These are common questions that I hear. Read on for information to help figure out whether you need a trust and, if so, what kind fits your specific situation.
For example, maybe you have a disabled child and you want a trust to permit that child to inherit without losing government benefits. Maybe your own or your spouse's health is heading into difficulties, and you can foresee eventually needing long-term care benefits. Trusts can also be an alternative to a formal probate court process in settling your estate. Or, you might be in the classic “trust fund” situation, where you're concerned that your children won't be able to manage money wisely due to their age, financial inexperience, or other reasons.
All these are excellent reasons to consider a trust. But what kind of trust? A quick count shows there are at least thirteen different varieties.
Here's the basic idea behind trusts, to help you understand why you might or might not need one.
What is a Trust?
Think of a trust like a safe deposit box. You originally bought property or earned money in your own name. You then transfer those assets into the trust's name – into your safe deposit box, in other words. The trust safe deposit box becomes a legal entity separate from you, which now holds your property in it.
Then you identify people who will occupy the three roles involved in managing trust property. First, you are the grantor, or settlor, or trustmaker – all those words mean the same thing, the “you” in this case. In Michigan, settlor has become the preferred term in recent years. Second, you appoint a trustee. That person or entity is responsible for managing trust assets and following directions contained in the trust document. Third, you decide whom you want to receive trust assets – your beneficiary or beneficiaries, in other words.
In legal terms, a trust is a fiduciary agreement among you the original property-owner, your trustee, and your beneficiary. The trust document contains instructions for what you want done with trust property, both for how you want it invested and, also, for how you want trust assets to be used for your benefit if you are disabled or frail and elderly and how you want them distributed when you pass. Trusts are, thus, a highly efficient hybrid between a power of attorney, an asset-management vehicle, and a Last Will and Testament, all rolled into one legal entity and document.
There are two basic kinds of trusts to understand, before they split off into their thirteen-or-more different flavors: revocable or irrevocable trusts.
The Revocable Trust
A revocable trust can be thought of like the safe deposit box with the open lid. As settlor of a revocable trust, you can get at trust assets freely.
You yourself can also initially occupy all three roles in a revocable trust – settlor, trustee, and beneficiary. If need be, you can also tinker with trust terms, by freely amending them to change the directions, beneficiaries, or trustees. Or, you can revoke the whole thing. Before that point, though, the trust document will be there to take care of everything you want it to.
If you should meet with an accident and lose capacity, the terms of your trust will designate a person to step in on your behalf and, thus, avoid the need to go to court to get a conservator for you. The trust can provide that your incapacity is determined based on the opinion of your doctor (or two doctors) instead of a probate court judge, who does not know you. The trust will also direct who inherits, thus keeping your affairs private and out of probate court. This feature is especially important if you (formerly) and then the trust (after you created it) owns real property in various states. The savings in court costs in that situation could be significant.
The Irrevocable Trust
This is the trust for you if you're seeing the need for Medicaid long-term care benefits in your future, or you work in a field where suits are common, such as owning a small business or in the construction industry.
The disadvantage to an irrevocable trust, however, is that you will be sacrificing all or almost all access to trust assets, unlike in the revocable-trust situation. Once an irrevocable trust is established, you as grantor/settlor/trustmaker cannot directly alter the terms and, generally speaking, your access to trust money is restricted or entirely precluded – as is required in order to enjoy the potent benefits of this kind of trust.
Think of an irrevocable trust as being like the safe deposit box where you give the key to someone else and they cannot give it back to you. Your trustee – who generally cannot be you – is the one with the key. You yourself can no longer reach your assets. This relinquishment of control is necessary to shelter your assets from creditors, or to protect your assets when entitlement to government benefits would otherwise require you to spend almost all you own first.
There are ways to draft an irrevocable trust carefully, so you can still exert your will over how assets are to be used. Just as in the revocable situation, you can impose conditions that must be met before a beneficiary can receive funds. You can designate how trust income is to be used for specific purposes like college tuition, business start-up, or travel. You can also reserve the right to change who the trustee is and who inherits any assets that may remain in the trust upon your death.
The above is a broad overview of trusts.
Trusts can be living trusts or testamentary trusts. A living trust is a trust that you create during your lifetime, that becomes effective immediately and that continues after the settlor's death until the directions and tasks in the trust have been carried out and completed. A testamentary trust is a trust that you create during your lifetime that does not become effective until after your death. Testamentary trusts can be contained in living trusts when the living trust contains a direction to hold property in trust for another beneficiary after the death of a settlor. As such, a living trust can also contain a testamentary trust within it. Living trusts can be revocable or irrevocable. Testamentary trusts are always irrevocable because they only come into existence after the settlor's death, so the settlor cannot amend or revoke the trust then.
Some sophisticated trusts do convey tax benefits, but, for the most part, IRS considers revocable trusts to be invisible for tax purposes. You as grantor/settlor/trustmaker will still pay tax on the revocable-trust income, albeit at your individual rate and not at the prohibitive trust rate.
As for estate taxes, in the past credit shelter trusts were frequently used when the estate tax applied to more people. As recently as the late 90's, people with an estate above $600,000 may have had to pay a large estate tax upon their death. For now, federal estate taxes are not an issue for most people. They are not incurred until the value of the estate exceeds $11.4 million as of 2019. Some states do impose estate and/or inheritance taxes, but Michigan no longer does.
Also, keep in mind that revocable trusts provide no protection against creditors. If you lose a legal action, the assets in the trust can be garnished just as they could be if you did not have a trust. Assets in certain irrevocable, asset protection trusts can be protected from lawsuits. These trusts must be established long before you run into that kind of trouble. If you create such a trust while credit problems are looming or have already arrived, you risk that your trust will be undone as a fraudulent conveyance.
Do I Need a Trust?
Trusts are very useful in providing for management of your assets, for your benefit to take care of you, upon your incapacity by an individual you designate (your successor trustee). After the settlor's death, it can be faster and less expensive to settle a trust then a probate estate, though there are still legal steps that have to be taken. For married couples, more comprehensive revocable living trusts can protect assets from the costs of long-term care in the event that the surviving spouse needs to qualify for Medicaid nursing home benefits. Not everyone needs a trust, and, in some situations, a Last Will and Testament and Power of Attorney plan can also be effective. Whether you need a trust depends upon your goals and the nature and extent of your assets.
As an elder law and estate planning attorney in metro Detroit, I create different types of revocable and irrevocable trusts for my clients as part of their overall estate plans. If you would like to schedule a consultation to discuss if a trust makes sense for you, feel free to contact my office.