The term “estate planning” encompasses several different legal instruments available to a person in arranging their affairs. When speaking with our clients, I have found it helpful to separate them into three broad categories.
- The first category, discussed in a previous entry on this blog, deals with healthcare arrangements. This includes Powers of Attorney, healthcare directives, and living wills.
- The second category is property distribution which can include Last Will & Testaments, Beneficiary/Transfer-on-Death deeds, and trust instruments.
- The final category I call “personal & intellectual asset distribution” includes personal assets outside property, such as one’s lived experiences, advice for future generations, and insights gleaned therein.[1] This might, for example, look like letters pre-written to be read after your passing.
The most common question I get when discussing the options available for property distribution is: what the heck is a trust? This confusion is understandable; popular culture popularized terms like “trust fund baby” so the average person knows such a thing as a “trust” exists but has little idea what a trust is, how they work, or why they are useful.
This article will briefly discuss the different elements of a direct trust and touch on some of the most common reasons for forming a trust. Future articles may discuss individual kinds of trusts in detail but this discussion will be limited to explaining the basic premise. As with all articles on this blog, this information is general in nature because the applicable law varies so much from state to state. Also, this article will not discuss more abstract concepts such as implied trusts; the focus is only on trusts created intentionally.
Trusts Generally
Black’s Law Dictionary defines a “trust” as: “an equitable or beneficial right or title to land or other property, held for the beneficiary by another person, in whom resides legal title or ownership, recognized and enforced by courts of chancery.” While this definition is technically accurate, it is written by an attorney for other attorneys. It is not very helpful if you lack a law degree.
My personal definition is: a “trust” is an arrangement where ownership rights to some amount of discreet, identifiable property is split between legal ownership and equitable ownership in order to accomplish a goal.
Elements of a Trust & the Lockbox Metaphor
After explaining what a trust is to my clients several times, I’ve found it easiest to use a metaphor for illustrating the three different elements of a trust.
- Picture a small lockbox. This is the trust where property goes into it. The person who bought the lockbox and places their own property into it is known as the settlor. He or she created the trust and decides on its terms in a document known as a trust agreement. Trust agreements can vary in broadly different ways so the exact terms will depend on the settlor’s goals.
- Every lockbox has a key. The holder of the key to the trust lockbox is the trustee. This person or entity is bound by the rules set by the settlor. Sometimes they are paid a fee for their services. Sure, the trustee has the key to the box, but they cannot just use the property inside how they see fit. They are bound by the terms set by the trust agreement made by the settlor. Because of these limitations, it is said they have legal title to the property (because they have the key) but not equitable title (because they cannot use the property as they see fit).
- Finally, every lockbox protects property for someone. The person who receives the property inside is the beneficiary. Sometimes they have a right to the property being kept for them by the trustee, but sometimes they are not able to control how, when, or in what manner it is received. It will all depend on the initial trust agreement created by the settlor. Because the property inside the trust is set aside for their benefit but they must go through a trustee to obtain any of it, they are said to have equitable title but not legal title to the property inside the trust.
Please note that these are not always different people. The settlor of a trust may also be the trustee and initial beneficiary for a trust. Trusts are extremely flexible provided they are executed correctly and allow for countless variations to help reach one’s goals.
What Are Some Common Reasons For Using a Trust?
Estate Planning: Imagine what would happen if you were given $100,000 in life insurance money when you turned eighteen years old. How well do you think that would go? That exact scenario is why trusts are extensively used in estate planning. The trust agreement can include provisions requiring some responsible third party (the trustee) to review what the eighteen-year-old beneficiary spends their inheritance on to prevent them from using it on drugs, exploitative romantic partners, and so on.
Such a trust can include conditions to entice them into doing things you think beneficial as well. For example, your trust might allow the entire remaining money in the trust to be paid out if the beneficiary graduates from college with a four-year degree. Or the trust might include protections to prevent creditors — such as divorcing spouses or car accident parties — from reaching the money within the trust so your loved ones will always have financial support.
Equally valuable, using a trust instead of a Last Will & Testament can eliminate any need for your family to go to probate court after you have passed away. People talk of probate court as a traumatizing experience where family members fight over what you leave behind while paying the government for the privilege to do so. Also, probate proceedings are public record as well; interested parties could see how much property is being distributed and potentially target your family for victimization based on their perceived wealth. Most people I speak with generally want to avoid probate for these reasons.
If you want to spare your family outcomes like those just mentioned or want to protect them from potentially ruinous outcomes after you are gone, trusts can be powerful tools to those ends.
Government Benefits Protection
Most government benefit programs such as Medicaid have asset limits. A person who has more than whatever the limit is will be cut from the program. For those with special needs such as severe intellectual disabilities, however, this can be doubly unfair. Because their loved ones set aside assets for them to use to live comfortably, they must burn through them until they are again destitute enough to qualify for government assistance.
For this reason, special needs trusts exist. While the details are beyond the scope of this article, a person can create a trust for someone with certain special needs to use for their personal needs while also remaining on government assistance programs despite having assets in excess of the limit.
Gun Trusts: Certain types of firearms fall within the National Firearms Act which require registration and severe fines if an owner allows other people to use or possess said firearm. “Gun trusts” are commonly used to allow multiple people to enjoy the use of NFA-regulated weapons. Because the gun trust is considered a separate entity like an LLC or corporation, the trust itself can register with the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives and name multiple people as beneficiaries. This arrangement simplifies the ownership of these weapons and allows flexibility without additional government involvement or a risk of severe fines.
Additionally, firearm owners receive so much scrutiny from government entities regarding their guns already. Even if you do not own an NFA-regulated firearm, you may want the privacy provided by a trust. As mentioned above, trusts do not go into probate after the initial beneficiary passes away. No one but you and your loved ones need know how many and what kind of firearms you own.
These are only some examples of the kinds of problems a trust can solve. There are countless types and variations available. Would you like more information in determining whether a trust may be helpful for your personal circumstances? Feel free to reach out to us at (903) 221-9150 and we will happily set you up a consultation to assist you.
[1] Credit for articulating the difference between personal and intellectual assets in regard to estate planning goes to James E. Hughes, Jr. in his book Family Wealth: Keeping It in the Family.
