I receive more than a few questions as a senior trust officer at Members Trust Company. These questions range from the general, “What are trust services?” and “What are the benefits of a trust?” to the more specific, “How do I open a trust?” or “How do I choose the right investment management firm?” Usually, people ask these questions because they’ve heard some of the benefits of a living trust, such as creditor protection, protection from taxes, protecting a minor child, passing wealth outside of probate, Medicaid planning, et cetera, but don’t know how to achieve those benefits.
Trusts are increasingly common in lieu of wills as the best means for estate settlement. Given trusts’ long history and the numerous varieties, it’s not surprising that most people don’t understand what a trust is. It exists within a counterintuitive classification, where the IRS considers the trust as a person for tax purposes, but the trust itself has designated beneficiaries and an administrator. Often, this administrator is a national trust company, leading to the common question: “What services do trust companies provide?”
A trust is simply a contract designed to protect your assets by giving trust administration power to a third party. Trust companies bring extensive experience to bear when managing trusts, as well as a contractual obligation, to put the best interests of the trust beneficiaries first. This obligation involves managing the trust to protect and grow its assets and to use those assets solely for the beneficiaries’ benefit. In the right hands, you can consider a trust to be the best individual retirement account and method of planning for the future.
A Personal History with Trusts
I was first introduced to the trust as a law student when I worked for an experienced estate-planning attorney. He focused on revocable living trusts and treated them as fictitious persons. These “people” acted like containers of assets, which served as a useful analogy to illustrate certain advantages of a trust. The industry at large shares this understanding, which is why you’ll hear questions such as, “Is your house in your trust?” Similarly, the IRS requires trusts to file tax returns as if they were taxpaying human beings.
This approach has holes, however, in terms of several other important aspects of trusts, including the trust contract’s fiduciary obligations. A trust, as the word’s dictionary definition suggests, relies on integrity, honesty and fidelity. Without firm confidence in these qualities, the trustor would never give their money to the trustee.
The grantor, settlor, or trustor provides the money to the trustee and expects the trustee to follow the contract’s terms when spending the money. The trustee cannot use the money for any other purpose whatsoever. Instead, the trustee is a fiduciary who must use the money on behalf of the trustor’s specified beneficiaries.
How the Trustee Provides Trust Services
Understanding a trust as a contract makes the other terminology easier to understand. Trusts can be categorized according to two main characteristics: (1) whether it is revocable and (2) whether it was created while the settlor was alive. Therefore, each trust is either revocable or irrevocable and either “living” or “testamentary.” The settlor can change a revocable trust but an irrevocable one cannot. A living trust simply means that the trust was created by the settlor while still alive. Otherwise, it is a testamentary trust created by provisions in the settlor’s will and only exists after the settlor has died.
In modern use, these terms have become somewhat blurred. For example, many professionals refer to a revocable living trust as simply a living trust, even though many irrevocable trusts are also living trusts. The term “testamentary trust” also frequently refers to any trust that arises after the death of the settlor, even if it was part of a revocable trust that became irrevocable upon the settlor’s death.
The most common current example of a trust is the revocable living trust, which has become very popular as a substitute for a will. The benefits of a living trust include incapacity planning and avoiding probate, both of which help your family. Most of the time, when a revocable living trust is first created, the trustor, trustee, and beneficiary are all the same person. If the trustor becomes incapacitated, a successor trustee takes over. The successor trustee continues to use the money for the now-incapacitated trustor/beneficiary. Similarly, when the trustor dies, a successor trustee takes over but now uses the money for the surviving beneficiaries identified by the settlor in the trust document.
Selecting the Right Successor Trustee
There are few decisions more important than the choice of a successor trustee. This person has power over your life savings during your potential incapacity, and after your death, so you’re relying on them to have exceptional investment management skills. Aside from their talents, you should select someone in whom you have a firm belief of integrity, ability and character. This person needs the integrity to do what’s right, the ability to manage investments and effectively administer the trust, and the character to exercise discretion in a manner consistent with your values.
As my response to the question, “How do I open a trust?” I would say this: Pick the right trustee, and everything else will fall in place. In my experience, credit union trust accounts offer the best balance of experience and personal values. With the right trustee, even a poorly drafted trust document can provide good results because of the integrity, ability, and character with which that trustee carries out your wishes.
This article is for informational and educational purposes only and is not intended to provide specific legal or tax advice. For specific legal or tax advice, please consult with your attorney and/or accountant. Trust and Investment Products are uninsured, not guaranteed by Members Trust Company, any credit union or any federal agency. Any investment exposes an investor to investment risk, including the possible loss of principal.
About the Author
David Carlson, JD, is Vice President and Senior Trust Officer at Members Trust Company. He has extensive experience designing estate plans and representing clients in all civil litigation matters. He is a regular speaker and recognized thought leader for the estate planning legal community.