Planning Matters | Sharpe Group
Posted April 1st, 2004

Planning Matters

Trusts are among the most popular estate plan­ning tools. Charitable remainder trusts, chari­table lead trusts, and living trusts give donors much-wanted flexibility as they determine how best to fulfill their desires to give to their favor­ite nonprofits.

Too often, however, both donors and devel­opment officers use the word “trust” as a catch­all term without having any specific knowledge of how a trust is constructed and executed. A thorough understanding of how and why trusts are established can help fundraisers determine if a charitable trust is the best choice for their potential donors.

What is a trust?

A trust is created when the owner of an asset (the grantor) transfers legal title to an asset to a trustee. The trustee then has all of the duties and responsi­bilities associated with property owner­ship and must manage the property according to state law and the grantor’s directions. The trustee, acting in that capacity, receives none of the benefits of ownership. Instead, the trustee holds the property for the benefit of one or more other persons or entities, the trust beneficiary(ies). The trustee makes payments from the trust to or for the benefit of the beneficiary(ies) according to the grantor’s instructions. When the property is exhausted or at the end of a specified time period, the trust ends and the remaining trust property is distributed to the individuals or orga­nizations that the grantor specifies, the remainder person(s).

A grantor may structure a trust to become effective after his or her death (a testamentary trust) or during life­time (an inter vivos trust). A person can create a testamentary trust by includ­ing trust provisions as part of his or her will, in which case the trust prop­erty is subject to the probate system. Testamentary trusts are often used in federal estate and gift tax planning, and in special needs trust planning for a disabled beneficiary.

Using trusts to avoid probate

Another option, and one that is particularly useful from a gift planning perspective, is a revocable living trust. This is an inter vivos trust, which is created during the lifetime of a grantor. Property in a revocable liv­ing trust does not become part of the grantor’s probate estate. Instead, any property remaining in the trust upon the grantor’s death is admin­istered and/or distributed according to the terms of the trust. It does not pass under the grantor’s will or by intestate succession.

There are many advantages to avoiding probate, including:

1. Faster distribution of assets. By avoiding the probate process, beneficiaries re­ceive the property much more quickly than with a will alone, especially if the will is contested.

2. Enhanced privacy. While probate estate proceedings are generally matters of public record, financial affairs and information about beneficiaries are private in the case of revocable living trusts.

3. Reduced estate administration expenses. Assets in a revocable trust avoid the costs typically associated with probate, including attorney’s fees, personal representative fees, and court costs. Although those fees vary from state to state, probate costs can average as much as five percent in a probate estate versus an average of one to two percent in non-probate estates—a potentially significant savings.

4. Minimized taxes. The IRS considers the person establishing a revocable living trust to be the owner of the trust’s assets for federal income tax purposes. If a revocable living trust is properly structured, however, the trust prop­erty will not be included in the grantor’s taxable estate. It is important to note, however, that by avoiding probate one does not automatically avoid estate tax. Probate governs the transfer of assets, not whether they are considered to be the property of the deceased for tax purposes.

To preserve flexibility, those who establish revocable living trusts retain the power to re­voke or change their trusts. However, there are occasions when one may want to establish irre­vocable living trusts for tax or personal reasons, such as to make a gift to a favorite charity or to pass assets to heirs over time making use of annual gift tax exclusion amounts. Others will sometimes establish irrevocable trusts for the purpose of owning life insurance that will not be included in the estate of the grantor at death.

No matter how they are originally struc­tured, however, trusts typically become irrevo­cable upon the death or incapacity of the person who established the trust, and the trustee must admin­ister and distribute the trust in accordance with stated provisions. It is also important to note that trustees of both revocable and irrevocable trusts are accountable under state law. There are legal remedies available to those who believe a trust established for their benefit has been mismanaged.

Other benefits of living trusts

Living trusts offer donors many benefits in addi­tion to those listed above. As in the case of a will, a property owner may establish a trust when he or she wants to eventually benefit a loved one or a charitable interest without making an outright, unrestricted gift. A trust enables an individual to protect and provide for a loved one or a favorite charity while still having some control over the way the property is used. The grantor can determine how the trustee manages and invests the property and direct how the trustee distributes the property and its income. Another reason to establish a living trust is that, if a grantor is deemed incompetent for any reason before death, the trustee or successor trustee has the authority to manage the trust’s assets. This can avoid potentially expensive and embarrassing legal proceedings.

Not a cure all

Despite these many benefits, donors should always be advised that a living trust is rarely if ever a com­plete substitute for a will. A will is an essential back-up device for property that isn’t transferred under the terms of the trust. For example, if a person acquires property after establishing a trust, he or she may not think to transfer ownership of it to the trust—which means that it won’t pass under the terms of the trust document. But a will can include a clause that either directs that property to the trust (a “pour-over” will) or names those who should receive any property that remains in the probate estate. Furthermore, in most states a will is the only mech­anism whereby a person can recommend a guardian for minor children.

Living trusts may provide tremendous benefits, including the ability to preserve property for loved ones, provide for favorite charitable interests, avoid probate, and reduce tax burdens. Despite the poten­tial benefits, however, the creation of a trust should be carefully considered, as they are not always the best tool to accomplish a person’s wishes and intent. In recent years, some have heavily promoted living trusts as an estate planning panacea, and as a result, several states have taken steps to further regulate trust services in order to protect the public from exaggerated claims of the benefits of trusts. Anyone who is thinking about establishing a living trust should speak to an appropriate professional advisor.

Sharpe offers a number of estate planning materials that explain the benefits of various giving options to potential donors. Special booklets devoted to trusts, including living trusts, charitable remain­der trusts, and lead trusts, are available, as well as several booklets that touch on all of these plans, “Charted Giving Plans,” “Better Estate Planning,” and “Reflecting on Tomorrow” (see page 6).

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The publisher of Sharpe Insights is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Sharpe Insights may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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