PART ONE: What is a trust?

What is a trust?

What is a trust?

To keep it simple – a trust is a legal/financial instrument that allows a 3rd party (trustee), to manage cash or invested assets; real property; securities; retirement accounts; art or collectibles and other valuables; life insurance or other annuities; as well as any number of different assets, held in trust… usually to be inherited     by a trust beneficiary, or several beneficiaries – and set up by a valid “trustor” who is a parent or some other family member.

California Trusts

In California trusts are often used by wealthy families, or by an individual, to avoid probate; to use as a trust loan & Prop 19 parent-child exclusion to keep  inherited property at a low tax base; to avoid property tax reassessment; to defer taxes, or avoid taxes altogether.

Or, when it comes to irrevocable trusts (trusts that can’t be altered), California homeowners and beneficiaries frequently make use of a trust loan & Prop 19 parent-child exclusion (formerly a Prop 58 exclusion) when inheriting a home in California & looking for trust loan property tax savings, and possibly buying out siblings that are inheriting the same property, that are looking to to sell their property shares for a higher price than an outside buyer would offer them.

Many people believe that beneficiaries get access to inherited assets more rapidly with a trust than they would through an estate with a Will… However, that is often not the case.  Inherited assets held in a trust fund are frequently received from any number of different “final distribution” or inheritance payout schedules – i.e., for example cash distribution every five or ten years; or when a beneficiary turns 21, or 30, or 50, or on some other birthday. 

A Spendthrift Clause (written into many California trusts) will make a trust even more inflexible, and insufferable for the beneficiary.

Trusts can be arranged in all sorts of ways, to specify exactly how and when inherited assets pass on to beneficiaries.  Often stemming from the view the person leaving the trust had of the beneficiary… whether he is responsible handling money, or if she   is a spendthrift with liquid assets… and so forth.

Different Types of Trusts

A Marital or “A” Trust is designed to provide benefits to a surviving spouse; generally included in the taxable estate of the surviving spouse

A Bypass or “B” Trust (also referred to as a “credit shelter trust”) is   established to bypass a surviving spouse’s estate in order to make full use of any federal estate tax exemption for each spouse

A Testamentary Trust is created through a Will after a someone   passes away, with funds subject to probate and transfer taxes; and  often continues to be under probate court supervision.

An Irrevocable Life Insurance Trust (ILIT) is an irrevocable trust designed to exclude life insurance proceeds from the deceased’s taxable estate while providing liquidity to the estate and/or the trusts’ beneficiaries.

A Charitable Lead Trust makes specific assets available to a charity; with the balance of the decedent’s assets going to his or her  beneficiaries.

A Charitable Remainder Trust enables a beneficiary to receive an income stream for a defined period of time and stipulate that any remainder go to a charity.

A Generation-Skipping Trust takes advantage of the “generation-skipping tax exemption”, distributing trust assets to grandchildren or even generations coming of age after grandchildren; without  a generation-skipping tax or estate taxes being imposed on the subsequent death of ones’ children.

A Qualified Terminable Interest Property (QTIP) Trust distributes cash flow to a surviving spouse.  When the spouse passes, those assets will then be distributed to other additional beneficiaries listed in the  trust document.  Often used in second marriage situations, or to maximize estate and generation-skipping tax or estate tax planning.

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust funded by gifts by its grantor; designed to shift future appreciation on quickly appreciating assets to the next generation during the grantor’s lifetime.

PART TWO: What is a trust?

What is a trust?

What is a trust?

Irrevocable Versus Revocable Trusts

It is important to make note of the fact that an “irrevocable trust” is inherited as a document left by a “grantor” once that person is  deceased, and cannot be altered; plus it may not be considered part of a taxable estate, therefore fewer taxes may be due on your passing. 

Whereas a “revocable trust”, also known as a “living trust”, can be a much more flexible inheritance instrument — and most importantly, the grantor who wrote the trust document can maintain control while still alive.  It is also worth mentioning, due to the problems many beneficiaries have with trustee, that it is critical to choose a trustee who will know his or her place, and not adopt an attitude that the money and assets belong to the trustee.

Another use for irrevocable trusts – in terms of beneficiaries getting trust loans that work hand-in-hand with Proposition 19, is a parent to child property tax transfer managed by a trust lender –  making sure that  the trust lender stays on top of the process, and  ensures that keeping a parent’s low property tax base  becomes a reality.

Moreover, the trust lender can help you, as a  beneficiary inheriting a parental home, buyout a sibling or several co-beneficiaries looking to sell their inherited property shares – with a sibling-to-sibling property transfer; at a much higher price range than any outside buyer would offer – due to the avoidance of a realtor, who would typically charge a 6% commission – plus other pricey  closing costs such as legal fees, paperwork processing fees; transfer taxes, escrow expenses, notary fees; as well as fees for credit checking, value appraisal, title search, home inspection, etc.

When it comes to selling a home, there is, as they say, “no free lunch”. Meanwhile, beneficiaries keeping a family home at their parents’ low property tax base, through an irrevocable trust loan in conjunction with Proposition 19 (formerly Proposition 58), is able to keep that inherited home in the family basically forever at the parents’ low  property tax base, thanks to tax relief still protected by Proposition 13. 

To be clear, an irrevocable trust typically transfers assets out of an estate and potentially out of the grasp of estate taxes and probate, but it can’t be altered by the grantor after it has been executed. So once you establish this sort of trust you lose control over the assets and cannot change any of the terms, or dissolve the trust. However, if you’re gaining the financial advantage of a parents’ low property tax base going forward – it’s generally worth the trade off.

A “revocable trust” can help assets pass outside of an estate in probate, and allows you to keep control of the assets, as long as you are alive. A revocable trust is flexible, and can be dissolved whenever you wish. A revocable trust generally becomes irrevocable when the grantor or trustor (i.e., the person who placed the assets into trust for his or her beneficiaries) passes away.

Trust Assets and Inheritance Distribution

An irrevocable trust is generally preferred over a revocable trust if your objective is to reduce the amount of estate taxes by removing inheritance trust assets from your estate. When the assets are transferred into a trust, you are of the tax liability on the income generated by the trust assets are relieved.  Even though inheritance distributions will most likely result in income taxes. However, this type of trust will also provide protection against a legal judgment, should that occur.

Assets in a trust may also be able to distribute to heirs outside of probate, saving time, court fees, and potentially reducing estate taxes as well. Other benefits of a trust include managing your money. You can set the terms of the trust to control when and who assets will be distributed to.

You can set up a revocable trust so the trust assets stay accessible during your life while deciding who remaining assets will pass to, regardless of family complications. Parents often set the terms of trust distribution to protect the money in a trust by holding off on final distribution until the beneficiary is sufficiently mature to handle inherited money wisely, such as distribution at age 30, and again at 40, or whatever.

Final Trust Distribution

Some trusts do not reach final distribution until a beneficiary, who may be considered to be a spendthrift, reaches his or her 60th birthday — imagine waiting that long! This type of trust can also protect an estate from creditors coming after heirs who unwisely get deep into debt. Most importantly for some, a trust can allow assets to transfer to beneficiaries outside of probate and thus remain private, along with lessening money spent on probate court fees and taxes.

However, attorneys bent on convincing a family to leave inheritance assets in trust and ignore probate when they pass on may fail to mention fees associated with a trustee, who typically remains with a trust for the life of that trust, as well as subsequent attorney fees, bank fees, and other nominal costs that add up.