by Jonathan A. Nelson
We have written in some detail in this series about using trusts for estate planning, with a particular focus on post-death planning. But the concept of a trust is very useful in a lot of contexts. What are some kinds of trusts, and what do some of the funny sounding names mean? The following list is not exhaustive and is meant to be very high level. Particular pieces may be treated in more detail in future posts. Estate tax planning is a specialized enough field that the trusts associated with it will be discussed in a separate post as Part 2 of this topic.
What is a Trust?
At the most basic level, a trust occurs any time a person (called the Grantor or Settlor) conveys an asset to a person (the Trustee) subject to terms that benefit a person (the Beneficiary). Even though the Trustee has legal title to the asset, the law holds the Trustee to fiduciary duties (a high degree of ethical conduct discussed here), to ensure that the asset is used pursuant to the terms of the trust. The law also protects the asset from the Trustee’s creditors because it isn’t really the Trustee’s asset.
A trust is not a legal person in the same way a corporation or an LLC is, however. It can only sue or be sued in the person of the Trustee, and the death or incapacity of the Trustee can lead to automatic succession, whereas an LLC may require a member meeting or even go through probate if the succession is not established beforehand.
Trusts Outside Estate Planning
Trusts can be useful in many contexts. In a divorce, a trust may be an effective way to make sure that college tuition or life insurance benefits the children without just giving money to the ex. Most people buying a house will sign a Deed of Trust in which they irrevocably appoint a Trustee to keep them from defaulting on their mortgage by selling the house and paying off the bank if they do not make their own payments on time. There is an interesting line of cases in Virginia dealing with that Trustee’s fiduciary duties to the homeowner, since the homeowner is both the Grantor and a Beneficiary of the trust.
A small business may be more efficiently run if one active Trustee holds the voting power of a group of less involved shareholders. (In fact, pooling voting power is so useful that Virginia allows a ‘Business Trust’ to register as a legal entity, in an exception to what I said about legal persons above.) A ‘Land Trust’ holds land and can aid in conservation or land use management, governing a group of investors, reducing premature disclosures while development plans are in the works, or providing continuity for a particular operation like a farm.
Trusts for Asset Protection
One clause frequently used in trusts is a ‘spendthrift clause’. This is a direction to the Trustee to prevent payment to a beneficiary’s creditors, and is important to protecting the trust from downstream anticipation of benefits invading the benefit (or asset) meant for the beneficiary alone.
Where the Grantor and the Beneficiary are the same person, however, the question is whether the trust can in fairness be interposed to avoid paying creditors. Although self-settled spendthrift trusts can be created and used effectively, they are intentionally cumbersome and difficult to control to reduce the temptation for overuse. For example, they usually need to be in place for five years before they provide any protection, and the Trustee must be true third party.
A particular application of this is the Medicaid Planning Trust. Here, one’s assets are sufficiently removed from personal ownership and direct control in order to qualify for long term care through Medicaid. For the reasons above, these are difficult to set up correctly and benefit from a high degree of attorney involvement in the creation and administration. In addition, it is a lifestyle decision, and checking which local facilities take Medicaid before setting up such a trust may be helpful in deciding whether it will be advisable for you.
Trusts for Estate Planning
A trust can be created by a will (called a Testamentary Trust); in Virginia, these tend not to be used heavily since they occur inside probate and can significantly increase the time and expense of probate.
As hinted at above, the Grantor, Beneficiary, and even the Trustee can be the same person unless otherwise prohibited by law. This combination allows the major use of trusts as an estate planning tool – the revocable living trust whereby the Grantor retains essentially unfettered control of his or her own assets, but can still avoid probate with very little paperwork. There are many variations possible.
A joint revocable living trust allows a married couple to create a unitary estate plan that is less dependent than individual wills on the happenstance of which spouse dies first. For spouses with separate resources or beneficiaries, options exist on how those are treated in individual or joint trusts, and can include a Qualified Terminable Interest Property (“QTIP”) provision that provides care for a surviving spouse but not the ability to invade the eventual inheritance.
Some trust terms are self-descriptive. A Trust for Minors is exactly that. A Pot Trust holds family resources in a common pot for use according to need, in a sort of rough facsimile of your having lived longer, and it is only later that the unused portion is divided into individual shares. A Pet Trust provides resources and oversight to ensure beloved animals live out their days in the manner you desire. The term Legacy Trust tends to be used to describe a long-running trust, often holding assets through at least one generation, in an attempt to build wealth rather than facilitate spending, and the term Dynasty Trust typically refers to trusts holding assets for more than one generation, often (but not always) involving estate tax planning, discussed in the next post in this series.
Trusts Which Intersect With Estate Planning
Special Needs Trusts (sometimes called Supplemental Needs Trusts) are designed to keep challenged or medically vulnerable beneficiaries from being accidentally disqualified from the public benefits they may depend on. If any of the beneficiary’s assets went into the trust, Medicaid can require reimbursement of lifetime expenses from the trust, so a special needs trust intended to administer an inheritance and then pass the unused portion to other family has to be careful about the sources of funding.
Finally, a Totten Trust is more commonly called a transfer-on-death or payable-on-death designation, but it involves the asset holder acting as a trustee for your instructions to transfer the asset as directed.
This post runs through a lot of detail quickly, but the most important thing to understand is that these tools are right for certain jobs, but there are no one-size-fits-all solutions. Talking through the pros and cons with an experienced estate planning attorney will help make sure you are taking the correct steps to handle your assets in ways that best meet your goals, handle your foreseeable challenges, and benefit those you care about.
Next time in Trusts 101: Kinds of Trusts (Part 2)
Virginia attorney Jonathan A. Nelson uses his extensive legal knowledge and trial experience to resolve conflicts, negotiate settlements, navigate compliance matters, and vigorously advocate in the courtroom in order to achieve the best possible outcomes for his clients. He practices in estate planning, probate, trust and estate administration, corporate law, and civil litigation related to these fields.
The attorneys of Smith Pugh & Nelson, PLC, offer the experienced counsel, personal attention, and customized legal services needed to address the many complex issues surrounding estate planning, probate, and trust administration. Contact us at (703) 777-6084 to schedule a consultation.