So Sue Me
How savvy people, just like you, use trusts to safeguard assets against potential lawsuits & creditors
If you’re like most people, you’ve probably not given much thought to concepts like estate planning, establishing trusts, or asset management. Don’t worry, though; you’re not alone. Recent studies have shown that nearly half of all Americans have not done any type of future financial planning such as preparing legal documents such as wills, healthcare powers of attorney, living trusts, and financial powers of attorney. Tools such as trusts are not only effective ways to plan for how your assets are managed and distributed after you’re gone, but also helpful tools to keep the wealth that you’ve worked so hard to acquire.
Admittedly, the idea of establishing a trust can be a bit daunting. Luckily, there are experts—a few of whom you’ll hear from here—who can guide you along the right path, and hopefully, help you better understand why having a plan is so important.
Will or Trust?
For purposes of our discussion, we’d like you to meet Bob. Bob is a Tennessean in his mid-thirties who is married to Jennifer. Together, the couple has two young children. Bob works outside of the home, while Jennifer is a stay-at-home mom. Bob has had a pretty good run career wise, and as a result, he and his family have been able to afford a nice home, a couple of cars, a cabin in the mountains, a decent-size sailboat, and a membership in the local pool and tennis club. Between his IRA and stock holdings, he has been able to—so far—set aside a mid-five-figure fund for college tuitions and retirement.
Bob’s been talking about estate planning for quite some time, but has put it off thinking it’s not going to be a need for years to come. Now, with two young kids, he feels it’s time to put pen to paper and properly prepare for both his present and their future. “Without a will or trust, without the proper plans in place, the assets that you’d hoped would pass quickly and easily to your heirs may pass neither quickly nor easily,” says Sonny Schow, an attorney with Woolf McClane. “I have seen far too many instances where young parents did not make plans. Those who are left behind, sometimes young children, are faced not only with a gut-wrenching loss, but an uncertain financial future, as well.”
In Bob’s case, if he were to pass on while his children were young, a trust would save them from lengthy—and costly—court proceedings. “With a trust, there is no need for court involvement and the assets can be transferred expeditiously,” says Stephen Gillman of Pryor, Priest, and Harber. “Since there is no such benefit with a will, a will can leave the fate of the minors in the hands of the court.”
Bob opts for a will rather than a trust, as it seems the simpler option. After all, trusts take more time and money to create. And yet what Bob doesn’t know is that of the two, trusts offer benefits that a will simply does not.
“Trusts are important for a multitude of reasons,” says Carolyn Levy Gilliam, attorney at McDonald, Levy, and Taylor, “as they can protect an individual’s assets and reduce attorney’s fees after their death.” Gilliam says that some of the most important times to consider a trust are when a beneficiary is a minor, is disabled or on Medicaid, or struggles with issues rendering them unable to make responsible resource decisions. The trust enables a person to gift without concern of it being mismanaged or causing a beneficiary to no longer qualify for health insurance and Medicaid services, says Gilliam.
In most instances, wherever there is a will, there is probate, the process by which the courts decide how assets are to be distributed. “Here in Tennessee,” says Gillman, “we can take advantage of what’s called ‘simplified probate’ where the regular, lengthier probate can be eliminated. This comes into play if the property…is $50,000 or less. Otherwise, probate proceedings can cost up to 10 percent of an estate, and probating a will can take, in some instances, not just months but years.”
Gilliam references an additional benefit: “If an individual owns land in more than one state, it becomes much more cost efficient to have a trust versus a Last Will and Testament, as it prevents the need to open probate in more than one state.”
It’s important to note that the probate process is a public one. All information about a deceased person’s assets, liabilities, and beneficiaries, are public. So if you avoid probate, you keep your family matters private.
How a Trust Works
As Bob learns more, he establishes a trust. At its most basic level, a trust is simply an agreement between a trustor and a trustee. In the example of Bob, he becomes the trustor. His trustee is a third party who Bob “entrusts” to hold his assets on behalf of his beneficiaries.
Bob chooses his best friend, Ted. The goal of the trust is to lay out how to transfer Bob’s assets to Ted, who then agrees to accept, manage, and protect them, administer them according to Bob’s instructions, and distribute the income and principal to his children.
Ted isn’t an attorney or a CPA, and he doesn’t need to be. A trustee is simply a party that is expected to act with reasonable care in administering the trust. “The role of the trustee can be as simple as writing an annual check to a beneficiary, or as complex as determining the needs of a beneficiary with a disability while managing multiple real properties for the benefit of said beneficiary,” Gilliam says. “The most important thing for an individual creating a trust to remember is that selection of the trustee is a key component of establishment.”
So Ted’s job is to manage Bob’s assets and oversee their distribution to his children, in accordance with the terms set forth by Bob in the trust agreement. In essence, the trustee need only be a reliable, reasonable person who the trustor, well, trusts.
“One will want to select a trustee that has good business acumen,” Gilliam says, “and is able to make decisions that are in the best interest of the beneficiary.
The trustee could be a family member or a friend, but it could also be an institution such as a bank or trust company. “An individual trustee may not be somebody who is as sophisticated in handling investments as an institutional trustee,” says Jackson Kramer of Kramer Rayson, who adds that while you may lose a little of the personal touch, in some cases that outside management can be advantageous. “The larger the trust is, the more money that’s involved, the more different types of investments that are involved, it generally is better suited for an institutional type trustee.”
These institutions can also provide continuity that an individual, perhaps, cannot. And sometimes it can be more efficient for trust assets to be managed by an objective entity, rather than a relative or friend where relationships and emotions can sometimes complicate matters.
That’s not to say there aren’t possible challenges. “Often times an institutional trustee has a minimum size or a minimum fee requirement to handle a trust like that so you need to make sure the trust is of a size where it makes sense to pay that fee,” Kramer says. “You don’t want to diminish the trust assets by paying fees that are more than what the trust can generate.” So if your trust is a modest one, a friend or family member might be your go-to.
Funded or Unfunded
Trusts can be set up at any point in a person’s life. A funded trust is one into which the trustor has placed assets during their lifetime. The more valuable an asset, the more it would cost to probate. When Bob establishes his trust, these are some of the assets he might choose to place in it: his home and any real estate holdings, stocks and bond, precious metals, works of art, antiques, and collections of value such as art or coins.
An unfunded trust consists of the trust agreement, but no funding. “One of the things that you need to be mindful of is…that you transfer your assets because if you don’t you’re still going to have to probate the assets that are not apart of that,” Kramer says.
If Bob were to pass away with an unfunded trust, the best-case scenario is that he had something called a “pour-over will” directing that any assets in the estate be placed into the trust. As long as no one challenges the estate, a probate judge will allow assets to be transferred to the trust and things should proceed normally from there.
However, if there is no will, getting assets into the trust can be very difficult, if not impossible. “When a trust remains unfunded at death,” explains Schow, “assets and property will not be distributed following the trust guidelines. Instead, the assets will be subject to probate, which it’s always best to avoid due to time and cost.”
Another unfunded trust downside? Any assets held outside the trust may not be passed to the intended beneficiaries since they do not fall under the control of the trust. The short of it is this: it’s important to properly fund a trust once established.
The Living Trust
Trusts aren’t just about what happens to your property when you pass on. Trusts can also be advantageous while you’re still here, too. The living trust, also known as an “inter-vivos” trust, is a legal agreement in which all of your assets are placed in trust for your use and benefit during your lifetime.
When Bob establishes a living trust, and places all of his assets within it, he can choose to establish a revocable living trust or an irrevocable one. As the term implies, a revocable living trust can be changed or terminated by the trustee during their lifetime, and as odd as it sounds, Bob can actually name himself as the trustee. He maintains complete control of his assets. He and Jennifer can sell their home and buy another, cash out and purchase stock, buy and sell cars, and more. Everything technically remains as part of his estate, though, so they are still subject to estate taxes. Bob can name Ted as his successor trustee, so if Bob passes with the trust still in existence, Ted automatically becomes the trustee.
While Bob didn’t choose an irrevocable living trust, it’s a good option for many. This type of trust is one that cannot be changed or amended once established. An irrevocable living trust can be advantageous, especially
when it comes to tax planning. “Tax laws, and with them, the amount of tax paid on the settlement of your estate, can change,” says attorney Philip Bryce of Bryce Law Offices.
Each administration takes a different stance on estate tax. Bryce points out that under current law, up to $11.7 million is exempt from being taxed. “Should a new administration decide to lower that exemption to $3.5 million, which is a very real possibility,” says Bryce, “that change would bring about a tax loss of several million dollars. My recommendation to anyone who might be affected is to establish an irrevocable living trust before year’s end in order to prepare for such an eventuality.”
Asset Protection Trusts
Living trusts can be a great way for high net worth individuals to protect their assets during their lifetimes, especially if they establish an asset protection trust. These trusts are irrevocable, which again, means that once an asset goes into this type of trust, it cannot be changed.
A domestic asset-protection trust (DAPT) is one in which the trustor is also named the beneficiary, which grants that individual access to the trust funds. In the case of Bob, Bob would be named the beneficiary of his own trust. The trust can include a wide variety of assets such as cash, securities, limited liability companies, business assets such as inventory and equipment, real estate, and recreational assets such as aircraft and boats.
“If properly structured, a DAPT could protect Bob’s assets from a creditor in the event that one should try to satisfy some judgment against him,” Bryce says, adding that there are other benefits including state income tax savings when the trust originates in a no-income-tax state, such as Tennessee.
There are also Tennessee Investment Services Trusts (TIST), a little-known asset protection option that came with the passage of the Tennessee Investment Services Act in 2007. “Very few people take advantage of a TIST, which is unfortunate since it can, in certain instances, be a real life saver,” Bryce says. “Say, for instance that you, or a family member, are involved in a car accident where a party is injured, and that party takes you to court seeking monetary reparations. As long as the trust has been established properly and all of the conditions met, the funds you’ve put into your TIST cannot be touched.”
Bryce admits, though, that establishing an asset protection trust is rare. “People don’t generally think of trusts as beneficial in one’s lifetime. Nor do they think of them as a means to protect one’s assets,” he says. “Truth is, they do both.”
Time and Money Well Spent
Bryce hits the nail on the head when he says that trusts, though not the go-to option for many, can be beneficial for individuals, especially while they are still here. They aren’t just things to think about for when you’re gone.
“Everybody’s situation is unique and everybody faces different facts and different considerations and has different things they want to accomplish,” Kramer says. “It’s not a one size fits all kind of thing. What you’re going to have to do is sit down, look at your situation, and decide what is the best vehicle to help you accomplish your goals.”
So how do you start doing that? While there are online companies that tout a quick and inexpensive trust establishment process, our experts warn against these. “Don’t do this online,” says Gillman. “There are a number of important questions that need to be asked when establishing a trust, probably the most important of which is this: Do you need a trust?”
Some people could really benefit from having one. Others, that’s just not the case. However, because trusts are extremely nuanced documents, your best bet is to do your homework and consult with an expert. Hopefully, our experts here have given you some concepts to think about.
“Do your research, learn what you can, and make an informed decision,” Gillman says. “The time you spend will be time well spent.”