A Trust is a very powerful estate planning tool yet many people don’t understand what a trust is and how trusts actually work. This article is a very basic overview of what trusts are, how trusts work and how to determine if a trust is right for you.
Definition of a Trust: A very simple definition of a trust is that it is a “bucket” that can hold assets. Any asset that is held in a trust is a “Non-Probate Asset.” This means that when someone dies these assets can be transferred privately and not through a state’s court process called Probate. There are many reasons to avoid Probate for your Estate — one of the main reasons is that the Probate process itself in Illinois can take a minimum of 9-12 months to complete – if there are no complications. Probate is also a public process where anyone can look in your probate court file to see assets of the estate and the details of your estate plan.
Below is a diagram I have created to show a high level overview of how trusts work.
The Three Roles in a Trust: A trust will always have three people involved – A grantor, a trustee, and a beneficiary. Here is a simple definition of each of those people.
Grantor: This person is who signs the trust document to create the trust. Once the Trust is created, the Grantor then transfers their assets into the trust.
Trustee: Once a Trust is created and assets are transferred into the trust, the Trustee is the person named in the trust as someone who manages those assets and makes distributions of those assets per the Trust Agreement Terms.
Beneficiary: Every Trust has to have a beneficiary. Beneficiaries are people named in the Trust the benefit from the assets in the Trust.
For “Revocable Trusts” – which will be further explained below – a person can name themselves for all three of these roles — the Grantor, Trustee, and Beneficiary.
The Two Major Categories of Trusts:
Trusts can be either “Revocable” or “Irrevocable” — the terms of the trust itself will tell us which type of trust it is.
Revocable Trusts are trusts that a Grantor can amend, revoke or terminate after the trust is created and the assets are transferred into the trust. For example if John Smith set up a revocable trust and transferred farmland into the trust — John could later change his mind and remove the farmland, change who the beneficiaries are or completely revoke and terminate the trust. John has complete control over this trust and can revoke or amend this trust if he wants to. These types of trusts are also known as “Grantor” Trusts.
Irrevocable Trusts are trusts that – once created – cannot be amended or revoked. The terms of the trust (for the most part) are set in stone and cannot be changed. If John wanted to change his mind like in our previous example – he could not take the farmland out of an Irrevocable Trust.
Many people use Revocable Trusts to avoid probate for their estate. Irrevocable Trusts are generally used for more complex estate planning issues – such as tax planning and asset protection planning. There are many different types of specific Irrevocable Trusts that are created by statutes and tax law.
Do you Need a Trust for Your Estate Plan?
Here are four Questions I ask my clients to see if they need a trust as part of their estate plan.
1. Is the net worth of your estate (including life insurance, retirement accounts and the equity in your home) approaching $4 Million? If you live in Illinois, then the Illinois Estate tax would apply to your estate. As of the date this article was written Illinois has a $4 Million estate tax credit. This means that any amount over $4 Million is going to be subject to an Illinois estate tax. Trusts are one way to make sure you use all of your estate tax credits – especially for married couples. The federal estate tax is much higher – currently $11.2 Million per person.
2. Do you need a Trust to Avoid Probate? When I meet with new estate planning clients we go through a formal “Probate Asset Analysis” process that I have developed. After this review we know whether a trust is needed to avoid probate for that client’s estate or not.
3. Do you have a “Complicated Family Situation”? Every Family is unique in its own family dynamics. For Estate Planning Purposes I consider these scenarios as “Complicated Family Situations”:
a. Blended Families: Married Couples where one or both spouses have children from a previous marriage – think of “The Brady Bunch” scenario.
b. Children are Minors: If you have minor children and you and your spouse both die – then a Children’s Trust is highly recommended as a tool to care for your children until they reach an age where they can manage the money themselves. Many people will choose to design their Children’s trust so that the money is in the trust until their Children reach their late twenties or early thirties.
c. Children are Spendthrifts: Even if your children are full grown adults in their 30’s; 40’s and 50’s – Do they spend money foolishly? Do they have creditor issues? Do they have a drug problem? Do they have a spouse with these problems? A trust is recommended for these situations.
4. Do You Want to Make Sure Your Children Receive their Inheritance? With a Will-Based Plan – upon the first spouse passing away the surviving spouse will inherit all of the estate assets outright – in their name directly. This means the surviving spouse can do whatever they want to with these assets – including giving them to a second spouse if they were to get remarried later – leaving your children with nothing. . . . It happens. A trust – based plan can make sure your spouse is taken care of for the rest of their life and your children receive the remainder of your estate assets.
It is impossible to talk about all the aspects of a Trust – Based Estate Plan in this article but these are the things I talk about with my clients when deciding whether a trust is needed during our Initial Consultation that I call our “Discovery Meeting”. Please contact the Ritchie Law Office, Ltd. if you would like to discuss whether a trust is right for your estate plan.