Basics of Trusts

WHAT IS AN REVOCABLE TRUST?

ADVANTAGES, DISADVANTAGES, AND BASIC INFORMATION EVERYONE SHOULD KNOW.

  • Introduction
    • Definitions
      • A Revocable Living Trust, also known as a Revocable Inter Vivos Trust, is a trust created during the lifetime of a “Settlor” (sometimes referred to as Grantor or Trustor), by written instrument, which gives Settlor the option to revoke or amend the Trust during his or her lifetime or at some other chosen time.
      • The Settlor is the one who creates the Trust and whose property the Trust is made up of. The terms Grantor and Trustor are also commonly used to mean Settlor.
      • A Trustee is the one who holds, manages and administers the property for another’s benefit (a beneficiary). A Trustee can be a person, bank or corporation.
      • A Beneficiary is a person or entity who may receive a benefit from the trust.
    • General Information about Revocable Trust: A Revocable Trust is a legal entity that has the power through a Trustee to own and control property. Property is transferred to the Trust by the Settlor and is managed and administered by the Trustee. The property in the Trust is called the Trust’s Corpus. The Trustee can only act in a way that is consistent or allowed by the Trust instrument or applicable law. Thus, a Settlor can define how much control he or she desires over the Trustee’s actions by drafting, amending, or revoking the Trust.
    • Purposes for a Revocable Trust:
      • A Revocable Trust can be used to avoid probate by transferring property to the beneficiaries at the Settlor’s death.
      • Revocable Trusts allow for the management of Settlor’s property during the Settlor’s life and after the Settlor’s death.
    • Alternatives to Trusts during Settlor’s life
      • Joint Tenancy with Right of Survivorship: Upon the passing of one Joint Tenant, the entire interest of that deceased tenant automatically passes to the surviving Joint Tenant without the necessity of probate. Each owner has the ability to use the whole property. This is beneficial in circumstances such as incapacity where one Joint Tenant has the ability to use the property for the others benefit. The disadvantages are that one joint tenant could withdraw the entire property, or creditors of one Joint Tenant can have claims against the entire joint property.
      • Legal Principal and agent relationships: Power of attorney, custodianships accounts and safekeeping arrangements where the agent’s authority to transfer property comes from the principal and ceases with death or sometimes incapacity.
      • A Trustee’s authority and power to act continue even after death or incompetency of Settlor. A Trust is the best option when the Settlor desires the authority and power of the acting party to continue after the Settlor’s death.
    • Advantage, Disadvantages, and other considerations involving Revocable Trusts during Settlor’s Lifetime.
      • Age and Trust: Age is a common reason people create a Revocable Trust. As we grow older, we experience cognitive decline and find it more difficult to manage our estates. Often, the aged person will fail to act in their own best interest, or they will make erratic decisions or mistakes regarding their property.  If there is substantial property at risk, those close to the individual may have to petition for a guardian or conservator to be appointed. This can be a very emotional and draining process.  A Revocable Trust is not a fix-all, but it can be a very helpful tool to prepare for these property management problems during the Settlor’s life.  A well-planned trust can eliminate the significant expense of a guardianship.
      • Revocable Trust as a Trial Run: Revocable Trusts allow the Settlor to test out a Trust during their life time.  If the Settlor is not satisfied with the how the Trust operates, the Settlor can change the Trustee, amend the Trust’s provisions, or even revoke the Trust and recover the Trust’s assets. These changes cannot be made with a Testamentary Trust (created by will) because it does not come into operation until death. Testing a Trust out during the Settlor’s life is particularly valuable when the Trust’s assets are a business or other investment that requires careful attention. It gives the Trustee an opportunity to get comfortable with managing these assets while the Settlor is still around to consult with.
      • Relief from Responsibility of Managing Property: By using a Revocable Trust, a Settlor can shift to a Trustee the tedious responsibilities of keeping records for property, preparing tax returns, and managing the property. The Settlor has the ability to oversee the Trustee’s performance of these responsibilities. Relief from managing property is especially beneficial to those who are older, retired, ill, or who enjoy traveling or some other activities that make managing their property complicated.
      • The Settlor who is constantly on the move: A Settlor who is constantly traveling from place to place may recognize substantial advantages of a Revocable Trust. People who move a lot or travel across the country or world because of a job or just pleasure can centralize management and responsibility of their assets with a Trustee. Revocable Trust can ensure that Settlor’s property is well managed even if they do not have the time, while giving the Settlor the final say through power of revocation and amendment. The Revocable Trust can also minimize any potential tax problems, especially those that arise because of the different places Settlor may live.
      • Possible disadvantage of Pre Death Administration: Unlike a will, which only requires execution, a Revocable Trust requires a number of pre-death actions. The Trustee must open a bank account(s) for the Trust to which the Settlor will transfer assets. The Trustee will operate the Trust as a legal entity independent and separate from Settlor’s other assets. Also, the Trustee must keep records of all the Trust’s activity.
    • How much of a disadvantage pre-death administration is depends on the type of Trust created, who the Trustee is, and who the beneficiaries are. If the Settlor chooses a bank or professional Trustee, then the only disadvantage to Settlor is the cost. If the Settlor chooses a friend or family member as Trustee, then performing all of the administrative requirements may be more of a burden to them than it would be to a professional Trustee.
    • Many people choose themselves and spouse as Trustees, which allows assets to be administered as if the Trust were not created. The main difference is that assets are administered in the name of the Trust and not the individual. This method is recommended when the individual is capable and willing to manage his or her assets.
    • Also, a Settlor may decide he or she wants to serve as Co-Trustee with the individual, bank, or trust company who would be the successor Trustee. A Settlor does this to establish a close working relationship with the Co-Trustee during the Settlor’s lifetime, and this ensures the Co-Trustee is familiar with the Trust for an easier transition over the Trustee’s duties at the Settlor’s death or incapacity.
      • A Possible Disadvantage of Amending the Trust: A Settlor or Revocable Trust can change beneficiaries who will receive the property following his or her death; however, if the Settlor doesn’t want the beneficiaries to know the Trust’s previous terms, a more difficult administrative problem arises. Typically, any amendment of the Trust is part of the Trust and its history, which the Trust’s beneficiaries have a legal right to. To prevent the beneficiary’s access to the previous terms, the Settlor must completely revoke the prior Trust and create a new Trust and transfer assets to it. The Trust is then rewritten to include the desire wording and eliminate the unwanted wording.
      • A Possible Disadvantage of Asset Transferring to the Trust: To fully benefit from the Trust, the Settlor must transfer his or her assets to the Trust before his or her death. If not, a probate or guardianship proceeding will probably be required to deal with those assets. A Settlor must take the time during his or her life to identify and actually transfer the assets.
      • Tax Effects: Revocable Trust’s do not have any tax effects during the Settlor’s life. Because the Settlor retains the power to revoke the Trust, the Settlor is treated as the owner of the Trust; therefore, the Settlor must report all the Trust’s income, deductions, and credits on his or her own tax return.
    • The Advantages and Disadvantages of Revocable Trust after the Settlor’s Death.
      • General: A Revocable Trust is a common tool used to avoid probate after the Settlor’s death. As long as title of the property was transferred to the Revocable Trust before the Settlor’s death, the property retained by the Trust will not be a part of the Settlor’s estate that goes through probate. Other than probate avoidance, there are numerous additional advantages.
      • Transferring Assets to Beneficiaries will not be Delayed: The speed distributions are made to beneficiaries depends on the Oklahoma laws allowing distributions, and also on federal or state law provisions that control if the fiduciary is liable for death taxes, decedent’s unpaid income taxes, or claims of decedent’s creditors.
        • If Trustee is sole beneficiary or has close relationship with other beneficiaries to where his or her potential liability for unpaid taxes or other claims is not important, the Revocable Trust’s property may be distributed shortly after Settlor’s death. Whereas, Probate Estate distributions cannot be made until the probate court enters an order of distribution, which can be several months or even years after death.
        • If Trustee is not the sole beneficiary and is concerned with any potential liability to creditors or taxing authorities, the big distributions should not be made from the Trust any sooner than they could be made from the probate estate.
      • Cost of Administration: Whether a executor of a probate estate will be more expensive than the Trustee of a Revocable Trust depends on circumstances, such as the following: how much property is involved, how long the administration takes, who the Trustee of a Trust is, and if the administration is followed by a continuing trust. An Executor’s fee is fixed by law, but a Trustee’s fee is not. Trustees’ fees are only required to be a reasonable fee. Usually a bank or Trust company will be more expensive than individual Trustee. A Trustee’s fee will typically be more than an executor’s fee but length of time the Trustee must act, amount of property being managed, and other factors should be taken into account. Often, the family members of the Grantor are successor Trustees, so fees are not a problem.
      • Attorney’s Fees: Typically attorney fees will be less when the property is in a Trust than if the property goes through probate. A lawyer probating an estate will charge a significant amount based on services rendered, time spent, nature or services, and other considerations. In total, these fees will often be thousands of dollars. Whereas, Trust fees should be significantly lower unless disputes between beneficiaries and heirs or tax problems arise, which would cost no more than if those problems arose in probate of the estate. However, creating a Trust does cost more than it costs to prepare a simple will.
      • Administering Assets after Death: The Trustee’s investment and administrative powers continue after death without the courts approval. If the Trustee was the Settlor, then a Successor trustee who is willing and able to serve can start acting immediately without a court proceeding. In probate, no one can act for the estate until the executor is appointed.
      • Multi Stat Assets: Revocable Trust can be used to avoid ancillary administration of property the Settlor owns in several states. Ancillary Probate is the administration of decedent’s estate to dispose of decedent’s property located in states where the decedent did not live. A revocable Trust is often advisable to someone who owns assets in multiple states.
      • Publicity: Wills and probate are public record that shows the nature and value of the decedent’s estate. A Revocable Trust is a much more private method of transferring a person’s property on death. However, Revocable Trusts are not completely private because they are still filed with taxing authorities and some transfer agents.
      • Trust Contest vs. Will Contest: A Revocable Trusts that has been active a while before the Settlor’s death probably will be more difficult to challenge than a will. Wills and Revocable Trust have similar legal requirements to contest, such as undue influence, fraud, and competency. However, a will does have a shorter time limit to be contested.
      • Taxability of the Trust’s Income: The decedent’s estate and a Trust are both taxed similarly, with the only differences being the estates income is taxable to the estate, except that beneficiaries are taxed on distributions made to them. This gives the Probate Estate more flexibility with income tax planning because they can affect the timing of distribution. A Trustee doesn’t have this flexibility because the distribution is taxed to the beneficiaries regardless.
      • Estate Tax: Property that the Settlor transferred to a Revocable Trust is still included in the Settlor’s total estate for estate tax purposes, so a Revocable Trust does not affect the property’s taxability. Any estate tax advantage realized by a will can also be realized by a Revocable Trust.
    • Trust Planning:
      • Choosing a Trustee: There are certain legal requirements that must be met when appointing a Trustee. The Trustee must be legally competent to contract and hold title. If a guardian or conservator is appointed for the Trustee, a Successor Trustee will normally take over. A Settlor may be the Trustee but there may be disadvantages to consider. One disadvantage is that it may be more difficult to find a Successor Trustee. A bank or Trust Company may be unwilling to take over as Successor Trustee due to the fear of liability for not discovering or redressing breaches that the Trustee before him caused. This may not be a problem when a family member is the Successor Trustee.
        • A beneficiary may also be the Trustee; however this may cause conflicts of interest between his or her rights as a beneficiary and his or her acts as a Trustee. These conflicts of interest can be dealt with by specifically defining the Trustee’s powers or appointing a Co-Trustee. Most problems can be avoided by careful drafting.
      • What Property Should you Transfer to Trust: When the Settlor establishes a Trust, he or she must decide if all or only some of their property will go to the Trust. If only part of the Settlor’s property goes into the Trust, the advantage of avoiding probate will be lost. Because the Settlor is still considered the owner of the property, there are few tax considerations to be concerned with (except with stock and stock options). The following are specific property considerations one should take into account when transferring property to a Trust:
        • Installment Notes Receivable: The IRS has said that a transfer of installment notes to a Revocable Trust is not a disposition that accelerates income under Internal Revenue Code because the Grantor is treated as the owner of the Trust.
        • Nonproductive Property: Nonproductive Property, like stock in closely held corporation, are usually appealing to transfer to a Revocable Trust because the inconvenient need for  separate trusts, tax returns, and bank accounts are missing with this property.
        • Encumbered Property: When transferring encumbered property, such as home with a mortgage on it, to a Revocable Trust, a determination needs to be made on whether the property will be self-supporting to produce income that is adequate to continue payments on the encumbrance.
        • Property Subject to Restrictive Agreements: Assets, such as interest in a L.L.C. or partnership, should be examined to see if their agreements permit transfer of interest to a Revocable Trust during the lifetime of the owner.
        • Interests in Professional Partnerships and Corporations: The interest of a Professional Partnership usually cannot be transferred to a Revocable Trust because they require that each partner be a licensed member of the profession. Typically, Professional Corporations have the same restrictions. On the other hand, the Settlors interest in property that is used by the partnership or corporation may be transferred to the Revocable Trust.
        • Out of State Real Property: The transfer of real property that is located in another state to a Revocable Trust will eliminate the need for ancillary probate proceedings upon Grantors death.
      • Powers of Trustee: The Trust’s provisions and state law govern the Trustee’s power and duties. Oklahoma law allows the Trust instrument to expand upon the Trustee’s power given by law, which enables the drafter flexibility to meet the various needs of different Grantors.
      • Distributing the Trust Assets:  Grantor needs to make the same decisions about distributing their assets as he or she would in a will. There is a lot of flexibility to drafting a Trust. Even after death, the terms of the Trust can control the management and distribution of property. This is one the primary reason Trusts are created.

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