There are many reasons why a client may want to make a gift in trust as opposed to outright. There are, of course, tax savings goals but, typically, these cannot be accomplished through revocable life insurance trusts.5 Generally speaking, revocable life insurance trusts save neither income nor estate taxes. So it is the people-oriented objectives of revocable trusts that provide the greatest incentive for their creation.
These can be categorized into the following broad terms of income and wealth:
- Management
- Conservation
- Distribution
More specifically, clients set up revocable trusts during their lifetime (intervivos revocable trusts) to accomplish the following objectives:
- Postpone ownership during incapacity or inability of the beneficiary – Quite often a client will feel that the beneficiary is unwilling or unable to invest, manage, or handle the responsibility of an outright gift. Gifts to minors, for example, would fall into this category. But a trust should also be considered for persons who are legally adults but who lack the emotional or intellectual training, experience, physical capacity, or willingness to handle either large sums of money or assets which require constant and high-level decision-making ability. So a trust is often used to postpone full ownership until the donees are in a position to handle the income and the property itself properly.
- Maintain control over a beneficiary – Some clients are reluctant to place all the ownership rights in the hands of a donee. They utilize trusts as the solution to the ambivalent position of wanting to institute a gift program but fear the possible results of an outright no strings attached transfer that lessens the donee’s dependence on them.
- Avoid fragmentation of property – A further impetus for the use of a trust is where the proposed gift property does not lend itself to fragmentation, but the client wants to spread beneficial ownership among a number of people. For example, a large life insurance policy and the proceeds generated by it at the insured’s death are often better held by a single trustee than jointly by several individuals.
- Retention of control over assets – A revocable life insurance trust, which the client can alter, amend, revoke, or terminate at will, should be considered where conservation of assets and particular dispositive plans are important. In other words, if retention of lifetime control is essential to the client, such as where the client wants to limit the class of beneficiaries (e.g., no in-laws) or where the client wants to prevent the beneficiary from disposing of the property to persons outside the family, a trust provides a vehicle for a client to make a gift with minimal loss of lifetime control. At the same time, the client builds in flexibility to meet future contingencies and attain personal objectives.
- Unifying receptacle for other assets – Because a trust can be named as recipient of almost any type of asset and because such property can be placed into trust at any time (and because parties other than the party who originally established the trust can make contributions of cash or property), a revocable trust makes an ideal vehicle for later contributions to “pour-over” into it. This unification of assets is particularly important if the client owns many different types of assets or owns property in more than one state. Bringing the assets together may save administrative costs and avoid multiple probates where property is owned in more than one state.
- Avoidance of publicity – The terms of a trust are not public knowledge. Therefore, the amount placed into trust, the terms of the transfers, and the identity of the income and ultimate recipients does not become public knowledge. Privacy is particularly important where there are (or there is the potential for) intra-family conflicts. Since there are no requirements that nonbeneficiary family members must be notified of the nature or extent of trust assets or the details of the dispositive plan of a revocable trust, the potential for family disputes is low. This is particularly important where the client wants to disinherit a particular family member or name a friend who is not a family member as a beneficiary.
- Opportunity for a trial run – Setting up a trust during the client’s lifetime affords an opportunity of seeing how well the trustee manages the property placed into the trust and how well the beneficiaries handle the income or other rights given to them. It also familiarizes the trustee with the client’s assets, family, plans, and relationship of each to the others. If the client doesn’t like what he sees, changes can be made.
- Selection of a favorable forum – A revocable trust allows the client to select a state where the laws are most favorable to accomplishing his dispositive and administrative objectives. It is not necessary to use the laws of the client’s domicile when creating a revocable living trust. To accomplish this objective, the trust should specify the state law that is to govern it. In some cases, it may be necessary to have trust proceeds paid to a trustee in the selected state. Planners must, however, take care not to set up a multiple domicile issue when setting up a trust outside the state of the grantor’s domicile.
Cases where it may pay to shop for more favorable state law include (as well as where it may pay to use a trust rather than dispose of property by will) where the other (nondomiciliary) state has a more favorable (from the client’s viewpoint) law regarding:
- The rule against perpetuities – This would allow the trust to continue longer than might be permitted otherwise.
- Elective share (surviving spouse’s rights to a statutory share of a deceased spouse’s estate) – For instance, in Florida, if property is placed into a revocable living trust, the surviving spouse has no right to it, since the elective share is defined as a percentage of the probate estate.
- Will contests – If the client anticipates an attack on the will, a revocable trust should be considered. One reason is that the trustees can use assets to defend the trust against a challenger. On the other hand, in a will contest, until the validity of the will is determined, neither side has access to estate funds and each must personally bear the costs of litigation. Furthermore, the criterion for proper execution of a trust may be more lenient and, therefore, more easily defended than the requirements for a valid will.
- Creditor’s rights – However, if the transfer is made to the trust in avoidance of existing or anticipated claims of creditors, it may be voidable.
- Charitable bequests – Some states contain charitable rules, called “mortmain” statutes that nullify or otherwise limit gifts to charities if made within a specified period prior to death. The use of a revocable living trust may avoid this rule in some states.
- Restrictions on qualification to serve as executor – Careful selection of applicable state law may allow a party to serve who might not be qualified under the law in the client’s state of domicile.
- Equalize risk and potential – A living trust can be a great equalizer for both downside risk and upside potential. For instance, if a parent owned several parcels of land of equal value or used life insurance proceeds to purchase several parcels of land, he could make outright gifts of Parcel A to his daughter and Parcel B to his son. However, the children may be treated unequally since one property could drop in value while the other could rise. Alternatively, both properties could rise or fall at different rates. Placing both properties in trust could equalize the risks and potential rewards between the children. Investment results of life insurance proceeds invested in a pool by the trustee could be shared equally by the beneficiaries.
- Provide for ownership flexibility during beneficiaries’ minority – Major decisions and actions cannot be taken if property is placed directly in a minor’s hands, but can be taken if the same property is placed in trust for the minor. This generally makes it possible to sell, exchange, or mortgage a minor’s property without the expensive, inflexible, and troublesome process of appointment of a guardian.
- Assure dispositive objectives – An outright gift to a beneficiary will often return to the child’s parents or go to the child’s spouse or someone other than to whom the client would want it to go. This may defeat many of the client’s non-tax objectives. A revocable trust would provide an assurance that the client’s dispositive objectives could not be easily defeated.
- Provide for the helpless – Physically, mentally, emotionally, and legally incompetent beneficiaries can be financially provided for through a revocable trust.
- Relieve the overburdened – Even beneficiaries who are competent adults can be both protected against their own indiscretions and relieved of the burdens of investment, management, and record keeping.
- Back-up for the healthy – A funded revocable trust can provide for the grantor in the event he is incapacitated and avoids the expensive, complex, aggravating, and embarrassing court process necessary to declare a person legally incompetent. A revocable trust, coupled with a durable power of attorney, can provide the basis for a contingency plan to deal with a client’s inability to handle his own financial affairs.
- Multi-state administration can be avoided through the use of a revocable trust – For instance; many clients will own property in more than one state. Ancillary administration (i.e., estate administration by a state other than the client’s domicile state) is both expensive and aggravating. The client can unify the process and, in many cases, significantly cut down administration costs by placing title to out of state assets in a single revocable trust.
- Reduce the risk of a successful challenge – Once an intervivos (during lifetime) trust is created, its ability to perform the task for which it was designed is more certain than a will. This is at least one reason to establish an intervivos trust, rather than a testamentary trust (one established under the grantor’s will). Particularly, when one or more provisions of the client’s will are controversial or likely to stir up a family dispute, a will is likely to be challenged or a surviving spouse may elect against (i.e., exercise a statutory right to take a share of the estate regardless of the terms of) the will. A trust is much less likely to be broken than a will based on the lack of capacity of the grantor or upon a claim of fraud or distress. Furthermore, the trustee can use trust assets to defend against a party who disagrees with the terms of the will.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM