At its most basic, a trust is a relationship whereby property is held by one party for the benefit of another. A trust is created by a Settlor, also referred to as a Grantor or Maker, who transfers property to a Trustee. The Trustee holds that property for the trust’s beneficiaries. The beneficiaries may be current and/or future beneficiaries and may be an individual, a charity or organization, or even the family pet.
Once upon a time, trusts were predominantly used by wealthy families to control the family fortune and to pass it down through the generations without incurring taxes. Those days are long gone. In fact, trusts are now found in the average estate plan given how user-friendly they are and how versatile they are. While high net worth individuals do still utilize trusts with great frequency, individual’s with a modest estate can also now benefit from incorporating a trust into their estate plan as well.
A trust is formally created using a written legal document called a “trust agreement.” The trust agreement reflects the terms of the trust as created by the Settlor. Though you probably do not ever think about it, you likely enter into oral trust agreements all the time. For example, if you asked a co-worker to hold a package for you while you are on vacation and give it to your niece when she arrives from out of town, you have created a trust wherein you are the Settlor, your co-worker is the Trustee and your niece is the beneficiary of the trust.
Trusts are broadly divided into two categories — living trusts and testamentary trusts with the former activating during the lifetime of the Settlor and the latter typically being activated at the time of the Settlor’s death by a provision in the Settlor’s Will. Living trusts can be further sub-divided into revocable and irrevocable living trusts while a testamentary trust is always revocable because a Will is always revocable. As the names imply, a revocable trust is one that can be modified or revoked by the Settlor at any time and for any reason whereas an irrevocable trust cannot be modified or revoked, once activated, by the Settlor.
One of the most important decisions a Settlor must make when creating a trust is who to appoint as the Trustee. In fact, a common mistake people make is appointing a spouse or close friend as Trustee without taking the time to consider if that individual has the experienced and/or skills to successfully serve as the Trustee. Sometimes, appointing a professional Trustee is the better choice. The overall job of a Trustee is to manage and invest trust assets and to oversee the administration of the trust. Generally, the reason behind appointing the wrong person as Trustee is a lack of understanding of the numerous and varied duties and responsibilities of a Trustee, such as:
- Following all trust terms unless they are illegal or unconscionable.
- Communicating with beneficiaries.
- Resolving disputes among beneficiaries.
- Investing trust assets using the “prudent investor” standard.
- Managing trust assets.
- Distributing trust assets.
- Keeping trust records.
- Preparing and filing trust taxes.
- Defending the trust against legal challenges.