What are Trusts? Main Trust Principles

by David A. (Andy) Hall

1. Trust Terms, Concepts and Definitions

A trust is, “[a]n equitable or beneficial right or title to land or other property, held for the beneficiary by another person, in whom resides the legal title or ownership, recognized and enforced by courts of chancery.”[1] It is worth noting that Maryland does not have courts of chancery and the Circuit Court where venue is appropriate would enforce a trust. More generally, a trusts is an important estate planning vehicle, but can also serve a vital role in the protection of assets prior to the Grantor’s[2] death.  They can serve as a desirable alternative to a will and allow the grantor’s family to avoid probate to a large extent and provide for greater control over the decedent’s assets after death.

Types of Trusts

Trusts are broadly split into two categories: living or testamentary.  The living trust, or inter vivos, is a trust created while the Grantor is alive.  A testamentary trust is a trust created in a Last Will and Testament.  Trusts can also be split in two other categories: revocable or irrevocable.  A revocable trust can be terminated by the Grantor during her lifetime.  An irrevocable trust cannot.  Finally, there are charitable trusts and non-charitable trusts.

Goals of Trusts

There are five key goals to trust planning.  1. Avoid Probate; 2. Protect the Grantor/Beneficiary’s Privacy; 3. Plan for Incapacity; 4. Tax Minimization; and 5. Creditor Protection.  By avoiding probate, grantors and their trustees can avoid cumbersome estate administration especially in estates with real property in other jurisdictions.  There is no immediate jurisdiction of the court for the administration of a trust.  The well drafted trust will contain a mechanism for succession should grantor/trustee become incapacitated.  Trusts, particularly those with charitable components can be an useful tool in the minimization of taxes.  Finally, trusts can help protect young or unsophisticated beneficiaries from their own poor choices and shelter assets in the event of a divorce.

Functions of Trusts

Trusts provide for flexible management.  They allow an orderly means for the transfer of authority in the event of a trustee’s resignation, incapacity, or death.  Trusts can also reduce the expenses of administration as compared to probate.  Trust planning is effective to protect the Grantor’s estate planning objectives by allowing her to shield beneficiaries’ from themselves and by exercising control for multiple generations.  Trusts can also serve as mechanism to manage litigation.  Litigation in trust cases is often more expensive and complex, which can deter a would be challenger.  And unlike a will, the filing of litigation does not strip the trustee of power to continue to act without seeking the order of the Court.  In many instances, there will be no need to file for guardianship for an incapacitated or underage beneficiary.

Definitions

  1. Beneficiary – One for whose benefit a trust is created[3]. “Beneficiary” means a person that:
    (1) Has a present or future beneficial interest in a trust, vested or contingent; or
    (2) In a capacity other than that of a trustee, holds a power of appointment over trust property.[4]
  2. Grantor – a person, including a testator, that creates or contributes property to a trust.[5]
  3. HEMS – Health, Education, Maintenance and Support – This is the most common discretionary standard.[6]
  4. Incapacity – inability of an individual to manage the individual’s property or financial affairs effectively due to:
    (1) Physical or mental disability;
    (2) Disease or illness;
    (3) Habitual drunkenness;
    (4) Drug addiction;
    (5) Imprisonment;
    (6) Compulsory hospitalization;
    (7) Confinement;
    (8) Detention by a foreign power; or
    (9) Disappearance.[7]
  5. Income Beneficiary – a person entitled to income from a trust
  6. Independent Trustee – A non-interested trustee who is granted additional powers under the Internal Revenue Code.[8]
  7. Interested Trustee –
  8. Under the Internal Revenue Code, a related or subordinate party. In simpler terms, someone working for or a first degree relative of the Grantor.[9]
  9. Power of Appointment – authority to designate the recipient or recipients of beneficial interests in property.[10]
  10. Property – anything that may be the subject of ownership, whether real or personal, legal or equitable, or an interest in the thing.[11]
  11. Qualified Retirement Benefits – amounts held in or distributed pursuant to a plan qualified under Section 401, an individual retirement arrangement under Section 408 or Section 408A, a tax-sheltered annuity under Section 403 or any other benefit subject to the distribution rules of Section 401(a)(9)
  12. Settlor – See Grantor
  13. Situs – The location of the trust for legal purposes. Maryland law provides that the situs of the trust is any county where the trustee may be sued.[12]
  14. Trustee – One who, having legal title to property, holds it in trust for the benefit of another and owes a fiduciary duty to that beneficiary.[13]
  15. Trustor – See Grantor

2.  Key Parties in a Trust and Their Roles

There are three key roles in a trust, but there are also additional roles to consider as well.  First and foremost is the Grantor.  The Grantor grants or gives property to be included in the trust.  The property is held by the Trustee for the benefit of the Beneficiary.  The Trustee is guided by the rules within the trust document and pursuant to state statute and case law regarding the management of the trust including, but not limited to, distributions to the Beneficiary.  The Trustee has a duty of loyalty to the beneficiaries.[14]  A beneficiary may be either a current income beneficiary or contingent beneficiary entitled to receive funds at some future date under certain specified conditions.

A role player not often contemplated, but which may be forced to decide on matters related to the trust, is the court.  The Court can modify the terms where appropriate or where all trustees and beneficiaries agree as long as it is not inconsistent with the grantor’s intent.  It can modify if unanticipated circumstances arise.  It can also remove a bad actor trustee.

Additional Roles to Consider

  • Trust Protector
  • Trust Company
  • Financial or Investment Advisor
  • Doctor or other mental health professional

A Trust Protector serves an oversight role of the trustee and the operation of the trust.  A trust protector can step in, and depending on their powers, remove the trustee, or amend the trust as necessary to keep it current with the intent of the grantor, or in line with changing laws.  A Trust Company can serve the same role as the trustee, but may have different members of the organization serving various roles.  A Grantor may appoint a Financial Advisor to serve as the investment manager.  Many times a trust instrument will provide that the Grantor or a Trustee can be considered incapacitated for the purposes of the Trust if two doctors certify that person lacks capacity.  In practical instances, it can be extremely difficult to get a reluctant Grantor to two different doctors.  In addition, long-time family physicians are going to be extremely hesitant to certify that her patient no longer has capacity.  Appointing a third party mental health professional, or a trusted person, to decide whether the Grantor has the capacity to continue managing assets is an option to remedy doctor shopping.

Care should be exercised before nominating any party for a particular role.  They should be consulted with prior to their inclusion in the document.  Trustees should affirmatively sign that they have accepted the position.

3. The Laws of Trust Creation and Administration

The most critical law for Maryland attorneys regarding the creation and administration of trusts is The Maryland Trust Act.[15]  It was adopted along with approximately 30 other states as a variation of the Uniform Trust Code.  It was not adopted to revise Maryland law on trusts, but to fill in gaps and codify much of the common law.  It applies, prospectively and retroactively, to all trusts created before, on or after January 1, 2015.  It is not applicable, however, to constructive or resulting trusts.

A couple of key provisions to note, it allows a trustee to terminate the trust if the fair market value is under $100,000.[16]  In addition, it codifies that the capacity to create, amend, revoke or add property to a revocable trust is the same as that to create a will, that is, the Grantor must know the nature and objects of her bounty.[17]

4.  Trust Revocability and its Implications

The ability of a trust to be revoked allows the Grantor to retain control over the trust property.  This gives the Grantor/Trustee considerable power to amend the terms of the trust, change beneficiaries, change or remove trustees, but with this power comes certain drawbacks.  The Trust property will still be considered an asset of the Grantor in most instances.  This can have important ramifications for tax or Medical Assistance planning.  In addition, a self-settled trust will likely not be afforded as much creditor or bankruptcy protection as an irrevocable trust.

5.  Trust Funding Basics

Too many attorneys draft great documents, but the plans they have drafted ultimately fail because of a lack of emphasis on funding the trust.  Clients do not understand that a trust is incomplete until it is actually funded with assets.  A trust is an empty vessel without property to fund the trust.  It is often left to the client to figure out the funding of the trust on their own with a few notable exceptions.  Many attorneys are familiar with the pour-over will and a deed titling real property in the name of the trust, but some may be less familiar with the assignment of personal property or dealing with retirement assets.  Finally, it is helpful for assets that are not titled to have the clients prepare an asset schedule to be included in the trust.

[1] Black’s Law Dictionary

[2] Also known as a Trustor or Settlor.

[3] Black’s Law Dictionary

[4] Md. ESTATES AND TRUSTS Code Ann. § 14.5-103(d)

[5] Id. § 14.5-103(v)

[6] See also Id. § 14.5-103(y): Support provision. —

(1) “Support provision” means a mandatory distribution provision in a trust that provides that the trustee shall distribute income or principal or both for the health, education, support, or maintenance of a beneficiary, or language of similar import.   (2) “Support provision” does not include a provision in a trust that provides that a trustee has discretion whether to distribute income or principal or both for the purposes under paragraph (1) of this subsection or to select from among a class of beneficiaries to receive distributions in accordance with the trust provision.

[7] Id. § 14.5-103(l)

[8] 26 U.S. Code § 674(c)

[9] Id. § 672(c)

[10] Md. ESTATES AND TRUSTS Code Ann. § 14.5-103(q)

[11] Id § 14.5-103(s)

[12] Md. Rule 6-111(a)

[13]  Black’s Law Dictionary

[14] Md. ESTATES AND TRUSTS Code Ann. § 14.5-802

[15] See generally Id.  § 14.5-101 et seq.

[16] Id. § 14.5-412

[17] Id. § 14.5-601.  It is silent as to irrevocable trusts.

 

David A. (Andy) Hall, Esq.
King|Hall LLC
410-696-2045
5300 Dorsey Hall Drive
Suite 107
Ellicott City, Maryland 21042
andy@kh.legal

457526bfb82f4540ba08c7cce8e707dd

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