Many people have heard of trusts as, among other things, an estate planning tool.
However, very few people understand how trusts work or why they are so beneficial. The trick is explaining it without going into 400 years of English property law. Here is my attempt:
Every property has two parts to it: the benefit and the burden. They are exactly what they sound like. The benefit to the property is any advantage derived from it (interest, rents earned, intangibles, etc), while the burden is any cost associated with it (taxes, rents paid, loans, other costs of upkeep).
A trust operates as a device that takes property from one person (the settlor) and splits the burden and benefit of it between a trustee and beneficiary, respectively.
As noted in an earlier blog post, the settlor, trustee, and beneficiary can all be one person in Minnesota. However, a legal mechanism called the “merger doctrine” operates in many other states that prevents this. The doctrine states that once the exact same person or people are the trustees and beneficiaries, the burden and benefit parts of the property are held by the same person or people, and are therefore merged together and the trust is destroyed.
However, there is a simple estate planning exception to this rule.
If there are “residual beneficiaries” at the time the trust is created, those residual beneficiaries – or individuals who are to receive whatever’s leftover from the property when primary beneficiary’s done with the property (i.e. has passed away) – are considered beneficiaries along with the primary.
Therefore, no merger occurs and the trust remains valid. There are several different varieties of trusts, each with distinct advantages and purposes.
In this blog entry, I will only be discussing the significance of revocable living trusts to estate planning.
Revocable (as opposed to irrevocable) trusts allow the settlor to change or revoke the trust at any time. While this allows the settlor a great deal of control over the assets in the trust, the downside is that the tax benefits brought by irrevocable trusts are not found. Living (or “inter vivos”) trusts simply refer to a trust created during the lifetime of the settlor, as opposed to a testamentary trust, which is created through a will at the time of the testator’s death.
The primary benefit of a revocable living trust is that it avoids probate, which can be a very costly and time-consuming procedure.
While it does not avoid estate taxes, this does not tend to be an issue for smaller estates (under $5 million in assets per person) since there is an exemption up to that amount.
An additional benefit of a revocable living trust is that it allows for the planning for incapacity: with the proper terms included, a successor trustee can be appointed in case you are medically incapacitated to use the property in the trust for your benefit and care.
No further changes to a properly drafted trust agreement need be made to account for such a situation.
The field of trusts is very complex and expansive, and a trust agreement should not be drafted without first consulting an experienced estate planning attorney.
If you have any questions about planning your estate, contact Byellin Law for a free consultation.