Most estate planners recommend having a living-based estate plan. The cornerstone of that plan is – you guessed it – the living trust. This post is going to cover everything you need to know about living trusts so you can do two things.

  1. Decide whether a trust-based estate plan is right for you.
  2. If you have already decided that a trust-based plan is right for you, or already have a living trust in place, then this post will also help you understand how your trust works, the important components of a trust, and the benefits of a living trust.

First, let’s start by defining what a “living trust” is. A living trust is just a regular trust made during the lifetime of a settlor. For example, if you create any trust during your lifetime, those trusts are called “living trusts.” By contrast, there are trusts that are not created until someone dies. For instance, a “testamentary trust” is created by someone’s will and comes into existence when the person dies. A “martial trust” is a special kind of trust that comes into existence on the death of a spouse. So for this post, we will focus on trusts in general.

So, let’s start with the most foundational question: what is a trust?

A trust is simply an agreement between the owner of property to own the property for the benefit of the property owner or someone else. In a trust-based estate plan, your living trust is a written document saying that you are holding your property for the benefit of your beneficiaries. Let’s look at how a trust works and how to create it.

1.  How a Trust Works

In a typical estate plan, a trust is a written document that defines how property is owned and how the property can be used. Once it is created, the law treats it as a separate “person.” You may already know that the definition of “Person” under the law includes artificial persons like corporations, limited liability companies, and living trusts. A Trust works a lot like a contract or a will. The person who creates it is called the “trustor” or the “settlor.” The trustor or settlor gets to decide what happens to the trust property.

Key Definitions:

Living Trust: A “living trust” or an “inter-vivos trust” is a trust made during the lifetime of a settlor or trustor. Most trusts are living trusts.

Settlor or Trustor: The person who creates a trust is called the “settlor” or “trustor” of the trust.

Trustee: The “trustee” of a trust is the person who manages the property in the trust, much like an executor of a will. But unlike the executor of a will, a trustee of a trust is required to carry out his or her duties immediately upon the trust’s creation, and does not need to be appointed by a probate court.

A trust is managed by a person called a “trustee.” The trustee’s sole job is to manage the property for the sole benefit of the “beneficiaries.”

Once a trustor or settlor places property into a trust, the property is no longer legally owned by the trustor or settlor. This is how a trust is able to avoid probate, because technically when the trustor dies, he or she does not own the property – the trust does. Thus, there is no “estate” left to probate.

After death, the trustee’s job is to do one of two things. One, the trustee holds the property inside the trust and makes payments to the beneficiaries. Two, the trustee takes the property out of the trust and gives it to the beneficiaries. Since it is a legal person, it can be used for all sorts of interesting things. For example, avoiding estate taxes, protecting your property from creditors, and creating a lasting legacy for your family.

2.  How to Create a Trust

Creating a trust is really easy. To demonstrate, let’s do an exercise (you can do it, or just visualize it).

Step 1: Get a blank piece of paper.

Step 2: Write “Trust” at the top.

Step 3:  Write the following sentence: “I [inert your name] hold the property listed on this document in trust for the benefit of myself, and when I die for the benefit of [insert name of beneficiary].”

Step 4:  Decide who you want to be in charge.

Step 5:  Write the following sentence: “I name [name of person] as the initial trustee of this trust, and [name of another person] as the successor trustee of this trust.”

Step 6:  Write a list of the property you own.

Step 7:  Sign and date the paper.

Congratulations! You have a living trust.

Of course, having a trust-based estate plan is more than having a living trust document. There are hundreds (maybe even thousands) of different clauses you can add to a trust. Each clause carries with it certain legal obligations, rights, and protections. Depending on what you and your estate need, your trust may be thickly laden with clauses written in legalese. Or you could have a very simple trust.

Regardless of how thick or thin your trust document is, as you can see from the demonstration above, the core of a trust is a very simple. But don’t let its simple façade fool you. Simple as it may be all trusts have a host of complex and interrelated legal rules and obligations. To underscore some of these, let’s start with one of the most important persons for a trust – the trustee.

3.  Choosing a Trustee

One of the biggest mistakes a person can make when creating their estate plan is choosing the wrong trustee. Parents often feel obliged to make their children feel equally loved. Sometimes I get clients who say that they want “everything to be even-steven.” While even-steven is fine for beneficiary distributions, it is not okay when picking your trustee. In fact, sometimes the best choice for your trustee is a friend or third-party fiduciary.

The trustee of your trust is going to be one of the most important legal decisions you will make when it comes to your estate plan. Acting as a trustee is more than distributing your property when you are gone – though that is a very important part of the job. There are two types of trustees. The initial trustee and the successor trustee.

Key Definitions:

Initial Trustee: The initial trustee is the person you name to be the first trustee of your trust. Usually, that person is you. But it does not need to be.

Successor Trustee: The successor trustee is the person (or persons) who you name to take over after the initial trustee. If you name yourself as your own initial trustee, then when you die or become incapacitated, the successor trustee will be the person who is in charge.

The initial trustee is the person the trustors pick to manage the property while the trustors are alive. Frequently, the trustors will choose themselves to act as the initial trustee. The successor trustee is always someone other than the trustors. A successor trustee takes over the management of the property when the trustors die or become incapacitated. You can have more than one successor trustee. You can have multiple persons acting a “co-trustees” who have to jointly decide how to manage the property.

Most people choose their children or other family members to act as their trustees. While choosing a family member to act as your trustee is perfectly fine, be careful. A trustee is a fiduciary. That means that your trustee has a special relationship between the trust property and the beneficiaries of your trust.  Therefore, holding the title of “trustee” creates a lot of legal obligations and liabilities. We will discuss the major duties of a trustee a little later in this post. For now, understand that being a trustee is a big deal and it comes with a lot of power over your estate. Therefore, you need to take extreme care in choosing the best trustee for your trust. To help you hone the list of possible candidates, here are the qualities of a good trustee:

Dependable

Financially Responsible

Capable of Understanding Your Intent and Wishes

Honest

Prudent

Humble

Not Greedy

Good with Numbers

Makes Good Choices

Not Addicted to Drugs or Alcohol

Not Convicted of a Felony

Naming your children or other family members is perfectly fine in most instances, but be sure that whoever you name as trustee has these qualities. Don’t just name your kids as trustee because you don’t want to hurt their feelings. Instead, make an informed decision and pick the best possible candidate(s). Once you have narrowed your list of possible candidates, consider the duties your trustee will be asked to perform and let that help inform your decision.

4.  Duties of a Trustee

There are 15 essential duties of a trustee. They are:

  1. Administration
  2. Loyalty
  3. Impartiality 
  4. Prudence
  5. Work with Co-Trustees
  6. Frugality
  7. Special Skills
  8. Delegation
  9. Control & Protect Trust Property
  10. Recordkeeping
  11. Enforce Claims
  12. Defend Actions.
  13. Collect & Preserve Trust Property.
  14. Make Trust Property Productive.
  15. Inform & Report to Beneficiaries.

Duties of a Trustee: Administration

A common complaint of beneficiaries is that the trustee is “not doing anything.” If a trustee is truly “not doing anything,” then he or she can be sued for violating the duty of administration. Trustees have an affirmative duty to administer the trust estate. This means that the trustee must act in good faith, follow the terms of the trust, and act in the best interest of the beneficiaries.

Duties of a Trustee: Loyalty

A trustee owes a duty of loyalty to all of the trust beneficiaries. If there is one duty that most trustees screwup, it is the duty of loyalty. This duty requires the trustee to take or refrain from taking specific actions. For example, every action the trustee does must be done solely for the benefit of the beneficiaries. Of course, this can be a problem if the trustee is also a beneficiary of the trust. The duty of loyalty requires this kind of trustee to not act in self-interest. Instead, the duty of loyalty requires the trustee to conform to his/her actions so that they benefit each beneficiary. So, if your trustee is also going to be a beneficiary of your trust, you need to be sure to choose a trustee that  will not let any personal vendetta or grudge deter him/her from your duty of loyalty.

The duty of loyalty includes the following things:

    1. Avoiding conflicts of interest.

It is illegal and a massive violation of a trustee’s duty of loyalty to use trust property or enter into transactions that benefit the trustee. A trustee has an affirmative duty to avoid any transaction with the trust that will personally benefit them or a close relative. Therefore, sales, loans, or contracts involving the investment or management of trust property entered into with a trustee’s spouse, relatives, agents or attorneys, and/or the trustee’s businesses are all conflicts of interest.

For example, suppose your trustee owns a construction company, and the trust owns a home that needs major renovations. It is a conflict of interest for the trustee to use their construction company to renovate the trust property. Here’s another typical example: suppose a trustee needs to sell a home owned by the trust. The trustee’s spouse, a real estate agent, wants the commission. It is a conflict of interest to use the trustee’s spouse as the real estate agent to sell the trust property.

Of course, there are some exceptions.

First, if the beneficiaries explicitly approve and ratify the trustee’s proposed.

Second, if the trust expressly authorizes the proposed transaction.

Third, if the court approves of the proposed action.

Fourth, if the person acting as the trustee entered into the proposed action before he/she became the trustee.

    1. Cannot be the trustee for a competing trust.

It is a conflict of interest for a trustee to become the trustee for another trust if that trust is in direct competition with the trust for which they are currently the trustee. For example, if a trustee’s parents’ trust owns a business, and they appoint him/her to act as trustee. It is a conflict of interest to become the trustee for another trust if that trust owns a business in competition with the company owned by the parents’ trust.

Duties of a Trustee: Impartiality

The duty of loyalty and impartiality are intertwined. Often, a trust has multiple beneficiaries. It is also very common to have at least one of those beneficiaries act as the trustee. It is part of the human condition to have favorites. We have our favorite foods, football teams, friends, and even relatives. But a trustee CANNOT have favorites, especially between the other beneficiaries.

Duties of a Trustee: Prudence.

A trustee is obligated to administer a trust as a prudent person would. This means that your trustee must consider the purposes, terms, distribution requirements, and other circumstances of your trust. Additionally, he or she will need to exercise reasonable care, skill, and caution when administering the trust.

Duties of a Trustee: Work with Co-Trustees

Sometimes a trust will appoint more than one successor trustee at a time. These kinds of trustees are known as “co-trustees.” If a trust appoints more than one trustee to act jointly, then each trustee has a duty to participate in the administration of the trust and to prevent the other co-trustees from committing a breach of the trust.

Duties of a Trustee:  Frugality.

The law allows the trustee to charge the costs of administration directly to the trust. This means that the costs of administration will be taken from your beneficiaries’ inheritance. But, this power to charge the trust is checked by the duty of frugality. A trustee can only incur reasonably necessary costs.

Duties of a Trustee: Special Skills.

One of the more confusing duties of a trustee is the duty to use his/her special skills or expertise. This means that if the person you name as trustee has special skills and training (like a lawyer, investment advisor, real estate agent, etc.) then he/she will be held to a higher standard of care. For example, if the trustee you pick has a business degree, a business decision made by your trustee will be reviewed under a higher scrutiny because the trustee has special knowledge or training.

Duties of a Trustee: Delegation.

Although a trustee can delegate certain tasks to more qualified individuals, a trustee can never delegate the ultimate responsibility for acting as trustee to someone else. Therefore, while it may be necessary for your trustee to hire an accountant to file tax returns, the ultimate responsibility will always lie with your trustee. So a trustee who delegates certain tasks exercise reasonable care in selecting an agent, and exercise general supervision over the agent to whom the task can be delegated.

Duties of a Trustee: Control & Protect Trust Property.

Every trustee must take reasonable steps to locate, control, and protect trust property. Some states, like California, call this “marshaling the assets.” A corollary to this duty is the duty of a trustee to no commingle assets. This means that a trust cannot keep the trust assets mixed with his or her assets.

Duties of a Trustee: Recordkeeping.

Every trustee must keep accurate records of everything they do for a trust. At a minimum, this means:

Keeping an accurate ledger of all income and receipts. Noting for each entry the date, the person to whom or from whom the payment was made or received, and nature of the payment, and the amount of the payment. Your trustee must keep all receipts, bank statements, bills, canceled checks, copies of tax returns, and all correspondence relating to the trust.

Duties of a Trustee: Enforce Claims

Sometimes someone dies with a debt owed to them. Or as the trust administration goes on, debts become owed to the trust. A trustee must enforce all claims that the trust may have to collect on debts owed to the trust. But sometimes a trustee must make a judgment call. For example, if someone owed a debt to the trust for $500, but it will cost $1,000 to enforce the debt, then the duty of prudence may require that the trustee not pursue this debt. The best practice is to inform the beneficiaries of your proposal and get their consent.

Duties of a Trustee: Defend Actions.

When a trust is sued, the law treats the trust just like any other defendant. If it does not defend itself, then the plaintiff may file a request for a default judgment against the trust. This is a bad thing. Since a trust can only act through a trustee, the unhappy burden of defending lawsuits falls on him/her.

This is a scenario where the trustee may delegate his duty to defend the trust by hiring an attorney.

Duties of a Trustee: Collect & Preserve Trust Property.

This duty may seem a repeat of the duty to control and protect assets. But it is not. This duty requires a trustee to compel a prior trustee to hand over any trust property. You could probably lump thus duty together with the duty to enforce claims and the duty to marshal assets, but the uniform Trust Code (used in several states throughout the Country) explicitly lists this as a separate duty of a trustee. I kept this as a separate duty because I believe that by isolating it, the Uniform Trust Code is highlighting this duty to make sure that successor trustees do not give their predecessors a “pass” when it comes to collecting and gathering the assets.

Duties of a Trustee: Make Trust Property Productive.

The California Probate Code imposes a duty upon trustees to make the trust property productive. Like the duty above, you could probably lump this with another duty, i.e., the duty of prudence. But, California likely wants to underscore the importance of keeping trust property productive. Some people look at the duty of prudence and say: “I’m just not going to do anything so that I do not lose any trust assets.” This is not what California wants from its trustees.

Instead, California wants trustees to act prudently, but also incorporate the circumstances and purposes of the trust. For example, if the trust’s purpose is to provide income for a surviving spouse, then the trustee has to find ways to use the trust assets to produce income. I most often see these kinds of conflicts with real property and vacant homes. On the one hand, the trustee does not want to rent the home because he or she is worried that the tenants will damage the property. On the other hand, if the home sits empty, it could invite theft and may be prone to waste.

Duties of a Trustee: Inform & Report to Beneficiaries.

Next to the duty of loyalty, the duty to inform and report to beneficiaries is one of the most important. One of the most common lawsuits against trustees is a lawsuit to compel the trustee to provide an accounting or some kind of information about the trust to the beneficiaries. These types of lawsuits are often unnecessary and avoidable if the trustee understands the duty to inform and report. Unless the trust says otherwise, a trustee is obligated to provide certain information and reports to the beneficiaries.

After reading the essential duties of a trustee you likely already know who should (and should not) be trustee of your trust. But, if you are a parent in denial and think that your 40-year-old, out of work, still-living-in-your-basement, son will “get his act together” after you die, let me try to save your trust and your beneficiaries a lot of trouble. Do not name someone to be trustee of your trust because you “think” that will be a good trustee at some date in the future. We never know the day or hour the Lord will call us home. So, whoever you name, it should be someone who is ready, willing, and able of performing the functions of a trustee.

You can easily amend your trust at a later date if your children become “ready” or if the person you name now does not look like a perfect choice five years from now. And remember, you can always name a professional fiduciary (like Wells Fargo or Vanguard) to act as your trustee (for a small fee). If you are interested in choosing a professional fiduciary, check out our article called “Choosing a Professional Fiduciary to Act as Trustee.”

Choose Your Beneficiaries

After you choose a trustee, you get to pick the persons who will get the immediate benefit of the trust property while you are alive. Not surprisingly, these persons are called the “initial beneficiaries.” In a typical estate plan, you will act as the initial trustees and the initial beneficiaries. If you act as the initial trustee and initial beneficiary of your trust, functionally nothing will change in your day-to-day management or use of your property.

But. Aside from the initial beneficiary, the next step is to decide who will get the benefit of your property when you die.

You can choose anyone to be a beneficiary. Frequently, people choose their children, their grandchildren, their church, and even their pets to be their beneficiaries.

The only real risk is that you need to clear about your beneficiaries. For example, if you do not specifically identify your beneficiaries, it can be hard to decide who your property goes to when you die. I once helped a client administer an estate plan that named “my church” as a beneficiary. Of course, her children and trustees knew of two separate churches she attended at the time of her death. So, it took a long time to figure out which “church” she meant.

Finally, the Catholic engaging in estate planning also should consider the following competing duties when picking a beneficiary:

  1. The extent to which your children or other family members depend on you for financial independence.
  2. The extent to which your children or other family members have ongoing special needs that will require financial investment I the future.
  3. Whether your children or other family members “need” any more material wealth.
  4. Which beneficiaries will help your wealth do the most good?

Put Your Property Into Your Trust

The final step after writing your trust document, picking trustees, and choosing beneficiaries, is to fund your Trust. This means, putting your property into it. For more information check out our post on trust funding. For now, understand that the #1 mistake people make when creating a trust is forgetting to fund their trust. An unfunded trust is just a fancy will. It needs to be probated.

Common Types of Living Trusts for Married Couples

If you are unmarried, your trust will be simple all you need to consider and plan for is what will happen to your trust when you die. But, for married couples there is one additional thing to consider: what do you want to happen to the trust when the first spouse dies? The answer to this question will determine the type of living trust you need. Luckily, there are only two basic options.[1]

California is a community property state. That means that all of the property acquired during marriage will be considered “community property.” Each spouse is entitled to their respective half of the community property. By contrast, separate property is property acquired by one spouse prior to marriage (or special property like an inheritance acquired during marriage) which is owned 100% (separately) by one spouse or the other.

For married couples, you each need to decide what happens to your community and separate property when you die. There are two options:

Option 1: the surviving spouse gets everything. Meaning, all of the deceased spouse’s separate and community property goes to the surviving spouse. From there, the terms of the trust will decide what happens after the survivor dies. Why would you what this? If you want the surviving spouse to have maximum flexibility or you want the easiest possible administration following the first spouse’s death, then this option makes sense. This option is sometimes called a “disclaimer trust.” But, this option is not without risks. If the surviving spouse gets everything, then the survivor controls its ultimate distribution. Meaning, the surviving spouse can amend the trust to cut out the original beneficiaries and name new ones. Thus, in mixed or blended family situations, this option is not always the best because there may be a concern about the stepparent cutting out the step children.

Option 2: when the first spouse dies, the trust splits into two trusts – a survivor’s trust and a decedent’s trust. The survivors trust holds all of the surviving spouse’s separate property and his or her half of the community property. Likewise, the decedent’s trust holds all the deceased spouse’s separate property and his or her half of the community property. This option is frequently referred to as an “A-B Trust.” The “A” trust (the survivor’s trust) is meant to allow the survivor flexibility regarding his or her share of the marital property. The survivor remains free to change the beneficiaries of the “A” trust. The “B” trust (the decedent’s trust, or marital trust, or bypass trust) is meant to preserve not only the deceased spouse’s share of his or her property, but also his or her beneficiary designations. This way, stepchildren or other beneficiaries cannot be cut out of the deceased spouse’s trust.

Not to confuse you any more than you already may be. There is another option, but it does not apply to all estates. If the value of your estate is above the estate tax exemption limit (which in 2021 means above $11,000,000) then you may consider another option.

Option 3*: On the death of the first spouse, you can split the trust into three (or more) trusts. This type of trust is called an “A-B-C Trust.” In this type of trust, the A & B trusts hold the maximum estate-tax-free property (as calculated be a number of different formulas). The “C” trust holds whatever property is in excess of the estate tax exemption amount. This trust is frequently called a QTIP Trust. How these get funded and created is beyond the scope of this post, but I wanted you to be aware that there is a third less common options usually recommended for estates valued above the estate tax exemption.

As you can see, a trust is an extremely flexible and helpful estate planning tool. While it costs more money upfront to create than a will-based plan, it saves thousands of dollars after you die. Additionally, its flexibility means that it can be specialized and uniquely tailored to any type of estate, and any type of family situation.

Regnum Legacy was founded to serve families and guide them through the often confusing and anxious process of creating an estate plan. If you are ready to put the “planning” in estate planning, give us a call today (951) 228-9979, or click here to schedule a time for Regnum Legacy to call you. Or if you want more information about our estate planning services, click here.

 

 

[1] This is a particularly California answer and there may be more options or considerations in your state.

About the Author: James

James Long is the founder of Regnum Legacy, and another legal resource website called "Regnum Legal." He graduated from the University of St. Thomas School of Law in 2010, and was immediately appointed to serve as an Expert for the Vatican at the United Nations. After 10 years as a litigator and estate and business planner, James decided to wave "goodbye" to litigation and focus solely on estate planning and transaction business issues.