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Estate Planning, Probate, and Elder Law

Trusts are some of the most useful planning tools available to estate planning attorneys. The flexibility available when drafting trusts provides an almost unlimited number of planning possibilities. Credit shelter trusts, marital trusts, asset protection trusts, generation skipping trusts, life insurance trusts, living trusts, minor’s trusts, charitable remainder trusts and qualified terminal interest trusts (QTIP trusts) are just a few of the types of trusts used in estate planning. The following is an excerpt from John’s book, Louisiana Retirement and Estate Planning. To order a copy of his book, click here.

The Parties to a Trust

A trust is the relationship resulting from the transfer of property to a person (the trustee) to be administered by him as fiduciary for the benefit of another (the trust beneficiaries). A trust may be created while the settlor is alive. This type of trust is an inter-vivos trust. A trust that is created by a will is a testamentary trust. An inter-vivos trust must be created an authentic act or by act under private signature. A testamentary trust must be created by a valid will. In addition, a trust may be revocable or irrevocable. If the trust document does not state that the trust is revocable, the trust is irrevocable.

The Settlor

The settlor is the person who creates the trust. There may be more than one settlor of an inter vivos trust. Any person who has the capacity to execute a binding contract may be a settlor. A person who transfers property to an existing trust is not a settlor.

The Grantor

The grantor is the person who transfers property to the trust. There may be multiple grantors, and the settlor and grantor may be the same person. Any person may make additional contributions of property to a trust by donation while alive or through their will. The right to make additions may be restricted or denied by the trust document.

The Trustee

The trustee is the person to whom title to the trust property is transferred to be administered by him as a fiduciary. The trustee must follow the instructions of the trust document with regard to the management and distribution of the trust assets for the benefit of the trust beneficiaries. The trustee may be a person or a corporate trustee.

Two or more co-trustees may be named. Co-trustees shall participate in the administration of the trust and use reasonable care to prevent another co-trustee from committing a breach of trust. If three or more trustees are named, a majority of the trustees must agree to exercise trustee powers, unless the trust document provides otherwise.

A trustee shall manage and invest trust property as a prudent investor unless the trust document provides alternative instructions. In meeting this standard, a trustee shall consider the purposes, terms, distribution requirements, and other circumstances of the trust. The trustee’s investment and management decisions are evaluated in the context of the trust property as a whole and as an overall investment strategy having risk and return objectives reasonably suited to the trust. Unless the trust document states to the contrary, the trustee may invest in any type of property.

A trustee removal clause should be considered to prevent the beneficiaries from being “locked in” with a bad or difficult trustee. Although it is not advisable to give a beneficiary the unbounded power to remove a trustee, an escape hatch should be written into the trust document. The authority to remove a trustee may be granted to the income and principal beneficiaries if all agree. Or, an uninterested third party can be given the authority to remove a trustee for just cause upon a beneficiary’s request. If such a removal clause is not drafted in the trust, a court order will be required to remove a trustee. The trustee’s removal may be warranted by poor investment decisions regarding trust property, or poor decisions regarding discretionary distributions to the beneficiaries.

If the trust property includes immovable property, the trustee must file the trust document, or an abstract thereof, for record in each parish in which immovable property is located.

The Beneficiary

A beneficiary is a person for whose benefit the trust was created. The beneficiaries may consist of income beneficiaries and principal beneficiaries. Income beneficiaries receive income for life or for a shorter duration as defined in the trust document. The principal beneficiaries receive the trust principal in accordance with the trust document. This may occur after the income beneficiary’s interest terminates. In addition, a trust may have more than one beneficiary as to income or principal or both. There may be separate beneficiaries of income and principal, or the same person may be a beneficiary of both income and principal.

Shifting of principal to another beneficiary is allowed if a beneficiary of a non-legitime portion (assets not subject to forced heirship) dies without descendants during the trust term or upon the trust’s termination. If the beneficiary is a legitime portion beneficiary, the beneficiary must die both intestate and without descendants. Thus non-legitime property may be shifted to another beneficiary if the original beneficiary dies without descendants during the term of the trust or at the trust’s termination. If legitime property is involved, the original beneficiary must die both intestate and without descendants.

Distributions of Income

The trust document may provide for how income is to be distributed among the beneficiaries. The trust document may also stipulate that all or part of the income be accumulated for a certain period of time. The trustee may be given discretion over the timing and amount of income distributions. A trustee may also allocate income among income beneficiaries based upon objective standards set forth in the trust document. Additional flexibility is given to trustees by Louisiana R.S. 9:1961 which allows a trustee to “spray” income by allocating and disbursing income in different amounts to the income beneficiaries. Unallocated income may be accumulated and allocated in a later year. The unallocated income may be added to principal each year or added to principal when the trust terminates. The trustee may also allocate principal without objective standards except that of a reasonable person. This type of flexibility allows a trustee to use discretion to distribute more income to a beneficiary who is more in need than other beneficiaries.

Distributions of Principal

The trustee may invade principal for the benefit of an income beneficiary under objective standards as provided in the trust document. The trustee may be directed to pay accumulated income and principal to an income beneficiary for health, education, maintenance, support or for any purpose subject to an objective standard. An objective standard looks to what a prudent person would do under similar facts and circumstances. It avoids giving the trustee unbridled discretion to distribute trust assets.

Common Trust Distribution Clauses

The manner, timing and other criteria for trust distributions placed on the trustee is limited only by the settlor’s imagination. A trust is simply a set of instructions directing the trustee as to the management and distribution of trust assets. These instructions vary upon the needs of the beneficiaries and the goals of the settlor. The following a few examples of common trust distribution clauses.

“I specifically request the Trustee to invade principal, if necessary, to pay all costs of education including all room, board, tuition, books, including a reasonable allowance to provide a standard of living to which the beneficiary is accustomed, and transportation, in the event a beneficiary is enrolled as a bona fide full time student in an accredited college or university, including graduate work, or other career training.”

“I specifically request the Trustee to pay all costs of education including all room, board, tuition, books, including a reasonable allowance and transportation, in the event a beneficiary is enrolled as a bona fide full-time student maintaining a 2.00 grade point average (on a 4.00 scale) in an accredited college or university, including graduate work, after considering all other sources of funds available to the beneficiary to pay such expenses, such as grants or scholarships. If the trust income is insufficient or unavailable due to the existence of the usufruct to pay for the costs, fees and expenses listed in this section, the trustee is to invade principal for pay for said costs, fees and expenses.”

“The Trustee may invade and distribute the principal of this Trust to the beneficiary, or his legal representative(s), when, in the Trustee’s sole discretion, it is necessary to do so for the beneficiary’s comfort, education, welfare, support or maintenance to support a lifestyle of which the beneficiary is accustomed.”

“The Trustee shall distribute to the beneficiary one-third (1/3) of the value of the trust corpus when the beneficiary attains the age of thirty-two (32); one-third (1/3 of the value of the trust corpus when the beneficiary attains the age of thirty-five (35); and the trust shall terminate when the beneficiary attains the age of forty (40).”

Creditor Protection

One of benefits provided by holding assets in trust is creditor protection. If you create and transfer assets to a properly drafted trust of which your children are the beneficiary, you can prevent your children’s creditors from seizing assets held in the trust. By adding a spendthrift clause in the trust, the trust assets can be protected. In addition, a trust beneficiary may transfer or encumber the whole or any part of his interest in the trust unless the trust document provides to the contrary. The trust may provide that a beneficiary may not voluntarily or involuntarily alienate their interest in the trust. If there is a concern that a beneficiary may transfer and or borrow against their interest in the trust, a spendthrift clause can prevent a creditor from seizing a beneficiary’s interest in the trust.

Credit Shelter Trusts

One way to preserve the federal estate tax credit exemption (aka the applicable exclusion amount) is to leave assets to someone other than the surviving spouse. Assets left to the surviving spouse are included in the marital deduction and the federal estate tax exemption will not apply to these assets. As a result, leaving the entire estate to the surviving spouse causes the estate tax exemption of the predeceasing spouse to be wasted, unless portability of the applicable exclusion amount applies. To avoid wasting the exemption, assets may be left to the children or grandchildren, and the federal estate tax exemption will apply to these assets. The problem with this arrangement is that the surviving spouse will not have the use of these assets because they belong to the children or grandchildren. For many individuals the trade-off between using the exemption and providing the surviving spouse with sufficient assets to maintain his or her standard of living is not a decision they wish to make. A credit shelter trust can help attain both tax savings and provide benefits to the surviving spouse.

A credit shelter trust is typically set up in a will; but, the trust may be set up and funded prior to death. The trust is typically funded with an amount equal to the federal estate tax exemption amount. The amount placed in the trust is not subject to federal estate taxes so long as the amount is not over the applicable exemption amount. Any future growth in the trust is not subject to estate taxes but will be subject to applicable income taxes. The children are typically the principal beneficiaries and the surviving spouse may be named trustee. The trustee may be given the power to distribute the income or other amounts subject to an objective ascertainable standard such as needs for the health, education, maintenance and support of the surviving spouse. If the surviving spouse, for example, needs to replace the roof on the family home, assets from the trust may be used to pay for these repairs because this meets the requirements of an objective ascertainable standard for maintenance and support. Additional restrictions may be placed on the trustee’s ability to make distributions, including no authority to make distributions to the surviving spouse or to distribute only the income to the surviving spouse. The key point is to not give the trustee unlimited discretion to make distributions to the surviving spouse without an objective ascertainable standard. If the trustee is given unlimited discretion not subject to ascertainable standards, the assets of the trust would be included in the surviving spouse’s estate.

Qualified Terminal Interest Property Trusts

A common type of trust used by married couples is a Qualified Terminal Interest Property Trust or QTIP trust. This type of trust allows you to name beneficiaries who will receive the property after the surviving spouse dies, and the property shall still qualify for the marital deduction at the first spouse’s death (and thus included in the second-to-die spouse’s estate). The surviving spouse must be given the income from the trust at least annually. Because the income must be paid to the surviving spouse, the assets in the trust will be included in the surviving spouse’s estate under the marital deduction. The testator need not give the surviving spouse any other ownership interest in the trust, other than the income paid at least annually. A QTIP trust is an excellent tool when children from a previous marriage are involved. You can guarantee children from a previous marriage will receive the assets in the trust while providing income to the surviving spouse.

The benefits of QTIP trusts also include that any federal estate taxes due on the assets are delayed until the surviving spouse passes away. Larger tax exemptions and consumption of other assets in the surviving spouse’s estate may result in fewer or no taxes due. The concept of using QTIP trusts is to ensure the beneficiaries will receive the assets when the surviving spouse dies, to delay estate taxes on the assets in the trust until the second spouse dies, and to give the income from the asset at least annually to the surviving spouse.

Assets with a lifetime usufruct are also allowed to qualify for QTIP treatment. If the naked ownership of assets is left to the children with a lifetime usufruct to the surviving spouse, an asset by asset QTIP election may be made. If the estate is taxable, select QTIP treatment for only those assets that you would like to fall under the marital deduction and will be included in the surviving spouse’s estate. Non-QTIPed assets will be included in the first to die spouse’s estate and will be subject to their federal credit shelter exemption (estate tax exemption).

The usufruct for the surviving spouse may also be over property held in a trust. This arrangement will give the trustee (and in essence the testator) more control over the assets. For younger beneficiaries or when proper management of assets is critical, the trust ensures that the assets will be properly managed once the surviving spouse passes away. In fact, many times proper management of assets is an issue when the surviving spouse is still alive and enjoying the usufruct over the property. Obviously, there are many planning options with usufruct, naked ownership, QTIP election and trust combinations.

Life Insurance Trusts

Another very useful trust in the estate planner’s tool box is the life insurance trust. Although this trust is primarily a trust to hold life insurance, the trust may hold other assets as well. If the estate will be subject to estate taxes, life insurance is the most economical source of funds to pay for estate taxes. If the insurance policy is purchased and owned by the decedent or the decedent’s spouse, the death benefit proceeds are included in the estate further increasing the size of the estate and increasing the federal estate taxes due. A better alternative is to have a life insurance trust purchase the policy. If properly arranged, none of the insurance proceeds will be included in the estate.

Once the trust is formed, the parents transfer assets into the trust. The trustee will use these assets to pay the insurance premiums. To enable the annual exclusion to apply (allows each spouse to transfer $14,000 (2016) per beneficiary into the trust annually free of gift taxes), the trust must be drafted with Crummey Powers. Crummey Powers allow the payments into the trust to be considered a present interest gift. If the transfers are not present interest gifts, the annual exclusion does not apply and gift taxes would be due on the first dollar transferred into the trust. A trust with properly drafted Crummey Powers preserves the use of the annual exclusion. Crummey Powers confer a right to the beneficiaries to withdraw the amount of the gift transferred into the trust. This right typically expires 30 days after notice of the right of withdrawal is given. After the 30 day window expires, the beneficiaries may no longer withdraw the transferred assets from the trust.

Upon the death of the insured, the death benefit proceeds are paid to the trust for the benefit of the insured’s spouse and children. The trustee is generally authorized, but not directed, to loan money to pay for estate taxes or to purchase property from the decedent’s estate rather than paying the estate tax outright. Purchasing assets from the estate provides a ready source of cash for the estate, while keeping the purchased assets within the family. Once the estate has been settled, the trust may be allowed to dissolve and distribute its assets to the beneficiaries of the trust. If the beneficiaries are in need of supervision over the assets due to being young in age or due to a lack of management skills, the trust may remain in effect until the beneficiaries are capable of managing the assets. In addition, a properly drafted trust can provide income to the surviving spouse for life and as much principal needed for “health, education, maintenance and support”. If the surviving spouse will need some or all of the insurance proceeds to provide income for living expenses, a first to die policy can provide the source of cash. If estate taxes are the main concern, a second-to-die policy will pay the death benefit only upon the death of the second spouse when taxes would generally be due on a properly arranged estate. Of course a second-to-die policy has significantly lower premiums than a single life policy.

If life insurance is already owned by the insured or the spouse, removing life insurance from the estate is one of the most powerful methods to reduce estate tax exposure. This avoids inclusion of the life insurance proceeds in the insured’s estate. Although life insurance proceeds generally are not subject to income taxation, they are subject to estate taxation if the owner has incidents of ownership. Transferring life insurance out of the estate is a taxable gift generally equal to the cash value of the policy. The insurance policy must be transferred to the children at least three years prior to death to avoid inclusion in the gross estate. Transferring a policy to a trust will prevent the children from having control over the policy. This arrangement avoids the possibility of the children removing the cash value or terminating the policy. As with any transfer of life insurance, if the transfer is within three years of the insured’s death, the policy proceeds will be included in the insured’s gross estate and possibly exposed to taxation. However, if a new policy is purchased by the trustee, the three year waiting period does not apply.

Other common types of trusts are Education Trusts to provide for educations expenses; Pet Trusts to provide for the care of a pet after the owner dies; Minor’s Trusts to provide asset management for a child or grandchild; and Special Needs Trusts helps to preserve eligibility for programs like SSI and Medicaid.

Contact attorney John E. Sirois in Houma at 985-580-2520 if you have questions about trusts and planning your estate. Click on the Estate Planning Checklist to begin planning your estate. You may also e-mail him for a consultation.