Howard On Trusts

An Overview of Common Trusts

Much confusion comes from slick marketing and uninformed talk show advice about the nature of trusts. A trust is a flexible legal device that allows one person to manage property for the benefit of another. There can be no trust without property but you can declare a trust in advance such that the trust comes into existence when it is "funded" with property. Trusts can be crafted in infinite ways to fit particular needs. You can't tell what a trust does until you actually read it and understand the relevant law.

Trusts are largely creatures of state law and, not surprisingly, California Trust Law (defined in Division 9 of the Probate Code) is somewhat unique. The law contains pages of default provisions that apply unless they are overridden by the trust. Thus, a simple trust scribbled on the back of an envelope actually incorporates many pages of boiler-plate duties. The law also contains mandatory provisions that override, as a matter of public policy, certain provisions you may write. Thus, trusts written by people unfamiliar California Trust Law often contain hidden surprises.

Trusts with similar names can be very different. Sometimes, the name hides or contradicts the language of the trust. For instance, the John Doe Revocable Trust may be irrevocable and the Jane Doe Irrevocable Trust may be revocable in practice. If parties dispute the language, you can petition a court for clarification.

Since trust terminology comes from jolly old England let me review a few trust terms. It's helpful to think of a trust as a property management agreement covering specifically identified property. The management agreement is called a Declaration of Trust. The property manager is called the Trustee. The person who provides the property is called the Settlor. The person who benefits is called the Beneficiary. Of course, you can have multiple settlors, trustees, and beneficiaries. The settlors, trustees, and beneficiaries can be legal entities such as partnerships or corporations. The property of a trust can include other trusts and legal entities which can in turn, control other trusts and legal entities. The settlor, trustee, and beneficiary can be the same person or they can be different entities scattered around the world. With that background, let's explore some common trust arrangements.

Living Trusts are commonly created by married couples, domestic partners, and individuals. When a couple creates a living trust, they sign and notarize a written document and then, hopefully, transfer title to their assets to the trust. While they are both alive and capable of managing their affairs, they manage the property themselves. While living, they can freely change the trust, take property out, or put property in. If they become seriously ill or otherwise incapacitated, they can select someone to manage their property for them (successor trustee). When they die, the property will be managed and distributed in accordance with the terms of their trust. Their deaths can trigger the creation of sub-trusts for the benefit of children, grandchildren, or most anyone else they choose. The primary benefits of a living trust are privacy from court proceedings, avoidance of probate fees, management during incapacity and after death, and, with properly structured sub-trusts, potential death tax savings. The disadvantages of living trusts include overhead and subsequent creditor issues.

Special Needs Trusts are created to improve the life of an often severely disabled person who receives or may become eligible for valuable Medi-Cal benefits. Third party trusts are funded by qualified family members and friends. First party trusts are funded by other family members, the disabled person, or an injury judgment (as a more flexible alternative to a settlement annuity). The law is a study in cross jurisdictional complexity because federal statutes and regulations define requirements that the each state implements with unique statutes and regulations. When someone is seriously ill or injured, a special needs trust may be a viable alternative to either "spending down" family assets or waiting out a disqualification period for donative transfers – especially under the new California rules.

Pet Trusts can be created under fairly recent California law. If you have animal companions that depend on you for their care and support, a pet trust can provide resources and instructions for the animals' uninterrupted care in the event of your death or disability. You can nominate trust protectors and others to oversee the care of your animals. Non-profit animal benefit organizations can inspect you animals and the place where they reside. My normal practice is to integrate pet trust provisions into a living trust or will - preferably a living trust. That way, the trust lies unfunded, dormant, and flexible until it activated by you, your disability, or your death.

Life Insurance Trusts are created to own and receive the benefits of cash value life insurance free of estate taxes. While life insurance death benefits are generally free of income taxes, death benefits may be included in the taxable estate of a decedent who held certain "incidents of ownership" within three years of death. Life insurance trusts are often structured to qualify premiums for annual gift exclusions and distance benefits from any incidents of ownership.

Creditor Protection Trusts are easily created to protect others, such as your children, from their creditors. However, it's not as easy to protect your money from your creditors. Confidentiality is critical and time can be of the essence. If you talk to others, they can be called as witnesses to your actions and intent. Transferring money out of the reach of a known creditor can violate fraudulent transfer rules. If you transfer your money to a foreign jurisdiction, a local judge may put you in jail until you move it back. If you wait too long, your choices may be limited to settling your debts, bankruptcy, or moving to an extradition proof third world country (not recommended). High risk individuals such as doctors, lawyers, property owners, and business owners are among those who look to trusts to protect their nest eggs. In my experience, they often wait too long and thus become trapped by federal fraudulent transfer rules.