Richard W. Kozlowski, Esq.

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What is a Living Trust?

A living trust is created by a written agreement between the individual creating the trust (known as the "grantor" or "settlor") and the person or entity who will manage the trust assets held in the trust (known as the "trustee").   In Vermont,  a grantor will often act as both grantor and trustee until the grantor's death (see Who Should be the Trustee?).   A living trust can also have more than one grantor (see What is a Joint Trust?).

In the trust agreement, the grantor defines the manner in which the trust will operate.  Typically, the grantor gives the trustee the legal right to manage, invest, control and distribute the income and assets of the trust.  The trust agreement can specify precisely how these duties will be carried out.  Conversely, it can give the trustee complete discretion over all decisions.  In most trusts, the trustee is granted some discretion which is limited by express instructions.

A living trust is "living" because it is created during the life of the grantor.  The grantor may transfer assets to the trust during life (a "funded trust"), or may wait until death to make transfers (an "unfunded" or "dry trust").

A living trust is revocable -- which means that the grantor may amend or terminate the trust at any time during his or her life.  In addition, the grantor is free to add or remove assets to or from the trust.  This flexibility makes a living (revocable) trust a valuable estate planning tool.

What are the Benefits of a Living Trust?

The major advantages of a living trust are: 

1.   Avoidance of probate 
2.   Estate tax planning and savings
3.   Planning for incompetency
4.   Privacy 
5.   Flexibility
 

Probate:  Many clients have read horror stories about the probate process, and in many states the stories may have merit.  Consequently, one of the main objectives of clients in creating a living trust is to avoid probate. 

Although the probate process in Vermont is relatively simple and inexpensive, probate can be avoided by placing all of your assets into a living trust during your lifetime.  Since these assets would then be owned by the trust (although totally within your control due to the ability to revoke the trust), they would not be part of your probate estate.  The trust, rather than your Will, would control the management and disposition of your assets.

Complete avoidance of probate is difficult to achieve, for if even one asset is owned at death, the probate process can be triggered.  Probate avoidance can also be cumbersome -- for example, holding your day-to-day checking account in a trust can make use of the account difficult at times.  Given the relatively streamline nature of Vermont's probate system, probate avoidance can be more trouble than it is worth.

For more information, visit the Wills webpage under the heading What is Probate? or the Probate webpage.

Estate tax planning and savings: A living trust is an excellent vehicle for estate tax planning, especially for married individuals.  Within a living trust, you can establish a number of subtrusts, each of which can have a specific purpose.  For example, for married individuals it is common to establish a subtrust that will hold assets to be sheltered under the grantor's unified estate tax credit, and a subtrust to hold other assets qualifying for the marital estate tax deduction.  For wealthier individuals, additional subtrusts can be established to maximize the benefits of the grantor's generation skipping transfer tax exemption.  Each of these subtrusts can have different schemes of management and distribution, making a living trust a very flexible means of accomplishing estate tax reduction.  (A complete discussion of estate tax planning can be found at the Estate Taxation webpage). 

One criticism leveled at living trusts is that the same planning can be accomplished by putting trust provisions in your Will, and thereby avoiding the cost of establishing a trust today.  Given that a similar amount of time will be needed to place complicated trust provisions in your Will, this criticism is misplaced.  More importantly, unlike assets governed by your Will, assets placed in a living trust, whether during life or at death, are not subject to continued oversight by the probate court.  Therefore, while you could accomplish the same estate tax savings via your Will, the cost to your estate could be higher given the probate court's continued involvement after your death.

Planning for incompetency:  A living trust can provide a means for managing your assets in the event of your incompetency.  Assets placed in a living trust during life are controlled by the trustee.  A successor trustee can be named to take over control of the trust if you become incompetent -- without the need for a guardian or conservator.  Remember that assets held outside of the trust would not obtain this same protection.  Coupled with a power of attorney and durable power of attorney for healthcare, a living trust can be invaluable should you face incompetency.

Privacy:  Upon your death, your Will becomes a public document, accessible by anyone upon request.  Moreover, any assets subject to probate are also part of the public record.  If you are concerned about privacy, a Will alone cannot afford you this benefit.

In contrast, assets placed in a living trust are not subject to probate, nor are the terms of the trust part of the public record.  By naming your trust as the beneficiary of all of your assets, you can keep private the ultimate distribution of your estate.

Flexibility:  For most individuals, a living trust can be drafted to accomplish all of their estate planning goals.  It can provide alternative plans of distribution depending on the circumstances present at the time a distribution takes place.  Beneficiaries can be given varying degrees of access to trust income and principal in order to match their abilities to handle finances.  Trustees, and alternate trustees, can be chosen in advance to ensure that the grantor's wishes are carried out.  With the passage of time, the trust can be amended to reflect changes in the grantor's and beneficiaries' circumstances.

There is no legally prescribed method for creating a living trust.  In practice, a living trust should be set forth in a written, witnessed document which clearly describes how the trust assets and income should be managed, invested, controlled and distributed.  Better still, the trust document should be executed with the same formalities as a Will.  If the trust is ever challenged, it may be able to stand alone as a substitute for a Will.

If I Have a Trust, Do I Need a Will?

Yes.  Unless probate avoidance is a primary goal, it is unlikely that you will have transferred all of your property to your trust.  You should therefore have a "pour over" Will which provides that any property owned at death pours over to your living trust.  If you inadvertently or purposefully fail to place all of assets in the trust during your life, the pour over Will ensures that those assets will be placed in trust and governed according to the trust's terms.

You may also need a Will for other important purposes - such as naming a guardian of your children.

If I Have a Trust, Will I Avoid Probate?

Maybe.  Remember that any assets owned individually by you at death are subject to probate.  If, during your life, you put all of your assets into a revocable trust, then none of those assets would be subject to probate.  See Probate, above.

Who Should be the Trustee ?

The trustee is a fiduciary, a person who occupies a position of trust and confidence, and is subject to strict fiduciary responsibilities. Without the settlor's express written permission, the trustee cannot use trust property for his/her own personal use, benefit or self-interest, but must hold the trust property solely for the benefit of the beneficiaries of the trust.

The considerations for selecting a Trustee are similar to those for an executor (see Who Should Be My Executor?), except that the role of Trustee is not limited - it may continue for many years until the beneficiary reaches the age of distribution.  During that time, the Trustee may need to exercise discretion on distributing funds for college, living expenses, medical care, etc.  Thus, a Trustee is potentially a more important role than that of executor.

In selecting a Trustee, you should consider who the beneficiaries are, and who the guardians of those beneficiaries might be.  For example, if you have chosen an individual to be the guardian of your children, you should consider whether that individual would also be the appropriate Trustee.

What is a Joint Trust? 

A joint trust is similar to a living trust except that it is created by two grantors -- typically a married couple.  The purpose of a joint trust is to set forth the couple's complete estate plan in one document.  Generally, at the death of the first spouse, the trust becomes irrevocable and therefore cannot be changed by the surviving spouse.

Joint trusts have some utility where spouses wanted to bind each other to a fixed plan at the first spouse's death.  They are, however, less flexible than separate living trusts, and can create unintended problems for the surviving spouse.  Consequently, a joint trust should only be used in the relatively rare circumstances where flexibility is not a major advantage. 

Do Living Trusts Pay Income Taxes? 

Not in most cases.  Where the grantor and the trustee are the same person, and the trust is revocable, there are no additional reporting requirements -- the grantor simply reports all items of income, deductions, etc. on his or her own income tax return.  The trust is not considered to be a separate taxable entity.  If the grantor is not the trustee, the trust is not required to file a tax return; however, the trustee must furnish the grantor with a statement showing all of the items to be included on the grantor's tax return.

After the death of the grantor, the trust becomes a separate entity for tax purposes.  The trust must file federal and Vermont fiduciary tax returns and, depending on the trust's activities, pay tax on income received.