A trust is simply a fiduciary arrangement that allows a third party, called a trustee, to hold assets on behalf of a beneficiary. Trust are really just a complex arrangement to make a gift. But instead of involving two people like most gifts, a trust also involves a trustee. The trustee holds legal title to the property held in trust and the beneficiary holds an equitable interest. That interest varies in scope, depending on the terms of the trust.
A trust not a document, but a relationship. Trusts don’t even have to be written, although there definitely should be a document that sets out all of the terms of the trust. In North Carolina, trusts can be created by a court, by transferring property to a trustee during the grantor’s lifetime, by Will, or by a declaration by the owner of property that he holds property in trust for another.
Trusts were first used in feudal England as a way to avoid strict laws of inheritance. In the 1500s, England passed a law called the Statue of Uses that required trusts to have a purpose other than getting around the laws. Over time, trusts developed into a method of maintaining wealth and transferring it to successive generations.
Trusts can be arranged in many different ways to accomplish many different things. They can be revocable or irrevocable. They can be taxable to the grantor, or can be their own entity for tax purposes. A trust that is taxable to the grantor for income tax purposes may nonetheless be outside of the grantor’s estate for tax purposes. Trusts can be created and administered to do many different things. But you have to understand the rules governing trusts to make a trust do what you want.
One of the most common types of trusts is a revocable trust. These are often used as Will substitutes. A revocable trust allows the grantor to remain in control of his assets while he is living. It can be changed or revoked at any time. However it becomes irrevocable at the death of the grantor. Revocable trusts are used to prevent probate, keep financial matters private, and provide greater incapacity protection during life. They do not provide creditor protection to the grantor or avoid estate taxes.
Another common type of trust is a testamentary trust created at the grantor’s death. They can also be created by will or inside a revocable trust. We often see trusts for minor beneficiaries in Wills or revocable trusts. However, there are many reasons to consider creating trust for adults as well. This type of trust is become irrevocable after death of the grantor.
Irrevocable trusts are used for different purposes. They generally cannot be altered once they are created. However, we do often try to build in some flexibility. The grantor usually transfers assets into the trust and no longer has control. Irrevocable trusts are often used to remove assets from the grantor’s estate for either tax purposes or Medicaid qualification purposes.
One example is an irrevocable life insurance trust (“ILIT”). When insurance is purchased by the trustee of an ILIT, the policy is not owned by maker of the trust. Therefore, the policy is not part of his or her taxable estate. If a person is expected to owe $1M in estate taxes, and buys a $1M life insurance policy, that policy become part of the estate, and only about $600K would actually be available to pay taxes. But if an ILIT owns the policy, the entire $1M is available.
While the definition of a trust is simple, the creation and use of trusts definitely is not. Many people don’t need a trust at all. For some people a revocable trust is a good idea. And for some, an irrevocable trust can be helpful. Every situation is different. If you think a trust might be helpful to you, contact us.