Here are some terms to help you understand this explanation. For our purposes, you may think of a “trust” as an estate plan under which property is held by one person for the benefit of others. The person who creates the trust is the “settlor.” The person who holds and manages the property for others is the “trustee.” The people (or entities) who receive benefits from the trust—now or in the future—are called “beneficiaries” (often, the settlor or settlors and the trustees are, in the beginning, the same person or couple). So a trust is a written agreement whereby a settlor makes a restricted transfer of property to a trustee with instructions about how the property is to be managed and distributed to the beneficiaries.
If two or more persons hold the property, they are called “co-trustees.” An alternate trustee who takes over management if the primary trustee ceases to act is called a “successor trustee.”
A trustee is a “fiduciary.” That means the trustee has a special relationship of confidence and trust with regard to the beneficiaries. A trustee must act in utmost good faith, integrity and fidelity as to the beneficiaries of the trust and the property held in the trust.
Many people elect to use a revocable living trust instead of a will as a way to pass property on to their descendants or other beneficiaries. Most people choose this alternative because they want to avoid probate. A person can pass property to his or her beneficiaries without any probate by preparing and funding a trust. In order to avoid probate, the trust must own all (or substantially all) of the settlor’s assets other than assets that usually pass by beneficiary designation, such as retirement plans and life insurance. A trust may also be used as a way to save taxes, but wills can be effective in saving taxes, too. It is the plan embodied in the will or trust that saves taxes, not the fact that a person uses (or does not use) a trust in order to carry out the plan.
HOW A REVOCABLE LIVING TRUST WORKS
In order to create a trust, there must be a written legal document called a trust agreement. The trust agreement creates the trust, gives instructions for managing the assets during the lifetime of the settlor, and provides instructions for distributing the assets of the trust after the death of the settlor. Trust agreements are very flexible and can be prepared so as to carry out almost any wish that the settlor may have.
The trust agreement is between the settlor, who creates the trust, and the trustee, who is the person or entity responsible for managing the assets of the trust. Often, the settlor also serves as trustee as long as he or she is able to do so. The settlor’s spouse or another family member is sometimes also named to serve as a co-trustee with the settlor. Nowadays, it is common for a husband and wife to each create a trust (or to create one joint trust) and to serve as the original trustees of the trust or trusts. However, some settlors choose to have a bank’s trust department serve as trustee (or as a successor trustee) in order to gain the benefits of professional management of the trust assets and to avoid conflicts and squabbles among family members after the settlor’s death. Banks charge fees for trust management, which vary from bank to bank.
Only after the trust agreement has been signed by the settlor and trustee may the settlor transfer his or her titles to real estate, securities, bank accounts and other assets to the trustee of the trust. This process of transferring property into the trust is called “funding the trust.”
Trusts that are “revocable” allow the settlor, at any time during the settlor’s lifetime, to change (amend) the trust, or to cancel (revoke) the trust altogether, or to take assets out of the trust, or to put assets into the trust. The term “living trust” means that the settlor creates and funds the trust while the settlor is alive.
ADVANTAGES OF A REVOCABLE LIVING TRUST
1. No Probate. Many people believe that a will does not have to be probated. This is not true. Probate of a will is usually necessary in order to transfer property that a decedent owned in his or her sole name at death. But property that is held in a living trust at the time of asettlor’s death is not subject to probate administration. Remember, however, that in order to avoid probate, the settlor’s property must be transferred to the trustee of the trust during the settlor’s lifetime. A living trust is not a “Super Will” that works automatically after it is signed. A living trust is best viewed as a three-step process: (1) creation of the trust, (2) funding of the trust, and (3) administration and distribution of the trust assets without court proceedings during the settlor’s life and after the settlor dies. If the original trustee dies, becomes incapacitated or resigns, a successor trustee, named in the trust agreement, either distributes the assets in accordance with the instructions set forth in the trust agreement, or continues to hold the assets in trust if that is what the settlor says to do in the trust agreement. If a settlor creates a trust, but does not transfer all (or substantially all) of the settlor’s assets into the trust before the settlor dies, then the assets that are not held by the trust at the time the settlor dies are subject to probate administration. Oregon law provides for a simplified “small estate” proceeding which can deal with such assets, but that procedure is available only if all real estate not held by the trust has a value of less than $200,000, and all other “personal” property not held by the trust has a value of less than $75,000. We always prepare a simple will (called a “pourover” will) to accompany the trust. After the settlor’s death, the pourover will enables us to transfer into the trust any property that the settlor did not transfer into the trust during the settlor’s lifetime. But in order to make that transfer, we have to either probate the pourover will or submit it for small estate administration. The pourover will is intended as a “backstop” for the trust, with the trust agreement functioning as the principal document that spells out what is to happen with the settlor’s assets when the settlor dies.
2. A Trust Speeds the Process of Distributing Assets. Because property held by a trust is not subject to probate administration, trust assets can often be distributed to the beneficiaries of a trust within a short time after the settlor dies and with less complexity than is often involved with probate.
3. A Trust Agreement is Confidential. Because it is not necessary to probate assets held by a trust, the trust agreement is not usually recorded or otherwise placed on record in any public office. So it is not possible for strangers to find out what assets the deceased settlor had, or what he or she did with them. Beneficiaries who are to receive anything under the trust are entitled to certain notices, but other people do not get information about the trust. A will, on the other hand, is probated; and anyone can go to the county courthouse after a person’s death and see what that person’s will said (including who will receive the deceased person’s property). Also, by looking at the inventory filed in the probate proceeding, anyone can also see what assets the deceased person owned and what they were worth.
4. A Trust May Cover Property in Other States. A significant advantage of a trust is that it can own property located in more than one state. Thus, if a settlor has a vacation home in another state or has an interest in family property elsewhere, those assets can be transferred into the trust. Then, when the settlor dies, the trust is able to control the distribution of those assets even though they are located outside of Oregon. But if the assets are not held in a trust, then the decedent’s estate must be probated not only in Oregon (or in any other state where the person resides), but also in each state where the decedent owned an interest in real property. This process of a probate in Oregon and ancillary probates elsewhere is often time consuming and can result in unnecessary duplication and cost.
5. A Trust Avoids Complications for the Incapacitated. Another advantage of a trust, as compared to a will, is that a trust can contain provisions designed to provide for the protection and investment of the settlor’s property if the settlor becomes incapacitated because of age or other cause. In this way a trust can often avoid the need for a protective proceeding (guardianship or conservatorship). A protective proceeding involves a court case and payment of fees that may not be necessary if the incapacitated person’sassets are held by a trust. However, a trust is not the only solution for dealing with a person’s incapacity without court supervision. A person can also provide for management of his or her property by using a durable power of attorney given to a trusted family member or other person.
DISADVANTAGES OF A REVOCABLE LIVING TRUST
The number of disadvantages listed below exceeds the number of advantages above. When deciding whether or not to use a revocable living trust, however, an individual should consider the entire picture as applied to his or her particular situation. Not all the advantages and disadvantages are of equal weight.
1. Initial Expense. One disadvantage of a trust is that it is more expensive to establish than a will. The cost of establishing a trust exceeds the cost of preparing a comparable will for two reasons:
a. Asset Transfers. Because it is customary to transfer all (or nearly all) of a settlor’s assets into the settlor’s trust at the time the trust is created, the lawyer usually must do more work to properly prepare and fund a trust than is needed to prepare a will. Funding a trust requires the lawyer to prepare bills of sale, deeds, and assignments, and to review and prepare other transfer documents and correspondence. By contrast, a will is not “funded” during a person’s lifetime; it takes effect only when a person dies.
b. Number of Provisions. It is usually necessary to include a greater number of provisions in a trust agreement than are necessary in a will, because the trust must operate while the settlor is still alive, instead of merely taking effect, like a will does, at the time the settlor dies. Moreover, the procedures for probating a will are set forth in statutes, whereas the procedures for administering a trust and for distributing the trust assets after the settlor’s death must be spelled out in the trust agreement. So the lawyer must devote more time to draft the trust documents and to review them with the client.
2. A Trust is Not Suitable for Some Assets. A trust is not well adapted for use by people who are involved in sole proprietorships (especially if a license or permit is required for the business) or who are active in partnerships. Such business interests can be transferred to a trust, but the settlor’s partners are usually reluctant to have the trust as a partner in the partnership, because the settlor can select a trustee (or successor trustee) who might not work well with the other partners. Stock in closely held corporations, on the other hand, may be included in a trust, although this would probably require some changes in the buy-sell agreement between the settlor and the other shareholders.
3. Inconvenience. In order to make a trust work to avoid probate, the settlor must transfer all (or nearly all) of his or her assets to the trust and be sure that for the rest of his or her life all the settlor’s assets are held in the trust. This requirement often involves more than routine communication with bank tellers, investment advisers, brokers, title companies, and the like, who often want to see a copy of the trust agreement. Some people may feel that this is more trouble than it is worth.
4. Problems with Borrowing. Banks and other lenders are sometimes skeptical of a trust as a borrower. Before a loan is made to a trust, the lender often requires a legal opinion from an attorney certifying that the trust exists, that it has not been amended or revoked, that the trustee is in fact the trustee of the trust, that the law authorizes the trustee to borrow money, and so on. This means that the trust must incur legal expenses that would not be necessary if the borrower held his or her assets in his or her own name. Sometimes a bank or other lender will not make a loan secured by real property that is in a revocable living trust. Instead, the lender may require the real property to be taken out of the trust before the loan is made.
5. Successor Trustee Unsupervised. The person who carries out the deceased settlor’s instructions (the successor trustee) is not required to post a bond, and the successor trustee’s actions are not supervised by a court (unless a beneficiary files a lawsuit). A successor trustee must, however, report to the beneficiaries periodically (if they request it) after the death of the settlor and the settlor’s spouse. By contrast, the probate of a will is supervised by a court; and the personal representative of the deceased person’s estate must present the court with an inventory of assets and must account to the court for all property received into the probate estate and paid from the probate estate.
6. Title Insurance, Property Insurance and Lender Consent Problems. There is a risk, under some title insurance policies, that the act of deeding a person’s real estate into that person’s trust may cause the loss of title insurance on the property. Most title insurance companies allow the policy to be endorsed to add the trust as an insured, but require payment of approximately $75. Also, under many homeowners’ and fire insurance policies, the transfer of property to a trust may cause loss of coverage unless the settlor remembers to notify the insurance agent to add the trust as an insured. And, if the owner has borrowed money on the property, it may be necessary to secure the lender’s written consent to transfer the property into the trust.
WHO SHOULD SERVE AS TRUSTEE?
It is very important to choose a reliable person or institution to serve as trustee (and successor trustee) of a trust. The trustee must be someone who has the ability to make good financial decisions and who will not take selfish advantage with regard to any aspect of the trust. Before naming a relative as a trustee or successor trustee, the settlor should be sure that the person whom the settlor is considering naming as trustee has the settlor’s best interests in mind and will deal fairly with other beneficiaries after the settlor’s death. It is dangerous to use a friend or relative as a trustee unless the settlor has great confidence in that person and in that person’s judgment and integrity. Remember that the trustee does not post a bond and acts without court supervision.
POSSIBLE TAX SAVINGS THROUGH THE USE OF A TRUST
Most estate tax planning, whether done through a trust or by use of wills, is designed to minimize estate tax when the surviving spouse passes away. A trust can be used as a means of incorporating the measures necessary to avoid or minimize the payment of federal estate tax and state inheritance tax. The federal estate tax credit amount for 2018 and years thereafter is now quite substantial, and only the largest estates pay federal estate tax.
However, the Oregon inheritance tax law still imposes an Oregon inheritance tax on estates in excess of $1,000,000.
It is easy to avoid tax on the death of the first spouse, since there is no tax at all on assets left to the surviving spouse. However, if the effect of leaving assets to the surviving spouse is to increase that person’s taxable estate to an amount greater than the exemption amounts, then a tax is imposed at the time the surviving spouse passes away. In order to avoid these taxes, it may be advisable that some or all of the assets of the first spouse to die be set aside in a “bypass” sub-trust, for the purpose of avoiding taxation of those assets when the surviving spouse dies. A properly drafted will or revocable living trust can provide for the creation of such a “bypass” trust if it appears that the couple’s estate exceeds the exemption amounts, or that their estate may in the future come to exceed the exemption amounts. The bypass trust can be funded automatically with the decedent’s assets after death, or trusts can be drafted to allow the surviving spouse to choose whether and to what extent to fund the bypass trust by making a “disclaimer” within nine (9) months after the date of the first spouse’s death.
This brief summary is intended only to illustrate very general tax principles. Further treatment of this subject requires discussion and interaction between the client and attorney, with possible involvement with the client’s accountant.