often important in the sensitive management of relationships with beneficiaries.

Trusts do not become valid until ownership of the property that is to form the corpus of the trust is transferred to it. Accompanying that transfer, a trust agreement should be drafted setting forth the specific powers and authority of the trustee, designating the beneficiaries, and specifying how the property in the trust will ultimately be distributed.

Although there are many types of trusts, the two general categories are revocable and irrevocable. In the case of revocable trusts, the grantor retains the right to revoke the trust and most control over the property. Irrevocable trusts are far more limiting and, in most cases, require that the grantor surrender most or all control over the property to an independent trustee.

The power to determine when a trust will end lies with the original grantor. The intent may be to have the trust exist for a relatively short period—to avoid taxes or probate—in which case the trust may end upon the grantor's death or shortly thereafter. In other situations the grantor's intent may be to provide for the long-term care of family and grandchildren, in which case the trust may run for many years. Drafters of trust agreements expected to last a number of years must consider the Rule against Perpetuities and Restraints on Alienation and their application in the relevant jurisdiction.

The type of trust a grantor chooses depends entirely upon the circumstances dictating the need for it. Trust law and trust planning have largely developed in response to tax laws—as the tax laws changed, new trust instruments were created by individuals seeking to minimize tax liability or protect their assets. Determining which trust form to utilize is dependent on the specific circumstances of the grantor, and acquiring competent professional advice prior to selecting a specific form is vitally important.

The creation of a trust does not mean the document cannot later be modified or terminated. Each jurisdiction has its own laws governing how modifications and terminations may be effected, but in general, such changes can be made as long as the grantor retains the legal capacity to convey his or her intentions. In circumstances where the grantor's legal capacity is in question and a power of attorney has been endorsed, or where the beneficiaries petition the court, the trust may also be modified or terminated.

The law surrounding trusts is complex and requires the services of legal and accounting professionals experienced in the area. Trusts are a powerful estate planning tool but must be used carefully.