A “trust agreement” or “certificate of trust” is a document establishing the trust. If the grantor can change the terms of the trust, the trust would be revocable. Of course, the grantor needs to be alive to change the terms (thus, “living trust” gets its name – they are the same thing). If the grantor could not change the terms of the trust, the trust would be irrevocable. When someone dies, a revocable trust becomes irrevocable.
Almost always, the grantor is also the trustee and the primary beneficiary during the grantor’s lifetime. That means the grantor controls the trust property and can benefit from the trust property. However, legally, the sole trustee cannot be the sole beneficiary. Therefore, the trust agreement will always name a successor trustee and contingent beneficiaries for when the grantor passes away (and contingent beneficiaries for when the other beneficiaries pass away).
To be valid, the trust must have some property in it. Sometimes there will be a list of personal property attached as an exhibit to the trust agreement, or there could be a statement that a small dollar amount (like $10.00) was given to the trustee. After the trust is created, people will gradually add property to the trust (but they should not take too long to do this, or it may defeat the purpose of the trust, which for most people is to avoid probate). Other reasons why you may want a revocable living trust are: to dictate who gets your property after the surviving spouse dies (often in cases of a second marriage), preventing probate in multiple states if you own real estate in multiple states, if you are likely to become incapacitated, for privacy reasons, and to lessen your potential estate tax liability. These topics, along with the myths surrounding revocable living trusts, will be discussed in a subsequent article.
The bulk of the trust agreement is going to consist of two provisions – one dealing with the distribution of property and one dealing with the trustee’s powers.
The distribution provisions in the trust address (1) who can access trust principle and income during the grantor’s lifetime and (2) who gets trust principle and income after the grantor has passed away. After the grantor’s death, trust property is typically divided into smaller trusts before distribution. There may be one contingency if the grantor is survived by a spouse, and a different contingency if the grantor is not survived by a spouse (for example, leaving property to children).
A brief discussion of estate tax is warranted here. Currently, for estate tax purposes, there is an unlimited marital deduction, meaning the surviving spouse does not have to pay any estate tax on the decedent’s estate passed to him/her. However, the surviving spouse’s estate will be responsible for estate taxes when the surviving spouse passes away.
The current estate tax exemption is $5,490,000. This means that a single person passing away with an estate worth $8 million will have to pay taxes on the $2,510,000 amount over the exemption (40% tax rate). For a married couple, the total amount is $10,980,000.
The trust agreement will create a “Family Trust” or “Credit Shelter Trust” or “Bypass Trust” (all of which are names for the same thing). The point of the Family Trust is to keep assets out of the surviving spouse’s taxable estate (the goal is to keep the total number below $10,980,000). To keep the Family Trust from being included in the surviving spouse’s estate, careful drafting is required--the surviving spouse cannot be the sole trustee and cannot have an unrestricted right to the trust property. The amount of property the beneficiary has a right to withdraw is included in his/her estate.
The remaining amount that can pass to the surviving spouse without him/her having to pay estate tax will either pass directly to the surviving spouse or will be included in a marital trust (see below for more details). Oftentimes, at the time of the drafting of the trust, you’re not going to know what amount is necessary to put in the Family Trust to avoid estate tax. Therefore, the trust will say something like this (except much more elaborate): “If my spouse survives me, the Trustee shall set aside, as a separate Marital Trust, the smallest pecuniary amount necessary to eliminate or reduce the federal estate tax liability of my estate. . . . The Trustee shall hold all remaining assets in a separate trust called the Family Trust.” The estate planning attorney, tax professional, and/or trustee will have to crunch some numbers and figure the amount out upon the first spouse’s death.
Whatever is not put into the Family Trust can be distributed to the surviving spouse outright. However, sometimes there may be a “Marital Trust,” which is where the grantor is concerned about the surviving spouse’s ability to manage money or, if it is a second marriage, the grantor may not want the surviving spouse’s children (that are not the grantor’s children) to inherit.
It is very important that the trust be worded correctly because the Marital Trust property must go to the surviving spouse to qualify for the unlimited marital deduction. However, the terms of the trust will provide that at the surviving spouse’s death, the remaining Marital Trust property will pass to someone whom the grantor has selected. Normally, the decedent is the one who dictates who gets her property when she dies, but not with this trust. Also, the terms of the trust will likely dictate that the surviving spouse can only use the property for her benefit only and not someone else’s during her lifetime. The most common type of Marital Trust is a Qualified Terminable Interest Property Trust (QTIP Trust).
The terms of the trust agreement control except for twelve mandatory rules under North Carolina law. Otherwise, the statute contains only default provisions that fill in when the trust agreement is silent. The trust agreement will tell the trustee how to make distributions (which is crucially important for tax planning), maintain trust property, how to terminate the trust, how to remove other trustees, how to name successor trustees, how to keep records and provide information to beneficiaries, and to use trust funds to pay the grantor’s funeral expenses, debts, taxes, etc. at the grantor’s death.
Due to the unlimited marital deduction and rising estate tax exemption (it has increased approximately two million dollars over the past ten years), the need for using revocable living trusts for estate tax planning has decreased exponentially. So why should “normal people” use them? The main two reasons are (1) to protect assets when the surviving spouse is a second marriage, and (2) to avoid probate. Using living trusts to avoid probate, and some of the other pros, cons, and myths, will be discussed in our next blog/newsletter.