A trust is created when the owner of property (“settlor”) divides the ownership of the property into a legal ownership held by a “trustee” and a beneficial ownership held by a “beneficiary”. The trustee controls and manages the property in accordance with the terms of the trust instrument. The beneficiary enjoys the property in accordance with the terms of the trust instrument. There can be multiple settlors, trustees, or beneficiaries. The same person or persons can hold two or three of the positions of settlor, trustee or beneficiary. Trusts are flexible planning tools that can facilitate the transfer of property with retained or specified restrictions.
Common Trust Types. The different types of trusts approach infinity. Some of the more common types of trusts many people encounter are briefly summarized below. The list is not comprehensive.
If the owner of property wants to benefit charitable and/or religious organizations, but desires to balance that goal with a desire to benefit the owner and the owner’s family, trusts can be a useful means of doing so. Charitable remainder or lead trusts can provide the means to obtain such a balance while achieving significant income and transfer tax savings. There are many variations of these basic remainder trusts and the tax law is complex.
- Charitable remainder trusts allow a settlor and/or other family members to retain a periodic payment or income stream from the trust property. When those payments or the income stream ends, the settlor’s choice of charitable or religious institutions will receive the trust property. The benefit of the charitable remainder trust is a current income tax charitable deduction for the value of the charitable or religious remainder a reduction in the value of assets held by the settlor in calculating transfer tax liabilities. The principal detriment is the reduction in the value of property that will eventually be distributed to family members from the owner. These trusts are generally of two types: charitable remainder unitrusts and charitable remainder annuity trusts. The settlor or other family members retain the right to receive a set percent of the value of the trust property revalued each year in the case of the unitrust. The settlor or other family members retain the right to receive a set periodic payment in the case of the annuity trust.
- Charitable lead trusts allow the settlor to give a period payments or an income stream from the owner’s property to charitable or religious organizations while having the property come back to the settlor or family members at some time in the future. Like a remainder trust, the lead trust can be either in the form of a unitrust or an annuity trust with the charity receiving the unitrust amounts or the annuity payments.
This is a complex area of the law. Although many charitable and religious organizations have prototype trusts you can consider adopting, Settlors will be well advised to have their own independent legal counsel review any prototype before adopting a prototype plan.
Credit Shelter Trusts
If the owner of property wants to place property in a trust that will use up some or all of his or her credit shelter equivalent for transfer tax purposes and keep the property out of the beneficiaries’ estates at their death, the trust employed is often called a “credit shelter” or “family” trust. Often in estate planning for married couples, a spouse will fund a credit shelter trust for the benefit of the surviving spouse and their descendants at the death of the first spouse. Whatever is left over at the surviving spouses’ death passes to the descendants without being taxed in the surviving spouse’s estate.
Dynasty trusts are designed to preserve family wealth for several generations and avoid the shrinkage that can otherwise occur in large estates from transfer taxes. Connecticut law allows for such a trust to last for 100 years and it is possible to invoke the law of other states to have such trusts last much longer.
Irrevocable Life Insurance Trusts. Irrevocable life insurance trusts are a type of irrevocable trust in which a trustee owns one or more life insurance policies on the life of the settlor and often some liquid assets from which premiums can be paid. This type of trust is sometimes referred to as an “ILIT”. Wealthy individuals seeking to maximize transfer tax savings to beneficiaries can sometimes benefit from placing life insurance ownership in an ILIT. These trusts work well for wealthy married couples, who purchase second-to-die life insurance, and persons, who purchase single premium life insurance policies, if these persons are not likely to need the cash value of the policies during their lifetimes.
Irrevocable trusts are trusts created by a settlor who gives up the ability to change or revoke the trust. These trusts are often used to transfer property to beneficiaries but place management and control over the property in a trustee. Irrevocable trusts are usually treated as completed transfers by taxing authorities but retaining too much benefit or control by the settlor may cause different tax results. For income tax purposes, an irrevocable trust generally has a separate federal tax identification number and does not use the settlor’s social security number. Income is usually reported on a separate trust income tax return.
Living trusts are usually revocable trusts that property owners establish and fund for the benefit of family or others while retaining control to amend the trust, to revoke it entirely and to change the trustee who manages the trust. The assets in such trusts are a part of the property owner’s estate for federal and state estate tax purposes, and for purposes of calculating Connecticut probate court fees. Caution, living trusts are often over marked as avoiding probate when in actuality Connecticut law requires the person handling the owner’s affairs at death to file the trust instrument and inventory in the probate court and to pay probate court fees based on the value of the living trust assets as well as other assets owned outside the trust. Living trusts are a useful tool to accomplish many estate planning goals, but they are ineffective to avoid probate court involvement or eliminate probate court expenses for Connecticut residents.
If the owner of property wants to place property in a trust that will qualify for the marital deduction provided by the federal and/or Connecticut estate taxes but wants to control the distribution of assets remaining in the trust at the surviving spouse’s death, a “marital trust” is often selected. To qualify for the marital trust all of the income of the trust must be distributed to or for the benefit of the surviving spouse during the surviving spouse’s lifetime.
Revocable trusts are trusts created by a settlor who retains the ability to change or revoke the trust. These trusts are often used to allow a trustee to manage and control property for the settlor and/or other beneficiaries. Revocable trusts are not treated as completed transfers by taxing authorities. For income tax purposes, the settlor’s social security number is generally used and all income is reported on the settlor’s personal income tax return.
Spray or Sprinkling Trusts
Most parents express a desire to divide their assets equally among their children when they die. Trusts for young children and outright distributions to older children may meet the goals of many parents for treating their children equally. Other parents may have provided substantial parental help with education or other needs to older children before they die and separate trusts at the time the parents die would result in unequal treatment for the younger children. Holding all distributions in a trust to ensure all the children have received a good education and the support help needed to give them a good start on their carriers may come closer to equal treatment and better achieve parental objectives. Such trusts are sometimes referred to as “sprinkling” or “spray” trusts.
Special Needs Trusts.
The quality of life for recipients of governmental benefits can be kept eligible for their benefits through special needs trusts (sometimes referred to as “supplemental needs trusts”). These trusts allow trust funds to be used to supplement what benefits are available through the governmental programs but not to replace those benefits.
Testamentary trusts are trusts created in a person’s will and can control distributions from decedent’s estates so that the distributions are managed and controlled by a trustee acting in accordance with the trust provisions in the decedent’s will. Sometimes it is best to have probate court supervision of a trustee and it is easy to invoke that supervision by use of a testamentary trust. Many decedents with young children have trust provisions in their wills to provide for a trustee to manage the children’s inheritances until a mature age when the trusts terminate and any remaining property is distributed to the children free of trust. In the meantime the trust provisions usually allow the trustee discretion to spend for the children’s support in reasonable comfort, health and education.
Without trust provisions minor beneficiaries named in a will, require the appointment of a guardian to control and manage the minor’s distribution. The probate court will appoint a guardian to handle the minor’s assets until the minor reaches the age of eighteen. If the deceased parent does not nominate a guardian in the will, the probate court must make the selection without the benefit of the parent’s nomination.
Most of what a property owner can accomplish by a living trust can be accomplished with a testamentary trust. However, a testamentary trust does not provide for the property owner’s needs prior to death. A will is only effective at death and never controls assets during lifetime.
A Totten Trust is created by a single depositor (settlor) depositing funds in a bank or credit union in trust for a single beneficiary. The terms of a Totten Trust are set out in the Connecticut General Statutes § 36a-296. The statute provides generally as follows:
- To create the trust the owner of the funds (depositor) deposits money in a separate account over which the owner keeps control by being the only person who can make withdrawals.
- If the beneficiary dies while the account is open, the trust terminates and the depositor becomes the owner the account free of trust obligations.
- If the depositor dies before the beneficiary, the trust terminates and the beneficiary becomes the owner of the account free of trust restrictions.
Money deposited in a Totten Trust account remain in the depositor’s taxable estate for transfer tax purposes. Money deposited in a bank trust account does not constitute a taxable gift to the beneficiary for gift tax purposes. The benefit of the Totten Trust is its negligible cost to establish. The principal detriment is the depositor’s inability to customize the trust provisions or to include property other than bank accounts as trust property.
Common Alternatives to Trusts. There are many methods other than trusts for dividing the ownership and management of property that sometimes can substitute for a trust. Most are inflexible tools for estate planning when compared to trusts.
- Voluntary Conservatorships. Connecticut law allows a competent person to petition a probate court to establish a conservatorship for the management and control of his or her property (Connecticut General Statutes § 45a-646). The main benefit of the voluntary conservatorship is that the conservator will be more closely supervised and controlled by a probate court than a trustee would be. The petitioner can excuse the need for the conservator to post a fidelity bond and retains the ability to terminate the conservatorship at any time. Some will decide that court supervision and control is too restrictive and costly to be an alternative to a carefully drafted trust or that their level of trust in the wise discretion of trustees they appoint is high enough to avoid close court supervision.
- Designations of Conservators. A competent person can execute a designation of conservator for future incompetence in which the person appoints a person or persons to act as conservator. If a court were to find the person to be incapable of managing his or her property at any time in the future, the designation serves as an endorsement for the designated conservator to be evaluated by the judge. The designation can excuse the posting of a bond for a designated person.
An owner’s property transferred to a custodian or retained as custodian for the benefit of a person under the age of 21 years pursuant to the Connecticut Uniform Transfers to Minors Act (Connecticut General Statutes §45a-4-546 – §45a-561) are in a virtual trust for the benefit of the young person (beneficiary). These transfers can be useful to impose restrictions on money or property intended for the benefit of an immature person without the expense of establishing a trust for the beneficiary. The terms of the custodial arrangement are generally as follows:
- Transfers are irrevocable gifts to the beneficiary subject to control by the custodian until the beneficiary reaches the age of 21.
- There can be only one person or institution serving as custodian at any one time but the property owner can name successor custodians to serve upon the death, incapacity or resignation of a custodian.
- A custodian must keep custodial property separate for his or her own property, must invest and reinvest the property for the benefit of the beneficiary exclusively and may be required to make periodic disclosures to the beneficiary upon the beneficiary reaching age 12.
- The custodial assets must be distributed to the beneficiary upon his or her 21st birthday or to the beneficiary’s estate if the beneficiary dies prior to age 21.
- The benefit of the Totten Trust is its negligible cost to establish. The principal detriment is the depositor’s inability to customize the trust provisions or to include property other than bank accounts as trust property.
The benefits of custodial property are the negligible cost of establishing it and the removal of the property from transfer taxation. The principal detriments to custodial property rather than custom trust property are two: First, the owner cannot extend the management and control of the property beyond the beneficiary’s 21st birthday. Second, the property owner cannot customize the trust provisions or include property other than bank accounts in a custodial account.
Guardianships of Minors
Connecticut law requires that minor (a person under the age of 18) entitled to receive assets that exceed $10,000 in value have a probate court appoint a guardian of his or her estate to manage and control the assets. (Connecticut General Statutes § 45a-631) Guardians are subject to extensive legal requirements, court supervision and expenses that many prefer to avoid in attempting to benefit minors. Trusts are usually the preferred alternative.
Powers of Attorney
The owner of property may authorize others (called “attorneys in fact” or “agents”) to manage and control the owner’s property by executing a power of attorney. The owner retains the ability to manage and control the property along with the appointed agent and retains the ability to revoke the agent’s authority. Ownership remains in the owner and the agent has a duty to act in the best interests of the owner. Powers of attorney can be general or limited. They can end at any time when the owner might become incapable or they can continue to be effective after incapability (“durable” powers). All powers of attorney terminate at the owner’s death and are no longer valid thereafter. A high degree of trust and confidence should exist before using a power of attorney because they are often misused. The main benefit to powers of attorney is the convenience to the owner without changing the owner’s estate planning and the low cost to create them. The main detriment is the risk that the agent will misuse or misappropriate the owner’s property and court supervision of an agent may be ineffective to rectify the agent’s misuse or misappropriation.