Definition of Trusts
A trust is a legally recognized arrangement that enables one person to transfer assets to another person, who holds and manages the assets for the benefit of yet another person. It is a contractual arrangement between three parties: the grantor or settlor, the trustee, and the beneficiary. The grantor transfers assets to the trustee, who holds and manages the assets for the benefit of the beneficiary.
A Trust Is an Agreement
Trusts have been in existence since ancient Roman times and were reintroduced to Western Civilization in England during the Crusades. English landowners who wanted to pass ownership of their land to female heirs or younger sons developed the concept of selling the land to a third party, with the agreement that the third party would hold the land in trust for the benefit of a specified individual.
In modern times, a trust is a similar arrangement. The grantor transfers assets to the trustee, who holds and manages the assets for the benefit of the beneficiary. The trust agreement is the contract between the grantor and the trustee. It is important to note that a trust is not a legal entity and cannot own assets or enter into contracts, only the trustee can.
Legal and Equitable Title
During the Crusades, nobles would transfer ownership of their land temporarily to a friend, who would manage and care for the land during their absence. On their return, some nobles found their friends unwilling to transfer title back to them. This resulted in a need to distinguish between legal title to the land (held by the friend) and equitable title to the land (still held by the noble).
In modern times, the trustee holds legal title to the assets of a trust, and the beneficiary continues to hold equitable title in the assets. The trustee has control over the assets but must always be mindful of the beneficiaries who remain the true owners of the assets. The beneficiaries hold all interests in trust assets other than legal title, including the right to income, right to possession, and the right to acquire legal title in the future.
Common Trust Terminology
There are several key terms used in the trust agreement that are important to understand:
- Grantor or Settlor: The person who transfers assets to the trustee.
- Trustee: The person who holds and manages the assets for the benefit of the beneficiary.
- Beneficiary: The person who receives the benefits of the trust.
- Trust Agreement: The contract between the grantor and the trustee.
- Trust Assets: The assets transferred to the trustee by the grantor.
- Legal Title: The title held by the trustee to the trust assets.
- Equitable Title: The title held by the beneficiary to the trust assets.
There are various benefits to using a trust, including:
Name Camouflage and Privacy
Trusts offer a high level of privacy and confidentiality, as they do not need to be registered with any state department or filed with the probate court. This means that both the details of trust proceedings and the nature of its assets can be kept private. Celebrities and high net worth individuals often utilize trusts for this reason, as it allows them to keep their names off public records and real estate rolls.
For instance, let’s consider a scenario where a celebrity wants to purchase a new house but wishes to keep her name out of the public eye. She can achieve this by creating a living trust under a different name, such as “The Starlight Trust,” and appoint her business manager or any other trusted advisor as the initial trustee. The public record would then show the title as “Business Manager, as Trustee of The Starlight Trust dated…”
Additionally, name camouflage can also serve as a deterrent against lawsuits. A plaintiff’s attorney may often look into a defendant’s assets to gauge the value of a potential lawsuit. If the assets are well hidden, the attorney or private investigator may not be able to uncover them easily and might reconsider filing a lawsuit against an apparently judgment-proof defendant. However, it’s important to note that name camouflage should not be relied upon solely for asset protection.
In California, the settlor or the trustee can present a certification of trust to third parties instead of the full trust document, which contains confidential information. The certification of trust typically includes information about the settlor and trustee and their powers, without disclosing the identity of beneficiaries or the details of trust assets and dispositions.
One of the key benefits of trusts is that beneficiaries do not hold legal title to the trust assets. Instead, the assets are held by the trustee. This means that creditors cannot simply attach the assets of a trust, unless the debtor is the settlor of a revocable trust.
Creditors’ ability to collect from a beneficiary with respect to a trust is limited to the beneficiary’s equitable interests in the trust, such as the right to income, use, and possession, and the right to future legal title. By limiting the beneficiary’s interests in the trust, creditors’ rights are also limited. To ensure that a trust’s asset protection features are effective, they must be properly drafted into the trust document and should activate automatically upon the occurrence of specific events to avoid fraudulent transfer challenges.
Avoidance of Probate on Settlor’s Death
One of the major benefits of a trust is that it enables the avoidance of probate upon the death of the settlor. Probate refers to the legal process of administering an estate, which involves verifying the will, collecting the decedent’s assets, paying off any liabilities, taxes, and debts, and finally distributing the assets to the heirs. However, assets that have been transferred by the decedent to an inter-vivos trust are not subject to probate, as the trust represents an enforceable contract between the decedent and the trustee. This also applies to certain other assets that are subject to an enforceable contract, such as life insurance policies or retirement plans.
Probate avoidance is generally a desirable outcome as the probate process is often time-consuming, taking at least six months, and is also expensive due to court fees, probate referee fees, executor’s commissions, and attorney fees. Furthermore, probate is not private, as the probate files are a matter of public record. It is important to note that the costs of administering a trust during the settlor’s lifetime may not always be lower than the costs of probate, especially if the trust requires the services of a professional fiduciary or a corporate trustee. In such cases, probate may be a more cost-effective option.
Continuity of Management and Succession Planning
A trust can be an effective tool for ensuring the continuity of management and succession planning, particularly in cases where certain assets require uninterrupted management, such as an actively operated business. In the event of the settlor’s death or incapacity, the business may come to a standstill, leading to adverse financial consequences. However, by transferring the ownership of the business to a trust and selecting a successor trustee, the settlor can ensure that the business continues to run smoothly. It may also be advisable to create a separate trust specifically for the active business, and to name a special successor trustee who is familiar with the business operations. For personal assets, another trust with a different trustee can be created.
For settlors who provide for their family, a trust can also ensure that the surviving spouse or children are never in need of money. The trust can specify any distribution scheme and timing desired by the settlor, thus ensuring the continued flow and availability of money to the family.
Planning for Incapacity
Another benefit of a trust is that it provides a useful mechanism for planning for the incapacity of the settlor. Once the assets have been transferred to the trust, the trustee can assume management powers and duties over the assets of the trust. An irrevocable trust can also allow the incapacitated settlor or beneficiary to qualify for certain government assistance benefits.
While revocable trusts do not offer any tax advantages, irrevocable trusts provide many income, gift, and estate tax planning opportunities. When transferring real property to a trust, it is important to be aware of potential property tax consequences, particularly if the transfer triggers a change in ownership and a subsequent reassessment. However, if the owner of the real property is the beneficiary of the trust, the property is generally not reassessed.
Revocable trusts can also be used to segregate assets, preventing commingling. For instance, married couples who do not wish to enter into a prenuptial agreement but want to preserve their existing assets as separate property can title their existing separate property into separate living trusts, one for each spouse. This makes it easy to track which assets are separate and which are community.
Types of Trusts
There are various types of trusts available, each serving a specific purpose.
- Inter-vivos trust: Also known as a living trust, it is established during the lifetime of the settlor. This type of trust offers probate avoidance and can act as a substitute for durable power of attorney if the settlor becomes incapacitated.
- Testamentary trust: This type of trust is established on the death of the settlor, it accomplishes the same tasks as an inter-vivos trust but does not offer probate avoidance.
- Revocable trust: As the name suggests, this type of trust can be revoked, cancelled or amended by the settlor. In the event of revocation, the assets of the trust are transferred back to the settlor, extinguishing the equitable rights of the beneficiaries.
- Irrevocable trust: Unlike a revocable trust, an irrevocable trust cannot be revoked or amended. Its existence can only be terminated as per the provisions of the trust itself.
- Purpose trust: This type of trust is created to serve a specific purpose and is most commonly used as a charitable trust. Some jurisdictions now allow purpose trusts to serve purposes other than charity.
- Marital deduction trust (QTIP trust): This trust is designed to meet the requirements of the federal estate marital deduction regulations and to qualify for the same.
- Survivor’s trust: This type of trust is comprised of the surviving spouse’s separate property and share of community property, it serves as a continuation of the original living trust.
- Exemption trust (also known as bypass or credit shelter trust): This trust is designed to qualify for the decedent’s federal estate tax applicable credit amount.
- Special needs trust: This trust is established to preserve government benefits for an elderly or disabled beneficiary.
- Split-interest trust: In this type of trust, some beneficiaries have a present interest and others have a future interest. Charitable remainder trusts fall under this category.
- Sprinkling trust: A trustee with sprinkling powers may pay income (and sometimes principal) to any of the beneficiaries in any proportion they deem appropriate.
Elements of a Valid Trust
When it comes to trusts, it is important to understand some of the common terms used. The grantor or settlor is the person who creates the trust and transfers assets to the trustee. The trustee is the person who holds and manages the trust assets. The beneficiary is the person who receives the benefit of the trust assets. The trust agreement is the document that outlines the terms and conditions of the trust, including the trust’s purpose, assets, and beneficiaries. The trust assets are the properties or assets that are transferred to the trust.
- Trust Intent
For a trust to be valid, there must be a clear intent on the part of the grantor or settlor to create a trust. This intent must be expressed in the trust agreement or other written documents. The grantor or settlor must clearly state their intention to transfer assets to the trustee for the benefit of the beneficiary.
- Trust Assets
For a trust to be valid, there must be specific assets that are transferred to the trust. These assets can be personal property or real estate, but they must be clearly defined in the trust agreement. The assets must also be properly transferred to the trustee, with clear documentation of the transfer.
A trust must have a beneficiary, the person who is to receive the benefit of the trust assets. The beneficiary can be a person, an organization, or even a group of people.
- Beneficiary Requirements
A trust is considered valid only if it designates a beneficiary or a clear group of beneficiaries that can be identified with certainty. The exception to this rule is purpose trusts, such as charitable trusts, which do not require a named beneficiary.
If the trustee and beneficiary are the same individual, there is no valid trust as legal and equitable title are vested in the same person. This is known as the doctrine of merger.
Any individual, including someone unknown to the settlor, can be named as a beneficiary, with exceptions for the trust’s attorney, the settlor’s conservator, and the care custodian of a dependent adult. These restrictions do not apply if the trust is reviewed by an independent attorney or if the beneficiary is a close family member.
- Legal Purpose
The purpose of the trust must be lawful and in line with public policy. Trusts that promote illegal activities or encourage fraud or divorce will not be enforceable.
The purpose of the trust must also be clear and defined. A transfer of property to another person with the instruction to hold it “as he may see fit” is not considered a valid trust purpose.
- Other Elements
The absence of a trustee designation in the trust document does not render the trust invalid. A court can appoint a trustee if needed.
A transfer of assets to a trust does not require consideration and can be made freely.
Recording a trust with the county recorder’s office is optional, and not required for real property.
Trustee Responsibilities and Powers
The selection of a trustee is crucial for a settlor as the trustee is responsible for managing trust assets and following the intent of the settlor. The trustee’s actions are subject to supervision by the Superior Court in California, but in practice, the court only intervenes if a complaint is filed. The settlor should exercise caution in selecting a trustee who is financially savvy, has integrity, and will carry out the settlor’s intent. The trustee can be an individual or a legal entity such as a corporate trustee or a professional fiduciary. A professional fiduciary must be registered with the Statewide Registry and must be mindful of conflicts of interest and dual compensation. When more than one trustee is appointed, they must act unanimously unless a trust provision says otherwise. If the sole acting trustee is also the sole beneficiary, the trust terminates under the doctrine of merger, except if there are named successor beneficiaries and the same person is the settlor, trustee, and beneficiary.
A professional fiduciary in California is required to register with the Statewide Registry of Conservators, Guardians, and Trustees maintained by the California Department of Justice. This is to ensure that professional fiduciaries meet the standards and requirements set forth by the state and to provide a resource for the public to verify the status and qualifications of a professional fiduciary.
The duties and responsibilities of a trustee can be summarized as follows:
- Not to deal with trust assets for personal profit or any purpose not connected to the trust
- Not to engage in any transaction that conflicts with the interests of the beneficiaries
- To administer the trust solely in the interest of the beneficiaries
- Duty to preserve trust assets and keep them productive
- To exercise a duty of care in accordance with the prudent person standard when dealing with the trust
- To follow the Uniform Prudent Investor Act when making investments
- Trustees may be granted a degree of discretion in administering the trust, as outlined in the trust agreement
- This discretion may range from limited to broad and is often indicated by words like “sole,” “absolute,” and “unfettered”
- The trustee’s discretionary powers are always subject to a duty of care and fiduciary obligations
- The use of discretionary powers may accommodate for changing circumstances and protect the interests of a beneficiary
- The settlor gambles on the trustee’s competence and loyalty when granting discretion, making it important to choose the right trustee
- The trust agreement can direct the trustee on how to structure distributions to beneficiaries
- Common distribution schemes include:
- Paying a fixed amount to a beneficiary, e.g. “$500 on December 31”
- Paying a specified percentage or formula, e.g. “10% of the trust’s assets on March 7”
- Paying a fixed sum on a certain event, e.g. “$5,000 when receiving a Master’s degree”
- Paying all income generated by the trust to a beneficiary (income trust)
- Paying the overall growth of trust assets, emphasizing both current income and asset appreciation (total return trust)
It is important to note that the trustee’s duties, discretion, and distribution directives can vary greatly based on the specific provisions outlined in the trust agreement.
Frequently Asked Questions
- What is a trust and how does it work? A trust is a legal arrangement where a person (the grantor) transfers assets to a trustee, who holds and manages the assets for the benefit of one or more beneficiaries. The grantor can specify how and when the assets will be distributed to the beneficiaries, and can also include conditions for distribution. The trustee is responsible for investing and managing the assets in accordance with the grantor’s instructions and for making distributions to the beneficiaries.
- What are the benefits of setting up a trust? There are many benefits to setting up a trust, including:
- Estate planning: A trust can help to simplify the probate process and reduce the costs associated with it. It can also help to avoid estate taxes and ensure that your assets are distributed according to your wishes.
- Privacy: Trusts can provide a level of privacy that is not available through other estate planning vehicles, such as a will.
- Protection of assets: A trust can protect assets from creditors, lawsuits, and other legal claims.
- Control: With a trust, you have control over how your assets will be managed and distributed after your death.
- Special needs planning: If you have a loved one with special needs, a trust can provide for their financial needs without disrupting their eligibility for government benefits.
- Who can be a trustee? A trustee can be an individual, a corporation, or a trust company. It is important to choose a trustworthy and competent person or entity to act as your trustee.
- What are the cautions of setting up a trust? While trusts offer many benefits, there are also some cautions to consider:
- Complexity: Trusts can be complex legal arrangements and may require the assistance of an attorney to set up and maintain.
- Cost: Trusts can be expensive to set up and maintain, especially if professional trustees are involved.
- Inflexibility: Trusts are generally irrevocable, meaning that once the assets are transferred to the trust, they cannot be taken back.
- Limited control: If you appoint someone else as trustee, you will be giving up control over your assets.
- How do I choose the right type of trust for my needs? There are many types of trusts to choose from, including revocable living trusts, irrevocable trusts, charitable trusts, and special needs trusts, among others. The right type of trust for you will depend on your unique circumstances and goals. It is important to consult with a qualified estate planning attorney to determine the best type of trust for your needs.