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What Is A Trust And What Does It Do?

A trust is a legal relationship between a trustee, a trustor and a beneficiary. The trustee is the person responsible for managing the assets and handling the trust on behalf of the beneficiary. A trustor is the person who creates the trust and the beneficiary is the person for whose benefit the trust is created.

A trust does not establish a legal entity. Rather it establishes a legal relationship and a set of duties and rights that are enforceable in court. A trust establishes a method for avoiding probate at the death of the trustor, meaning the person who created the trust. It also establishes a method for placing funds into the hands of a trustee, who manages those funds for a beneficiary.

So, for instance, if parents are concerned about their children inheriting a significant amount of money at the parents’ deaths at a time when the children would not be capable of handling the money responsibly, an estate planning attorney can set up a trust for those children and put the money in the hands of the trustee who has the legal responsibility to handle the money for the kids until they’re ready to handle the funds themselves. This is one primary use of a trust although there are other uses as well.

What Kinds of Trusts are Available for Succession Planning?

There are two primary types of trusts. There is a revocable trust, which is the type of trust that most people create as part of their estate plan. This type of trust is typically formed by a husband and wife who act in all three capacities, that is they are the trustors, meaning they have created the trust; they are the trustees, meaning they manage the trust; and during their joint lifetimes and during the lifetime of the last spouse to die, they are the beneficiaries as well.

So, in that capacity, they are essentially wearing three separate hats and the law recognizes that as a valid trust relationship even though it involves the same two people acting in all three capacities. Sometimes a portion or all of a revocable living trust will become irrevocable at the death of either the first spouse or more commonly at the death of the second spouse. This is the point at which either new trusts are created for the kids if they are not yet old enough or mature enough to manage the assets successfully, or the trust simply terminates and the money is distributed to the children or other beneficiaries and terminates.

The other type of trust is an irrevocable trust that can be set up for other purposes. For instance, if a person has a child with developmental disabilities who was receiving federal benefits in the form of social security disability (SSI) or Medicaid (Medi-Cal in California), then a special needs trust will be set up. The advantage of a special needs trust is that the money or the assets are by statute not considered as available assets for purposes of SSI or Medicaid eligibility.

Another type of irrevocable trust is the life insurance trust which is typically used for federal estate tax planning purposes. Often, a person wants to purchase a life insurance policy for the benefit of his or her children but does not want that life insurance policy included in his or her gross estate for federal estate tax purposes because it will increase the amount of federal tax. In that case an irrevocable life insurance trust will be created. Sometimes it will be funded with a set amount of cash at the beginning that is intended to pay all the premiums that come due on the policy. More commonly, the creators of the trust (who are typically the parents who are also the insured persons) will make annual gifts to the trust for the purpose of allowing the trustee to pay the premiums that come due on the policy. Since the premium contributions that the parents make each year are considered gifts to the trust, the money that is in the trust and the life insurance proceeds that are paid when the insured parent dies are not included in the parent’s gross estate for federal estate tax purposes. This is because they are owned by the trust and the premiums have been paid as a gift so that money is excluded from the gross estate.

This type of planning is a little less common now that they have increased the federal estate tax exclusion amount dramatically, such that now in 2015, it’s $5,430,000 per person. This means that in 2015, a married couple could have a combined estate of $10,860,000 sheltered from federal estate taxes without using things like life insurance trusts, so they have become a little less common but still are useful in larger estates.

An Asset Protection Trust Can Be Set Up in States With Enabling Legislation

Another type of irrevocable trust is what’s called an asset protection trust. Those can only be set up in states that have enabling legislation that allows an asset protection trust to be created. The person creating a trust hires an attorney and a trustee. North Dakota allows them as do Utah and Nevada. The person creating the trust is typically a high income, high asset person who has high liability risks in his or her business. A prime example would be a surgeon who is concerned about malpractice liability exceeding his insurance limits.

Often times he will set up an asset protection trust in a state like Nevada and hire a Nevada attorney and trustee to manage the assets. If it does happen that he is found liable for malpractice liability that exceeds his malpractice insurance limits, the assets in the asset protection trusts are protected from that claim. The person holding the judgment has to go into the state in which the trust has been organized and try to penetrate the asset protection trust. Because Nevada law authorizes the trust and provides that its assets are not subject to being liable for a judgment, the creditor is usually unable to reach those assets.

California does not permit asset protection trusts. A creditor cannot place assets into a California based trust and protect those assets from execution by creditors.

For more information on Benefits of a Trust, a free initial consultation is your next best step. Get the information and legal answers you’re seeking by calling (916) 635-0302 today.

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