American Estate Planning Attorney Directory

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Testamentary Trusts

What is a trust?
A trust is property given to a trustee to manage for the benefit of a third person. Generally the beneficiary gets a "trust income," the interest and dividends on the trust assets, for a period of years. After a certain time specified in the trust (say the beneficiary's turning 25) the trust "terminates." At this point the beneficary gets the remainder of the principal (whatever hasn't been paid out during the life of the trust).

There are two main kinds of trust: those created by provisions in wills, called testamentary trusts (as in last will and testament), and those created during the maker's lifetime, called living trusts. Some living trusts are set up so that they can be changed during the grantor's lifetime, but others are set up so that they can't be touched. The first kind of living trust is called "revocable," the second is called "irrevocable." There are major tax law differences between each type, and people setting up trusts should be sure they understand the tax consequences, which can be very complicated.

Can a trust protect assets from a child's creditors?
Generally, yes. If you think your child could have problems with creditors, you should give the trustee broad discretion to withhold income and principal from the child.

Let's say your 25-year-old son goes into default, after your death, for $40,000 in college and law school loans, and you have left him a trust worth $50,000. You could have set up the trust as a spendthrift trust, which is designed to keep the money out of the hands of creditors. The sum in the trust will generally be safe from the banks, though creditors can collect from any money paid directly to your son from the trust. To be fully effective, a spendthrift trust must be irrevocable, it must last for the entire lifetime of the beneficiary, and it must give the trustee full discretion over the assets of the trust.

Is a lawyer necessary to set up a trust?
Most trusts should be drawn up with the help of a lawyer or financial manager. Because there are so many issues to consider, with so many weighty consequences if things go wrong, it is a situation in which expertise is really needed.

The only exception is the totten trust, which allows you to go to a bank and open an account yourself, while naming a beneficiary. A totten trust is best for amounts of about $20,000 or less--larger amounts could present problems in payment of estate tax at your death, since the assets in these accounts are added to you taxable estate. A totten trust can be paid out quickly after your death with a minimum of formalities. Because the money transfers directly, there's no need for choosing a third-party trustee, and the advantages are the same as with any other trust--you keep those assets out of probate.You can revoke a totten trust at any time during your life, and the beneficiary can't take out the money until you die.

Who should be selected as a trustee?
Many people choose relatives or close friends, though institutions--banks or trust companies--also provide this service. Often a person selected as a minor child's guardian is also named a trustee of any trusts established for the child--but there is no requirement that these be the same people.

State law often sets commissions for trustees, but different rates can be specified in a trust, and institutions usually get paid commissions under their regularly published fee schedules. Friends and relatives often waive commissions.

Why set up a trust?
There are many reasons, but some of the more common are as follows:

• to manage assets during the lifetime of the person creating the trust, and to pass them on to chosen beneficiaries without probate (often done through revocable living trusts).
• to manage assets for a child until he or she reaches a certain age. The trustee can use the income or principal as he or she sees fit to pay for the child's needs, such as college.
• to manage assets for an adult who is incapable of handling them.
• to attempt to shield assets from creditors through irrevocable and spendthrift trusts.
• to manage assets for a surviving spouse while holding property for the children of a prior marriage.
• as a way to reduce estate taxes for couples with estates of over $1,000,000.

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AEPAD is the American Estate Planning Attorney Directory.  While the information on this site deals with legal issues, it does not constitute legal advice. If you have specific questions related to information available on this site, you are strongly encouraged to consult an attorney who can investigate the circumstances of your situation and the particulars in your state.