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FAQ: Trusts

Answers To Your Questions About Trusts

What is a trust?

A trust is an agreement between the maker of the trust and the trustee(s) of the trust for the benefit of persons who are called “beneficiaries.” (A trust agreement is sometimes referred to as an “indenture.”) The person making the trust is sometimes called by many different names, all of which mean exactly the same thing: Grantor, Settlor, Trust maker, Trustor, Creator. In the trust agreement, the trust maker gives instructions to the trustee concerning the holding and administration of trust assets. These instructions specify how the assets are to be held and distributed during the trust maker’s good health, upon his or her disability, and ultimately upon his or her death.

A trust can be revocable or irrevocable. The words speak for themselves. A revocable trust is able to be revoked or amended, usually by the trust maker. An irrevocable trust cannot be revoked or amended by the trust maker (though it may be able to be changed by another party.

A trust can be created by the maker while he or she is alive — in which case the trust is known as a living trust or an inter-vivos trust (the Latin term for “during life”), or it can be created after death through the operation of a will — a testamentary trust. A living trust can be revocable or irrevocable, depending on its purpose, while a testamentary trust is always irrevocable.

With a revocable living trust, a person can (and usually is) both the trust maker and the trustee. In a marriage situation, often both spouses are trust makers and co-trustees. The flexibility of a revocable living trust makes it an ideal foundation for almost all estate plans. Such a trust can be designed to control all of the trust maker’s property, totally avoid the probate of the maker’s estate, and maximize federal estate tax savings.

Irrevocable living trusts are typically used in conjunction with revocable living trusts to hold certain, select assets of the trust maker for the benefit of the trust maker’s beneficiaries. If the trust maker retains no rights in the irrevocable living trust and is not a trustee or a beneficiary of the trust, the assets of the trust can be excluded from the trust maker’s taxable estate. This allows the trust maker to reduce and, at times, eliminate federal estate taxes.

How do I most effectively avoid a living and a death probate?

Through a revocable living trust, living and death probate proceedings can be totally avoided. You may incorporate instructions into a revocable living trust which specify how your disability trustee should manage your assets if you become disabled. This simple procedure allows you to have the benefit of your assets, consistent with your directions, during the period of disability while avoiding the expense, delay and lack of privacy imposed by the living probate process.

Similarly, a revocable living trust enables you to leave instructions for your death trustee, indicating how assets should be distributed. Because the assets are titled in the name of the trust, you avoid the expense, delay and lack of privacy afforded by a death probate.

How can life insurance policies be totally protected from both probate systems?

The best way to totally protect your life insurance policy and proceeds from both living and death probate is to designate a revocable or irrevocable living trust as both the owner and the beneficiary of your life insurance policy.

My husband is not well: his memory and his mental acuity have degenerated over the last several years. If I die before my husband, how can I allow him the dignity of his independence and still protect him from the problems related to his failing health?

With a funded living trust as the center of an estate plan, a trust maker can select a co-trustee to serve with the spouse as trustees of the trust. This enables the surviving spouse to retain control and independence while having the advice and counsel of the co-trustee.

In the event that the surviving spouse’s health further diminishes, the trust can provide for a smooth transition in the management of his or her affairs. For example, a son or daughter could be named to serve as co-trustee with the father. The selection of a family member provides personal sensitivity as well as the security of joint management for the ailing spouse.

What is the difference between a “living trust” and a “living will?”

A “living will” is the document which deals with physical care decisions for you. With a “living will,” you can specify what health care decisions are to be made for you if you are unable to make the decisions yourself because you are incapacitated. A “living will” is one of the most important of your estate planning documents, because it allows you to maintain control over what happens to you even when you are not able to tell providers what kind of treatment you want.

A living trust deals with your financial affairs rather than with your personal care.

Isn’t creating a revocable living trust just a waste of time and money if my estate is not subject to estate tax?

Absolutely not. Your estate may pass estate tax-free on your death, but there is more to planning than taxes. In fact, the many personal benefits existing in a revocable living trust may be significantly more important than estate tax savings. Consider once again our definition of proper estate planning:

  1. I want to control my property while I am alive and well
  2. I want to care for myself and my loved ones if I become disabled
  3. I want to be able to give what I have to whom I want, the way I want, and when I want
  4. And throughout the process, I want to save every last tax dollar, professional fee and court cost possible

Please note that many goals precede the concluding phrase, “save every last tax dollar.” It is those preceding goals which have priority in proper estate planning.

Is living trust planning a good idea for a single parent?

Yes. In fact, it is the best overall solution to the planning problems of the single parent. In most respects, it offers the same advantages to a single parent as it does to a married parent. However, because there is no spouse to assist the parent if he or she becomes disabled or to provide for the emotional and financial needs of the child(ren) if the parent should die, living trust planning is particularly beneficial for a single parent. Carefully selected guardians and trustees and detailed instructions for your own care and that of your child(ren) will ensure that, no matter what life brings, your wishes will be carried out and your child(ren) provided for.

What is the income tax effect of a revocable living trust?

A revocable living trust is tax neutral in that the trust maker is considered the owner of all trust assets for income tax purposes during his or her lifetime.

What happens to the trust upon the death of its maker?

At the trust maker’s death, the trust may continue according to its terms or may be terminated with the trust assets being distributed to the beneficiaries.

Can a married person create a living trust plan without the knowledge of his or her spouse?

Yes. A spouse can transfer the ownership of separate personal property — such as bank accounts, money market accounts, certificates of deposit, stocks or bonds to a living trust without the other spouse’s consent or signature on any of the transfer documents.

In some instances, a person will not be able to transfer joint title to real estate into his or her living trust unless the other spouse cosigns the deed that is necessary to vest title in the name of the trust

Can I have more than one revocable trust?

Yes, you can have any number of revocable or irrevocable trusts.

I’m afraid I’ll lose control of my assets if I don’t own them anymore. Why do you say I won’t lose control?

First, you create a trust agreement with the help of a qualified estate planning attorney, who makes sure the plan design fulfills your objectives while staying within the bounds of trust law, debtor-creditor law, marital law, bankruptcy law and tax law. Among the provisions of your trust are your instructions for the trustee in regard to managing and distributing the assets for and to your beneficiaries — you dictate the terms which your trustee must obey. There is no higher duty under the law than that owed by a trustee to a beneficiary.

If that is not enough control, you can be the sole beneficiary of the trust during your lifetime. Your trust will contain instructions on how to take care of you during incapacity, and your instructions must be followed and your property used for your benefit. If you become disabled, you actually have more control over your property than you would have if you owned it outright, since without the trust your assets would be subject to a living probate.

And finally, for the ultimate in control, you can be your own trustee while you are alive and competent. You make all the decisions to buy, sell, give away, acquire and use the property, just as you always have

How does a revocable living trust avoid probate?

Regardless of the specific types of property that a decedent may have, all property will be either probate or non-probate property. Probate property is all the property that is personally owned by you and which must pass through the probate process. Trust property is legally owned by the trustee (though beneficially owned by the beneficiaries) and does not usually fall under the jurisdiction of the probate court.

I understand that the probate process is public. If I had a revocable living trust, would everyone still know my affairs?

No. Unlike the probate process, a living trust provides complete privacy and does not enable public scrutiny.

Does a living trust avoid an ancillary probate?

When a revocable living trust is properly implemented, and assets located in other states are funded or transferred into the trust, no ancillary probate proceedings are necessary.

If my state has simplified or informal probate laws should I still consider creating a living trust?

All states differ as to the formality of their probate laws. Many states have adopted probate laws that reduce some of the requirements of traditional probate (e.g. court hearings). Even if your state has informal probate, certain procedures must still be dealt with, resulting in the possibility of significant cost, delay and frustration. Additionally, a probate that begins as an informal process can instantly become a very formal probate once the slightest problem occurs.

Further, even if your state has an informal probate process, you may own real estate in a state with formal probate. The probate laws of the state where you own real estate apply to that real estate. A trust can avoid all such probates.

Is my living trust something that the government will shut down?

No, the living trust has been authorized by common law for hundreds of years. Trusts had their origin in England more than 500 years ago, and their use is alive and well in the United States.

Does a revocable living trust always have assets in it?

A revocable living trust may be unfunded, partially funded with only specific assets or fully funded. If a revocable living trust is unfunded or not fully funded, then the trust maker’s assets not held in the trust will only pass to the trust pursuant to a provision in his or her will called a “pour over” provision. The assets not held in trust and owned in the maker’s name will be subject to probate.

Can I keep some of my property outside of my trust?

Yes, you can. But any such assets will have to go through the probate process which the trust is created to avoid.

Are assets held in a revocable trust protected from creditors’ claims?

Generally speaking, when assets are held in a revocable trust, they are not protected from the legitimate claims of the trust maker’s creditors. This is because the trust maker can revoke the trust and take back the trust property at any time. The law finds that it is inequitable to allow the trust maker to have this control and full use and benefit from the trust property while denying creditors the power to compel revocation in order to satisfy their just claims.

An irrevocable trust may provide some creditor protection because the maker is not able to revoke the trust and get the property back. The maker may have a beneficial interest in the trust, such as a right to income or to principal, and that interest may be reached by the trust maker’s creditors. However, if the beneficial interest is subject to the discretion of the trustee and the trust maker is not a trustee, creditors can be thwarted. In fact, four states, Alaska, Nevada, Rhode Island and Delaware, allow trust makers of certain irrevocable trusts to retain rights in the trust and still have the trust assets be free from creditors’ claims.

Are there ways to draft my living trust so that the trust assets are less vulnerable to my beneficiaries’ creditors?

While a revocable living trust cannot protect the maker from his or her creditors, it can protect the beneficiaries from the claims of their creditors. When special language is inserted into the trust document to protect trust assets from claims of the beneficiaries’ creditors, the trust is said to be a spendthrift trust.

Spendthrift trusts are not valid in all states. In addition, the mere presence of a spendthrift clause does not always ensure creditor protection. There are, however, several measures that can be taken to make a spendthrift trust less vulnerable if it is attacked by a beneficiary’s creditors. For example, trust agreements may specify that the trustee must make distributions for the support of the beneficiary or that the trustee may make distributions based solely on the trustee’s discretion. Courts have generally held that spendthrift trusts which require that distributions be made for the support of the beneficiary may be reached by creditors for support-related debts; creditors generally cannot seize assets of a spendthrift trust that allows the trustee to distribute trust assets based solely on the trustee’s discretion.

If your objective is to protect your beneficiaries from their creditors, it is generally best to give the trustee of the spendthrift trust sole discretion as to whether to pay the trust’s income or principal to the beneficiary, as opposed to requiring mandatory payments of income or principal to the beneficiary. Additionally, it is not advisable to name the beneficiary of the spendthrift trust as the sole trustee of his or her own trust. Doing so could invoke the doctrine of merger of equitable and legal title, thus allowing the beneficiary’s creditors to reach the trust’s assets.

Creditors can also reach the assets of a spendthrift trust if the conditions necessary for the trust to terminate have already occurred but the trust has not been terminated. For instance, if the terms of the spendthrift trust require that the trust terminate when the trust beneficiary reaches 30 years of age, a creditor of the beneficiary may require that all assets be distributed to the beneficiary when he or she turns 30. The beneficiary cannot elect to wait out the creditor. To solve this problem, you can make the term of the trust be the duration of the beneficiary’s life.

Is the cost of a will or a trust income tax deductible?

Though the legal fee for drafting a will is generally not tax-deductible, a portion of the fee for the planning and drafting of a revocable living trust generally is. The maintenance, conservation and protection of income-producing assets are deductible, subject to the 2 percent floor for itemized deductions.

If I set up a revocable living trust, will it help me avoid taxes while I am alive?

No, a revocable living trust will not help you avoid taxes while you are alive. Because you still control all the assets, you still pay the taxes on the income from them.

Why do you recommend a revocable living trust as a basic strategy for proper estate planning rather than other traditional methods?

A revocable living trust estate plan meets all of the criteria in the definition of estate planning:

It allows you to control all your affairs and assets during your life and after your death.

It minimizes taxes, fees and costs, thereby preserving your wealth.

If you procrastinate and do nothing, the courts will take control of your assets. When you die, your assets will be distributed according to state law; if you become incapacitated, your assets will be managed by a conservator. The outcome, in either case, may not be what you desired.

With the traditional methods of planning, you can lose control. A will probably will not control all of your assets, and it does not avoid probate when you die. Furthermore, it provides no protection in the event of incapacity.

Joint ownership doesn’t avoid probate; it just postpones it. If a joint owner becomes incapacitated, the other joint tenant could end up in the probate court. Joint ownership can also cause the unintentional disinheritance of a tenant’s own family.

Beneficiary designations are not always effective either. They create problems if the beneficiaries are minors or are disabled or if they have creditor or marriage problems.

Finally, none of the traditional methods is particularly useful as a basic strategy for wealth preservation.

If revocable living trusts are such an outstanding planning tool, why do attorneys either downplay their use or fail to recommend them to clients?

Most attorneys are required to take basic courses in wills and probate administration in law school. Trusts are, in many instances, an elective course. Even though the popularity of revocable living trusts as a basic planning vehicle has blossomed in the last ten years, many schools and continuing legal education programs have failed to catch up to the public demand.

Many attorneys are also reluctant to recommend this planning tool since they believe it will mean less income to them. They mistakenly believe a relatively small fee for sophisticated planning now is not enough to forgo the eventual probate estate revenue. They fail to realize that clients will complete this planning elsewhere to avoid probate and obtain all the advantages of revocable living trust planning.

What are the benefits of a revocable living trust?

Control, cost, convenience and confidentiality are the four primary reasons that many people turn to trust-centered estate planning.

Control. A fully funded revocable living trust allows the trust maker to retain control of his or her estate planning affairs while avoiding probate and its related pitfalls.

Perhaps the most important attribute of a revocable living trust is that it allows the trust maker to retain control of both personal health care and financial affairs even in the event of his or her disability. Studies have shown that people are much more likely to experience a lengthy period of disability during their lifetime than they are to die suddenly without any period of disability. While a will has absolutely no effect until the will-maker has died, a revocable living trust is effective as soon as it is executed by the trust maker. That means that the provisions of the trust can go into effect while the trust maker is alive, so he or she can plan for disability and other issues that may arise during life. Matters including who the successor trustees will be, how the trust maker’s medical expenses will be paid, and where the maker will live and what standard of living he or she will retain during the disability can be planned and will take effect immediately upon the trust maker’s disability without any need for a living probate. The people designated by the trust maker to handle such matters simply follow the directions that are included within the trust and supplemental documents, including durable powers of attorney for health care.

In the absence of proper planning, the trust maker’s wishes may remain unknown and decisions affecting the trust maker may be left to chance.

Cost. Because property that is held by a revocable living trust avoids probate, the cost of administering the trust estate after the maker’s death is much lower than the professional fees for administering that same property in the probate process.

With a revocable trust, there is no need to retain an attorney to steer the estate through probate. The directions to the successor trustees for the administration and distribution of the trust property are in the trust document. Of course, the successor trustees may seek the advice of an estate-planning attorney and a knowledgeable accountant as needed, but in most cases the assistance required from professional advisors is minimal.

Further, trust estates avoid such costs as filing fees, newspaper publication costs, and other expenses associated with the required notices, hearings, and other procedures dictated by probate laws.

The fees and costs associated with administering an estate using a revocable living trust are nominal. A trustee’s fee is based upon the “going rate” of bank trust departments, and national surveys show that the average total cost of administering a revocable living trust estate is less than one percent of the gross value of the estate!

Similarly, living probate proceedings are avoided with proper trust-centered estate planning in which health care agents are appointed and successor trustees are designated in the trust agreement. Living probate—related costs, including attorney fees, filing fees, costs of publication, and the like, are avoided, resulting in preservation of trust assets for the benefit of the trust maker.

Convenience. While the results of administration of a probate estate or a trust estate are the same — taxes are paid and distributions are made to the beneficiaries — the probate process is cumbersome and time-consuming in comparison to the process of administering a trust estate. The trust maker’s specific directions within the trust document address the contingencies of disability and death and appoint successor trustees to carry out those directions.

Upon the disability or death of the trust maker, the successor trustees have legal control of the trust assets immediately, without involvement of any court, so the trust maker’s lifetime endeavors may be continued without interruption. If the trust maker was engaged in a business enterprise, the ability to continue its operations is generally critical to the health of the business. In addition, the successor trustees carry out the administration of the trust in a timely manner, whether by creating sub-trusts for the benefit of the beneficiaries or making immediate distributions.

Confidentiality. Trusts are private. While wills and the entire probate process are open to the public, trusts remain confidential. For many, this in itself is a compelling factor in favor of revocable living trusts.

It is unlikely that we would discuss our income or net worth with neighbors at a social gathering. However, if you die with a will controlling your affairs, then all of your sensitive financial matters are at once open to public scrutiny. Your will and the accompanying inventory of your estate, the value of your assets, and your outstanding debts are all filed with the probate court in the county where you resided at death. Anyone, such as an intrusive neighbor or potential suitor for your business, can simply contact the court, forward a small check to cover the expense of photocopying your estate file and receive copies of all papers filed in your estate.

Since fully funded trusts are not subject to the rules of the probate court, the inventories notices to beneficiaries, and accountings of all assets and debts of your estate are not filed with the court and hence not open for public scrutiny.

Are there any disadvantages of a revocable living trust?

There can be, though they are few in number, and most of these problems depend upon the state(s) in which you own real estate. Even when there are disadvantages, the benefits of a revocable living trust usually far outweigh the drawbacks.

Expense. One objection to a revocable living trust is that it is more expensive to create than a will. True enough. Wills have been priced below cost for years by attorneys who build up huge files of wills and then reap the probate fees in years to come. Executors do not have to use the attorney who drafted the will as their attorney, but in fact, most do.

A living trust-centered plan is only initially more expensive than a will. The cost of a will and after-death administration through the probate process almost always exceeds, by a large amount, the cost of a funded living trust and its private after-death administration.

Reducing the cost of death administration is only one benefit of avoiding probate, and avoiding probate is only one (small) benefit of a revocable living trust.

Funding. Some people find it annoying to have to determine what they own and how they own it and then have to change ownership of their property to a living trust. Yes, this can be annoying, but it has to be done only once. And if people think it is a problem for them while they are alive and well, think of what a problem it will be for their spouses or children if they become disabled or die.

The choice is this: People can either “probate” their own estates themselves or pay the courts and lawyers to do it for them after they are no longer around to answer questions such as, “Where is the deed to the house?”

Most people who have gone through the funding process, one piece of property at a time, report that they feel a great sense of relief and peace of mind, knowing that they finally have their records in order.

Tenancy by the Entirety Property. If a married couple own property as tenants by the entirety and transfer the property into their revocable living trusts, the property is no longer tenancy-by-the-entirety property. However, for most people, the benefits of tenancy by the entirety are not that substantial.

Homestead. In some states, homeowners may not be entitled to protections afforded by a declaration of homestead if they place their homes in revocable living trusts. Even in these states, however, there are often ways to title a home so that the benefits of placing the home in a living trust and the declaration of homestead can both be obtained. To what extent a declaration of homestead can protect a home, under what circumstances, and for how long are matters of state law. Generally, like tenancy-by-the-entirety, it is not permanent protection; and, like tenancy by the entirety, it does not protect the home from claims by the mortgage holder.

Miscellaneous Issues. Retirement plans and certain professional practices or franchises may require some special handling for living trusts. In some states, real estate transfer taxes may be triggered upon transfer of real property to a trust (this is very rare); the title insurance company may have some particular requirements, or real estate tax breaks available for owner-occupied residences or the elderly or disabled may not be available when real estate is placed in a trust.

If debt-encumbered property is to be held in a living trust, written assurance should be obtained from the lender that the transfer will not trigger a “due-on-sale clause” (by federal statute this cannot happen with respect to a personal-residence mortgage).

Your estate planning attorney should guide you through any issues regarding funding your revocable living trust in your state with your particular assets.

Isn’t a will just as good as a trust?

That depends on what contingencies are important enough to you that you wish to plan for their occurrence. How sure are you that you will die suddenly without any intervening period of incapacity? Are all of your intended beneficiaries of legal age and sound mind? Are they solvent, free of other disabilities, capable of handling the assets you wish to transfer to them, in sound marriages, likely to use the assets the way you intend that they be used? Are any of your assets of a nature that makes privacy desirable? Do you care about the potential expense and delay involved in the probate process? These points are just the tip of the iceberg.

Why is having a will and durable powers of attorney not just as effective as having a living trust?

A will is a form of death planning, and durable powers of attorney are a form of disability planning. But a living trust is a form of living planning.

A will is used to transfer assets upon death. It takes effect only upon the death of its creator. A durable power of attorney is used to manage the property of a disabled person. A durable power of attorney for health care is used to manage the health and medical care of a disabled person. Both powers cease upon the death of their maker. Thus, a will and durable powers of attorney are limited in duration. The duration of a living trust can be of whatever duration is necessary in order to achieve a family’s objectives.

Although a will and durable powers of attorney are integral parts of a comprehensive estate plan, on their own they are limited in scope. Your control under these forms of estate planning is restricted to stating who will receive your assets and who will act as your agent. A living trust allows you to fill in the “hows, whens and whys.” It can contain any instructions as long as they are not unlawful or against public policy. Having a living trust puts you in control during life, disability and death.