Welcome.
I’m very happy to have the chance to speak with you about the types and uses of trusts. My name is Russ Lombardy and I’m an attorney here in Longmont. I am an estate and disability planning attorney and use trusts regularly in my practice.
I’m also happy to be able to introduce my colleagues who will also be speaking today. We anticipate taking about 20 minutes a piece to discuss a specific aspect of planning related to trusts or trust alternatives. After that, we will be happy to take your questions during a general Q&A session. We will do our best to be finished just about an hour from now. If any of you have any unanswered questions, or do not wish to ask your questions publicly, please see any of us after the seminar. We will be around for half an hour or more after the seminar.
I hope to be able to answer some of the most basic questions regarding trusts—what they are, how they work, and in what specific circumstances they are the especially useful. Up after me, is my colleague at the Kapsak Law Firm, Bruce Danford. Bruce is also an attorney and he will be speaking to you about some of the tax related aspects of trusts. After Bruce, Don Thompson will speak to you regarding some of the practical workings and responsibilities of being a trustee or fiduciary for a trust. Don is a First Vice President in the Trust Division of American National Bank in Boulder and has worked as a tax officer and trust administrator for many years in the Denver / Boulder area. After Don, Sandy Johnson will then speak on the use of annuities as an alternative to the use of a trust. Sandy is a First Vice President of investments at Smith Barney in Broomfield and has been assisting families and individuals with their financial planning needs in Boulder County for over twenty years.
Like I said, we are going to try to have this seminar finished in an hour, so let’s get started.
The first question I would like to address is the question: What exactly is a trust. Most of us know something about a trust and trustee relationship, but for the sake of clarity, I would like to address this issue explicitly.
When most people refer to a trust, they are usually referring to a document. Although a trust document is at the heart of most every trust, a trust is, actually and legally, a relationship involving several parties. The first party that comes to mind in this relationship is the settlor, also called a grantor. A settlor is someone who places something, the trust assets, into a trust (thereby settling the trust). If assets are moved into a trust at the death of someone, this someone is referred to as a testator. Now—the settlor puts assets into a trust for the benefit of someone (or several someones), called, naturally enough, the beneficiary. In some circumstances, the beneficiary and settlor may be the same person. Now that we have a relationship developed between someone with assets, the settlor, and someone to benefit, the beneficiary, the last party that is usually a part of this relationship is the person who manages the trust assets, the Trustee. Depending on the type of trust, a trustee may be the settlor, an independent individual, or a bank or trust company.
This relationship is governed by the trust instrument. This is the document that most people think of when they think of the word “trust.”
So—we have the relationship formed by a settlor transferring assets to a trustee to be managed according to the trust document for the benefit of beneficiaries. Note that the title of the property actually transfers into the name of the trustee, but title is held specifically as a trustee and not as an individual or company.
Trusts come in many different flavors. A trust that comes about through the trust language contained in a testator’s will at death is referred to as a testamentary trust. A trust drafted during the life of the settlor is an inter vivos trust. Trusts created during life may be either revocable (meaning that they are subject to change and may be terminated by the settlor) or irrevocable. Irrevocable trusts are typically entities separate from any of the other parties involved in the trust relationship for both property and tax purposes. It is probably worth mentioning at this point that trusts can be created in a number of different ways: by wills, other trusts, and, of course, individuals.
One type of trust that is set up at death, either in a will or by the terms of a revocable living trust, is a Credit Shelter Trust which allows the best use of the estate and gift tax credit. In many estate plans drafted for families that could have a taxable estate at death, a Credit Shelter Trust is used and funded with some of the decedent’s assets so that the decedent’s spouse and family will receive the use of the assets without wasting any part of the decedent’s lifetime estate and gift tax credit.
A common form of revocable trusts is a Revocable Living Trust. This type of trust is created by a person who is both the trustee and beneficiary during that person’s life. This type of trust allows a person to put all of her assets into the name of the trust, yet manage them more less as she would have managed them had she owned them personally. At the settlor’s death, the assets in the revocable living trust will continue to be held and managed by a successor trustee or will be distributed according to the terms of the trust. The assets in such a revocable living trust will still make up part of the person’s taxable estate, but will not be probate assets required to go through the state probate process. The primary benefits of using a revocable living trust here in Colorado, because our probate process is not excessively burdensome, lengthy, or expensive, come from the fact that the trust instrument does not become a public record like a will, thus preserving your family’s confidentiality if this is important to you. Another very important aspect of the Revocable Living Trust is that if the Settlor becomes incapacitated, a successor trustee will be able to step in and manage the disabled person’s assets with minimal disruptions. Finally, if the trust holds assets such as real property that is located in another state (like a Northern California vacation home, for instance), a revocable living trust is a great way to avoid probate in jurisdictions in which probate is costly and lengthy.
A common form of irrevocable trust is the Life Insurance Trust. This type of trust is created to hold life insurance assets. The primary benefits to this trust are asset management and tax benefits. A settlor may fund an irrevocable life insurance trust in such a way that the moneys used to fund the trust do not count against the settlor’s lifetime estate and gift tax credit (meaning there is no chance that these transfers could lead to an estate tax at death). Additionally, the insurance proceeds that are paid out at death do not go into the taxable estate of the decedent, and are therefore not subject to his or her estate tax.
One type of trust that highlights the flexibility of the trust relationship is the Special Needs Trust, also know as a Supplemental Needs Trust or a Medicaid Trust. Public assistance programs such as Medicaid have precise needs-based requirements for qualification. If a person in need of assistance such as Medicaid were to own assets directly, those assets would have to be used for the basic Medicaid-type services before Medicaid would contribute to the person’s care. However, with sufficient advanced planning, it is possible to put funds in trust to benefit a person who will need Medicaid-type services but which funds will not have to be used for the basics of care and will not disqualify such a person from Medicaid. A word of advice with respect to using trusts for the benefit of a person who will require Medicaid or a similar public assistance program: This type of planning is somewhat complex and is changing as we speak.
I mention that a Special Needs Trust is a great example of the flexibility of trusts. These types of trusts are written to be a type of discretionary trust. Discretionary Trusts are drafted to give the trustee discretion with respect to how she moves the assets in the trust to the beneficiaries. If drafted specifically for beneficiaries that are anticipating the need to qualify for Medicaid, these trusts allow the trustee to provide benefits to the Medicaid beneficiary without creating a legal right to the assets on behalf of the beneficiary that would disqualify the beneficiary from Medicaid. In all of the above types of trusts, one aspect of the trust relationship that is especially useful is a trust’s ability to provide for the separation of current and future benefits. For example, in many trusts, the current benefit from the income generated by the assets that are in the trust is separated from the future benefit of the ownership of those assets themselves. A typical type of planning that I personally see on a regular basis is where parents work into their estate plan a tiered payout of their assets to their children in the event of the parent’s death. A typical payout would be some portion of the income the trust assets generate being used for the benefit of children with the assets themselves distributed partially when the child reaches a certain age (21 or 23, typically), with several additional portions being distributed each five years thereafter until the trust assets are completely distributed. This, in effect, protects the children from their parents’ assets by giving them the benefit of these assets without giving them the immediate ownership of them.
In a similar situation that we encounter on a regular basis, one spouse wants to protect his or her assets at death from the person that his or her spouse may remarry in the future. This type of planning may include using a trust to ensure that the income from all of that spouse’s assets is available for the life of the surviving spouse but, after that spouses death, the assets themselves are to be distributed to the children. This prevents the assets from going to the surviving spouse outright and potentially winding up in the hands of a third person should the surviving spouse die after remarrying (in which case the new husband or wife may inherit the assets originally owned by the first husband or wife).
So, as you can hopefully see, trusts provide a very flexible platform from which to plan. Under many circumstances, a trust may be an appropriate planning tool. However, trusts are sometimes sold like commodities: either as a one-size-fits-all solution to every planning challenge, or as a solution that is always appropriate. First, let me say that in my opinion, no type of estate planning should be one-size-fits-all. You need to ensure that you are dealing with professionals you both trust and like. This word of advice applies to every professional you deal with. Second, there are many situations in which a trust may not be the best solution to the challenge at hand. Experienced planners can assist with these types of determinations.
One aspect of using trusts that is often either overlooked or misunderstood is how trusts are taxed. With more on this issue, I turn the floor over to my colleague Bruce Danford.
