Estate Planning: Understanding Trust Management
There are many types of trusts that can be used in estate planning for a variety of reasons and benefits. In this article we will discuss what trusts are and how they are different. We will cover several of the most popular and beneficial such as living trusts and charitable trusts, learn why they are useful and learn the basic requirements of creating them.
What is a Trust?
A trust can be defined as an arrangement wherein one person holds property or money for the benefit of another person.
According to the Living Trust Network every type of trust you will ever confront must have the four same basic elements, they are as follows:
- Someone must create the trust. We call this person the "grantor." Other people call the creator of a trust the "donor," or the "settlor," or the "trustor." All these terms are used interchangeably.
- Some other person or entity must agree to hold money and/or property for the benefit of someone else. We call this person the "trustee." There may be more than one trustee and the trustee need not be a person. It may be a corporation with trust powers, such as a bank.
- Some money and/or property must actually be held by the trustee for the benefit of someone else. We call this money or other property the "principal" of the trust. Some people also call this money or other property the "corpus" of the trust. The principal (or corpus) of the trust never stays the same; some is spent by the trustee, some is invested - earning dividends and interest, and some of the principal appreciates and/or depreciates in value. Collectively, we call all of this money and property the "trust fund."
- Someone else must benefit from the trust. We call this person the "beneficiary" of the trust. There may be more than one beneficiary. In that case, they are collectively called the "beneficiaries."
What's The Difference Between. . .
Living Trusts and Testamentary Trusts:
Living trusts become effective during the grantor's lifetime; testamentary trusts become effective after the grantor's death.
Revocable and Irrevocable trusts:
When the grantor retains the right to revoke the trust after it is effective, including the right to change any and all terms and provisions of the trust, it is revocable.
It the grantor gives up any rights to revoke the trust after it becomes effective, then it is considered an irrevocable trust.
A Look at Several of the Most Used Trusts in Estate Planning
Credit Shelter Trusts
The Credit Shelter Trust is another name for the Bypass Trust. See Lesson Six for information on Bypass trusts.
Charitable trusts have one or more charitable beneficiaries. When established according to federal tax laws these trusts will allow the grantor to deduct a portion of the total gift as a current charitable tax deduction. Further, depending on the type of charitable trust it is, the trust may qualify for an estate tax deduction upon the death of the grantor.
Dynasty trusts are created and designated to last forever so that generation after generation receives distributions from the trust. Thus, they are designed to last beyond the lifetime of any beneficiary plus 21 years.
These trusts include language that gives the trustee (the person holding the trust for the beneficiary) discretion in making distributions to named beneficiaries. For instance, if the trustee believes that the trust will be used to pay a creditor or that it will be wasted or used in a questionable way by the beneficiary, they have the right to withhold payment until such time that the beneficiary will use the money wisely. These types of trusts are excellent for a beneficiary who may have current financial problems or have poor judgment. This is often the case with younger people who have not yet learned the value of spending their money wisely. Spendthrift trusts can be revoked (or changed) when the beneficiary reaches a certain age or until after they are educated in the management of money.
Just as the name would imply, incentive trusts are created to provide monetary enticement for good behavior on the part of the heir. Incentive trusts can be set up for a variety of reasons: to get heirs to finish college, work a full-time job, stop using drugs, quit drinking or settle down and get married, the list of conditions can be rather long. Reminiscent of movies like Brewster's Millions, Arthur, Billy Madison, The Fighting Temptations, The Bachelor and others, incentive trusts are used as leverage to encourage good behavior. While the concept sounds good in premise, and makes for great movie plots, most experts agree that they don't work that well. Many feel that imposing this type of inheritance on an heir makes them dependant upon outside rewards rather than learning to rely on internal strength to make positive life changes. They can also be a burden to heirs rather than a catalyst for change. Some see them as a sign of "conditional love" on the part of the parent. On the other hand, other experts believe that these trusts work quite well. Many people will only make positive changes when forced to do so. If given large amounts of cash some will literally cause their own early death due immaturity, illnesses such as alcoholism or drug addiction, or, simply, the lack of self-control.
Some experts suggest creating a secret trust instead of an incentive trust to help wayward heirs get on track. A secret trust can instruct the trustee to distribute the inheritance on a "necessity only" basis without divulging the terms of the trust. The heir is given only what they need to live and not made aware of the full value of their trust. The trustee can then be instructed to only distribute the total amount after the heir has solved their problems on their own and are able to handle a large cash inheritance.
Life Insurance Trusts
Life Insurance trusts are designed to exempt the policy from estate taxes upon the death of the grantor. It is an irrevocable trust that holds an owned life insurance policy "in trust" for the beneficiaries. These trusts are often used by individuals whose assets exceed the federal estate tax exemption cap.
The Crummey Trust is named for Clifford Crummy who created this particular life insurance trust. It is designed to allow beneficiaries to make payments on the life insurance policy of the grantor tax free by using the gift tax rule. It works like this: Beneficiaries make a "gift" to the trust that is equal or less than the gift tax cap, the trustee is prohibited from using the money gifted for a 30 to 60 day period. During that period, the beneficiaries are given the right to withdraw the money. If they don't withdraw the money within the given time period, their rights are terminated and the money may be used to pay any premiums that are due.
Speaking to Loved Ones and Friends about Your Estate Plan
Talking to loved ones about your estate plan before you die will clarify things and help avoid any misunderstandings among those you love. It is a very important aspect of estate planning and should not be ignored for the pure nuts and bolts of planning. For many, this task will not by easy, but it is a necessary fact of life. Some family members and/or friends will find this discussion too painful and will want to avoid it completely. They will make excuses to put it off for another time, however, you should not give in to avoidance tactics. Other family members will want to discuss your estate plan so that they have a clear understanding of your wishes. Don't take this as a sign that they look forward to your passing! Everyone deals with these things differently and many feel it is more caring to listen to those you love and follow their directions rather then avoid confronting the inevitable. No matter how your loved ones handle the discussion of your future estate plans, be sure to make an effort to sit down with each heir individually, or as a group, and discuss exactly what your plan is. Discussions about your estate plan should be calm and non-threatening and preferably in a quiet, somewhat private setting.
An important thing to remember is to never use an inheritance as leverage against your children, family members and/or friends. While it is appropriate to discuss your plans with those you will be naming beneficiaries, it is not appropriate to create hostility by using your estate to produce certain behavior in your heirs. Incentive trusts aside, using money to influence family and friends is not a recommended way of communicating with those you love. Often, when there is tension between siblings it is caused by "inheritance threat" behavior by the parents who tell one or more of their children that one sibling will get more than the other for reasons they deem appropriate. If you want your children to cooperate with one another, support each other after you are gone and get along well, then you should not encourage fighting among them by pitting them against one another. That said, this section will give you some methods and ideas for discussing your estate plan with your spouse, children, extended family and friends.
Spouse to Spouse Discussions
The first conversation you should have when it comes to estate planning is, of course, with your spouse; provided you have one! As you are creating your estate plan be sure to include your spouse in the process. It is best to have two wills, one for each of you, when your assets exceed the estate tax cap. Your spouse needs to understand why two wills are important and have discretion when drawing their individual will. If you and your spouse decide to set up charitable trusts, you should discuss which charities you both support and make an effort to agree on those who will become beneficiaries.
In the case of second marriages, you should also discuss your estate plan with your partner. If you have left money to your first wife or husband, you should explain this to your new spouse. Likewise, if you have set up trusts for your children from a previous marriage, you should let your spouse know. Some people will see mechanisms such as Bypass trusts as a sign that you do not trust them personally. However, they need to put this type of reasoning aside much in the way people put over sensitivity aside when making a prenuptial agreement. This is not a personal attack on them or a display of distrust, but rather legal protection for your children and also a way to take any hassle and complications out of the big picture after you are gone.
If you are unmarried, but in a long-term, committed relationship it would be wise to discuss your estate plans with your partner. Do you plan on leaving him or her a part of your property or estate? Do you plan on leaving all of your assets to children or grandchildren only? Your significant other needs to know these things to avoid surprise or hurt feelings later on. If you live together, it is all the more important to let your partner know where a copy of your will and important papers are kept.
Try to keep discussions on topic and avoid arguments. Estate planning should be a tool used to help families acquire peace of mind rather than stress or discomfort for the future.
Parent to Minor Children Discussions
Discussions with minor children should be kept to a minimum and be basic, simple and straightforward. There is a limit on a child's level of understanding in regard to the topic of death, particularly when it concerns their parents. Age is a large factor when disclosing information. Use common sense when talking with minor children. You certainly would not give a seven year old the same information you would a seventeen year old. Obviously, you do not want to scare your children or cause them undue concern, but you also do not want to keep them in the dark about your estate plan. Doing so will only perpetuate the cycle of ignoring these important matters out of fear or denial of death. If your children grow up with the understanding that estate planning is simply a fact of life--something you take care of and then put aside--they will have a more pragmatic attitude about the topic.
If you are preparing a will with guardian designations, it is important to get input from your children. Ultimately, as the adult and their parent, the final decision rests with you, however, you must take their feelings into serious consideration. You may be surprised to learn that your children strongly dislike a relative that you plan on naming their appointed guardian. They may dislike only half of a husband and wife team, and this may seem minor to you because it is only an "emergency" plan, created in the "unlikely" event that something happens to you and your spouse, but to draw this document with that attidude is counter productive. You must name an appointed guardian as if the worst case scenario really could occur, simply because that is the fact of the matter. Would you want your children growing up in an environment that would cause them unhappiness? Children are very honest and great barometers of hypocrisy that adults often cannot see. So, do not discount their feelings and opinions! After you and your spouse have narrowed your choice down to a few people, get feedback from your children on each of them before choosing the final guardian(s) and back-up guardian(s). This will greatly improve your peace of mind as well as that of your children.
Parent to Adult Children Discussions
At some point, after your estate plan is in place or during the process, you will want to discuss your plans with your adult children. Adult children should be able to handle full disclosure. Share with them your estate plan as it pertains to them and their siblings. If you have several children, speak with your spouse about how best to handle the discussions. You may decide to talk them separately with their spouses or all together over an informal dinner or gathering. Only you know the dynamics of your family well enough to decide this. Your family may be an easy going bunch who all get along fairly well and avoid sibling rivalry and arguments, or, alternatively, there may be a great deal of fighting and competition amongst them. Either way, below are some points you might want to consider discussing with your adult children in regard to your estate plan.
Some things you should explain to adult children are:
- How you have distributed your estate among them and why
- If you have set up a "by need" distribution explain your reasoning for doing so. Some of your children may find this to be unfair, but it is your money and your decision. Your children do not have to like it, but they should be aware of why you made that decision.
- If you have set up an "equal" distribution, regardless of need, the same reasoning applies as above.
- If you have set up trusts, you should tell them what those trusts are and why they were created.
- If you have chosen one of your children as executor or executrix of the estate, you should explain the reason for this decision.
- If you have set up trusts for grandchildren, their parents should be told.
- If you have step-children and have included them in the distribution, you should explain this to your natural children.
- The health care directives of you and your spouse should be explained briefly.
- If you have chosen a particular child or family member to be your health care director, you should briefly explain why you chose this person.
- Your children should understand that you and your spouse have made your final decisions and that it would be a waste of their time and money to try to dispute your will in probate after you are gone, whether they agree with your decisions or not.
Hopefully, your children are amiable with each other and the estate plan you have created seems fair and agreeable to all concerned. You by no means are required to explain all of your estate plans to your children, what you choose to disclose is entirely up to you and your spouse. The point is to avoid conflict, hurt feelings and pointless, expensive probate issues amongst your children after the deaths of you and your spouse.
Discussions with Others
It goes without saying that you should have your estate plan in place and have discussed it with immediate family before discussing it with extended family and/or friends. You may have included one or several people in your will that are not related or your children. Many people make heirs of siblings, nieces, nephews, uncles, cousins, friends and others. This is particularly true when there are no obvious heirs, which is often the case for unmarried or childless people. If you have left the bulk or part of your estate to an extended family member or friend, you should make them aware of this.
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