Do I need a trust?

“Do I need a trust?” While there is widespread consensus that just about every adult, especially those who have people who depend on them financially, needs a will, there is considerably less agreement about how often trusts should be part of someone’s estate plan. There are a substantial number of attorneys and financial planners who argue that everyone should have a trust. My impression, however, is that a larger contingent believes that for most Colorado residents, at least, a will is enough.

What is a trust?

Before deciding whether you need a trust, it’s important to understand what one is. A trust is not a thing. It’s a relationship. Creating a trust simply means giving property to one person to hold for the benefit of another. The person who creates the trust is called the grantor or settlor. The person to whom the property is given is called the trustee. And the person for whose benefit the property is being held is called the beneficiary. The grantor provides the trustee with instructions on when to give assets to the beneficiary in a document called a trust agreement.

Many people are surprised to learn that you can be your own trustee. In other words, you can give property you already own to yourself to hold for your own benefit. Why would you do this? Although the day-day-day impact of holding your own property in trust for yourself may be imperceptible to the naked eye, holding your property in trust opens up all kinds of possibilities for what you can do with that property that you don’t have when you hold it in your name.

The benefits of a trust

Some of the things that holding your property in trust allows you to do are:

  1. Avoid probate. Perhaps the most often cited benefit of holding your property in trust provides is that doing so allows you to transfer that property to other people without the need for a probate court. When you die, any assets that you have titled in your name alone need to be transferred to other people. The legal process for accomplishing that transfer is probate. Probate has a terrible reputation for being slow and expensive (whether this reputation is still accurate is debatable). As noted above, however, moving assets into a trust takes them out of your name. So now, instead of relying on a probate court to figure out who you wanted to receive your assets, the person you name to serve as your trustee can simply follow the distribution instructions you leave in your trust agreement. No need for a court’s oversight or approval.
  2. Protect your privacy. Court hearings are open to the public. This includes matters handled in probate court. So if your assets pass to your heirs through the probate process, that all can become part of the public record. Assets transferred by trust are not exposed to public inspection.
  3. Maintain control. A will allows you to dictate who should receive your assets when you die. A trust can go far beyond that, giving you the ability to determine what should happen to your assets while you are still alive and long after you are dead. You can, for instance, specify who should manage your assets for you if you become incapacitated. And if you feel uncomfortable about giving your assets to your spouse or kids without any limits on what they can do with those assets, you can put restrictions on when they will receive them. You could, for instance, specify that your kids will receive your assets in chunks when they turn 35, 40, and 45 years old. Or you could specify that they need to attain a certain level of education before receiving everything. And if you have heirs who might be unhappy with how you have decided to distribute your assets, it will be much more difficult for them to mount a legal challenge to that distribution if you carry it out through a trust than if you do it through a will.
  4. Asset protection and tax reduction. Certain types of trusts can protect your assets from creditors and reduce the taxes your estate owes when you pass away. These types of trusts, however, are significantly more complicated than ones where you act as your own trustee. The IRS isn’t going to let you avoid taxes, and courts aren’t going to help you avoid your creditors, if all you’ve done is give your assets to yourself to hold in trust. If you are trying to shelter assets from creditors or the IRS, there are strict rules on who can be the trustee and how much control you have to dictate what gets done with the property after it has been put into the trust.

Why wouldn’t I want a trust?

So now you may be wondering why you wouldn’t want a trust, if they’re so great. The power and flexibility that are inherent to trusts mean that there are more decisions that need to be made and, therefore, more opportunities for mistakes and unintended consequences. Because they are more complex, they typically take a little more work and a little more money get in place.

Also, having a trust requires ongoing maintenance. If your goal in setting up a trust is to avoid probate, you have to re-title your assets in the name of the trust. And you have to keep doing it as you replace assets or as you acquire more. And each time you move assets into your trust, you need to check in with any insurers or lenders to confirm that you don’t create any problems. If your estate isn’t that complex, this can end up being more work than going through probate would have been.

Unlike wills, which usually only require occasional updates, maintaining a trust is an ongoing project. The benefit of all that work by you is that people responsible for handling your estate when you pass away will have much less to figure out. People who have overseen the administration of estates that were built on trusts, and which avoided probate, almost always choose to set up trusts for themselves because of how easy their job turned out to be.

Are there situations where having a trust is recommended?

Although I don’t subscribe to the position that everyone should have a trust, there are situations in which having one is probably going to make sense:

  1. Dependents who will need financial assistance for years. If you have people who will be financially dependent on you for years, such as minor children, you will need to have a trust in place to provide them with ongoing oversight. You don’t necessarily need to set that trust up now. You can direct the creation of a trust in your will. Be aware, however, that doing it this way doesn’t help you avoid a probate. A probate will need to be opened to transfer the assets into the trust.
  2. Special needs child. If you have a special needs child, that child might need financial oversight for his or her entire life. That child may also qualify for certain government benefits to help with their ongoing care. You can, however, inadvertently disqualify that child from receiving those benefits by leaving them a large amount of unrestricted cash. A “special needs trust” can provide you with a way to support that child without disqualifying him or her from receiving government assistance as well.
  3. Blended family. If you leave money without restriction to a spouse and that spouse lives longer than you, he or she will ultimately get to determine what happens to assets that had been yours. Even if you have made wills together, there is nothing to prevent that spouse from changing his or her will after you die. This can be a problem if you have kids from a relationship with someone other than that spouse and you want to be sure those kids receive some of your estate. If you want to provide for a spouse, but also be sure that your kids receive some of your assets as well, you will need a trust. A typical arrangement is for the trust to provide for your spouse as long as he or she lives after you pass away, with whatever remains at the end of your spouse’s life going to your kids.
  4. Kids who need oversight. While most of us assume that receiving a large inheritance would be a wonderful thing, it can be ruinous for some people. If you’re not sure that your kids will be able to handle receiving a large amount of unrestricted money, you can address your concerns by giving it to them in trust with specific instructions about when, and under what conditions, they can access it.
  5. Disinheriting. If you’re planning to cut an heir out of your estate plan entirely and are concerned that he or she will respond with litigation, you can make his or her task much more difficult with a trust. When your assets pass through probate, a court case is opened, your assets become a matter of public record, and all potentially interested parties receive notification. Everything is in place for unhappy heirs to file an objection. When assets pass through a trust, however, no court case is opened. A disappointed heir has to file a lawsuit and convince a court they have standing to sue. They then have to hope that the court will allow them to broad enough discovery to figure out what they may have been entitled to receive.
  6. Real estate in more than one state. If you own real estate in more than one state, and you hold the properties in your name, your personal representative is going to need to open a probate case in each state in which you own property to get that property transferred to your heirs. You can avoid that by holding the property in trust instead.
  7. Non-citizen spouse.If you are not a US citizen, or if you are married to someone who is not a US citizen, there are special tax concerns that you can address with a trust. Specifically, while spouses can usually leave as much as they want to each other without incurring a tax bill, there are limits to how much you can give to a spouse who is not a citizen without having to pay tax. Although this tax cannot necessarily be avoided, it can at least be delayed until after the non-citizen spouse passes away with something called a Qualified Domestic Trust. There are specific rules that need to be followed with regard to who can serve as trustee for this type of trust to work.
  8. Asset protection and tax avoidance. If you are in a profession or have a hobby that comes with a high litigation risk, putting your assets into a trust can help mitigate that risk. Trusts can also help you move assets out of your estate if you have enough for taxes to be a concern. Both of these situations, however, require special kinds of trusts to accomplish these goals.

Trusts can provide a lot of wonderful benefits for you and your family. But their flexibility can also make them difficult to deal with if you are not sure what you are doing. Even more so than wills, creation and management of a trust requires the assistance of competent legal counsel.

Dan McKenzie
Dan McKenzie
dan@themckenziefirm.com

Dan specializes in estate planning, estate administration, and small business counsel. He opened the McKenzie Law Firm in 2013, after spending 10 years as a litigator, seeing what can happen when people fail to carefully identify and mitigate their risks. He is pleased to be raising four kids in the same state where he grew up.