Trusts are a fundamental component of estate planning, and clients here the term often. However, understanding the nature of trusts themselves, and their role in an individual client's planning can be difficult, both for clients and professionals. Here is the Who, What, and When for understanding how Trusts are used:
Who is involved in setting up a Trust? First, the Grantor is the creator of the Trust, typically the one who is contributing the funds, but not always. The Trustee in charge of the Trust, a person or entity who manages the assets contributed into the Trust for the benefit of its Beneficiaries. The Beneficiaries are the person(s) who receive some benefit from the Trust, including income, or access to principal assets, or both.
In some cases, these roles can be filled by the same person(s). For example, Tom creates a trust during life by contributing some of his funds. The Trust document names Tom as the Trustee, who is control of the Trust. Tom has reserved the right to receive income from the Trust for his life, then the remainder goes to his son, Paul. As you can see, Tom is both the Grantor, the Trustee, and the income Beneficiary. Also, Paul is a Beneficiary.
What (and How):
Trusts have two basic distinctions: testamentary and inter vivos. The differentiation is based on when a trust receives funds.
Testamentary Trusts receive funding after a person dies, typically through a person’s Will or via some non-probate funding source (such as life insurance) which occurs after the Grantor (Creator of the Trust) dies. Inter Vivos Trusts are funded during the Grantor’s (Creator) life.
Beyond this preliminary distinction in timing of funding, there is another important distinction to be made: whether a trust is Revocable or Irrevocable. Generally speaking, a Revocable Trust includes funds which can be removed from the trust by the Grantor (Creator), at least until a certain point, such as the Grantor’s death. An Irrevocable Trust includes funds which cannot be so easily removed; usually the funds placed into the Irrevocable Trust can be removed only under certain circumstances, or not at all, especially by the Grantor (Creator).
Some examples can be helpful:
Bob forms a revocable living trust in 2016, with the intention of avoiding probate for the assets contributed into the trust. He transfers his house into the revocable living trust. As a result, his trust is an inter-vivos revocable living trust, since he can revoke the trust and he has contributed funds, as Grantor (Creator) during his life.
James forms an irrevocable trust in 2016. The trust provides that he cannot remove assets from the trust or otherwise remove its contents, once contributed. He transfers his house into the irrevocable trust. As a result, his trust is an inter-vivos irrevocable trust, since he cannot revoke the trust and he has contributed funds, as a Grantor (Creator) during his life.
Janet prepares a Will that provides that upon her death, the residue of her estate passes to a trust for the benefit of Alex. The trustee is Billy, who can only distribute funds to Alex under certain circumstances. As a result, Janet’s Will creates a testamentary trust which is irrevocable (since the Grantor/Creator is deceased).
Once these initial distinctions are identified, we can take a closer look at when certain types of trusts might be used:
When would a person use a trust? A better question would be Why. There are plenty of lawyers and other professionals who mistakenly generalize the need for trusts. Instead, it makes sense to view trusts as a tool to be employed in response to certain situations. For example:
1. A future beneficiary of your Estate receives (or likely will receive) public benefits. In this case, a testamentary irrevocable special needs trust or supplemental needs trust probably makes sense.
2. You desire to avoid probate. This has debatable benefit in Pennsylvania, but generally an inter vivos revocable living trust might make sense.
3. You wish to protect assets from exposure to long-term care costs. Such an goal may require an inter vivos irrevocable trust to hold assets which you desire to protect.
4. You have a disabled child and you are entering a skilled nursing home. Depending on your situation, an inter vivos irrevocable special needs trust or supplemental needs trust may allow you to protect those assets to provide care for that child.