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What is a trust, really? A comprehensive and digestible guide

What is a trust?

Why make a trust?

Are trusts only for rich people?

If I make a trust, can my cat be a beneficiary?

Can I protect my money from creditors or debt collectors with a trust?

Trusts achieve many goals.

A trust is not like a company, corporation, or entity (except for tax purposes). It’s not a theoretical box that seals away cash from debt collectors. A trust is simply a type of legal relationship between people.

There are three participants in this legal relationship.

First, a trustee owns an interest in property at the request of another person. This other person is called the grantor. The trustee manages the property for the benefit of a third person, the beneficiary.

I’ll give you an example.

Let’s say Danny Tanner, the grantor, makes a trust and names his best friend, Joey Gladstone, as trustee. Danny chooses as beneficiaries his 3 daughters – D.J., Stephanie, and Michelle. The daughters have a beneficial interest in the trust property. Danny Tanner transfers his 500 shares of Walt Disney Co. stock into trust. A trust is born!

The stock is owned by Joey Gladstone, as Trustee of the Danny Tanner Living Trust. Joey can vote on the stock, sell it, trade it, and control it. Joey owns title. Per the terms of the trust agreement, D.J., Stephanie, and Michelle receive quarterly dividends from all stock held in trust (income). The 3 daughters have a beneficial interest because they are entitled to the use and enjoyment of the income.

In New York, Danny Tanner can even set up a separate Pet Trust for his dog, Comet. I know what you are about to ask, and the answer is yes!, the trustee of the pet trust will have a fiduciary duty to know the price of dog food!

A trustee holds legal title, which is actual ownership and evidences apparent ownership. The beneficiary has the beneficial interest, meaning the beneficiary benefits from the use and enjoyment of the property. When property is held in trust, there is a division of legal ownership and beneficial ownership.

Common Reasons to Make a Trust

Reason 1: Avoid Probate

In New York, a will speaks at death, but not immediately at death (generally). Probate is the process of proving to a court that a will is valid (“probate” is the latin word for “prove”). Once the will is deemed valid by the New York Surrogate’s Court, the executor of the the estate (or the administrator of the estate if there is no will) takes the necessary steps to transfer assets from the name of the decedent to the names of the beneficiaries (this is called re-titling the property). This lengthy and complicated process is known as administration of the estate.

Administration is not always easy, and is almost always time consuming and expensive. The proposed executor or administrator must petition the Surrogate’s Court for authority to act, must often account to beneficiaries, keep accurate records of assets, pay taxes, and deal with countless other matters. Probate and administration are the last things someone should be dealing with after the death of a loved one.

But assets held in trust are not probate property. When the grantor dies, assets are not owned by the grantor in his or her individual name. Instead, the legal owner is the trustee. (the trustee may have even been the grantor him or herself). The terms of the trust agreement (or trust “declaration” if the grantor and trustee are initially the same person) govern who gets the property at death. This all happens without any court involvement so long as the terms of the trust are properly drafted.

Remember, the grantor does not own property in trust outright in his or her own name. The grantor may own the property as trustee or appoint another to act as trustee, but in either case, the title to the property is not in the grantor’s name individually, but rather, in trust. The trust document itself governs what happens to the trust property after the death of the grantor.

Reason 2: Asset Protection and Qualifying for Public Benefit

Asset protection planning is proactive legal action that can protect one’s assets from creditors, the high costs of long-term care, a potential divorce, lawsuits, and judgments. Trusts can be used as an integral part of asset protection planning. For example, a Medicaid Asset Protection Trust can protect you from the high costs of long-term care by qualifying you for Medicaid. In addition, if you believes your assets may become subject to creditors’ claims, you may consider transferring some or all of your assets to an irrevocable trust, so that the assets are not held in their own name. However, transferring funds to trust to protect oneself from creditors must be approached with great care to ensure the transfer is not a fraudulent conveyance. Finally, trusts can be used to leave money to minors or other loved ones who shouldn’t be handling money on their own.

Reason 3: Avoid Estate Tax

Trusts are often used to avoid estate tax. U.S. citizens and residents must be very wealthy before they will be liable for estate taxes. There is a federal estate tax exemption of $11,400,000.00 in 2019. Simply put, an individual can die with $11,400,000.00 in assets in 2019 and will not be required to pay federal estate tax. (Note, this is somewhat of a simplification, as taxable gifts enter into the equation). In New York, the estate tax exemption in 2019 is $5,740,000.00. There is generally no gift tax in New York. The estate tax exemption for non-resident aliens (non-U.S. citizens who are not residents) is a mere $60,000.00 in 2019.

Two Broad Categories of Trusts

In New York (and for the most part everywhere in the U.S.), there are two broad categories of trusts: (1) lifetime trusts; and (2) testamentary trusts. Lifetime trusts exist while the grantor is alive. Testamentary trusts take effect only after death.

Lifetime Trust

In New York, a lifetime trust is created during the grantor’s life in writing. It is an express trust, meaning it is created with the grantor’s express intent. The lifetime trust almost always survives the death of the grantor and continues to operate, at least for some time, after the grantor’s death. It is distinguished from a testamentary trust, which only operates on or after the grantor’s death.

Testamentary Trust

A testamentary trust is any trust created in a will. The person who makes the will, called a testator (male) or testatrix (female) creates a trust in their will which comes into effect once the will is probated. The person who is to act as trustee must petition the Surrogate’s Court for Letters of Trusteeship. This means that the person who is named trustee in the testamentary trust goes to the Surrogate’s Court, and prepares a formal document called a petition, usually with the assistance of an attorney, and asks the court to award Letters of Trusteeship, which authorize the person to act as trustee.

Daniel J. Reiter, Esq.

Daniel J. Reiter, Esq.

Daniel J. Reiter is an adult guardianship and estate litigation attorney in New York City.

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