Setting up a trust? They’re not just for the wealthy. A trust can allow for greater flexibility than a will, provide tax benefits and make sure your wealth and assets are managed across generations. Before setting up a trust however, there are several things to consider, from the type of trust to whether you should hire a trust company to professionally manage the trust.
There are many different types of trusts. One of the most common ones is a testamentary trust. A testamentary trust is a type of express trust, meaning that it is created on purpose and not imposed by a court. It is included as part of a will or in a document incorporated by reference into a will.
A testamentary trust specifies how funds and other assets are to be distributed after the death of the settlor. The settlor, also sometimes referred to as the trustor or grantor, is the person whose assets are put into the trust. Oftentimes, the settlor establishes a trust to prepare for their death, and to make sure they have control of their wealth after death.
To create a testamentary trust, the settlor must designate a trustee (the party that manages the assets) and specify beneficiaries (the party who will receive assets from the trust). Once the settlor dies, the trust comes into effect. While other types of trusts may avoid probate, a testamentary trust must go through probate. This means it must be legally evaluated to determine if it is valid.
A testamentary trust is often preferred over simply having a will, as it provides more flexibility than a will and helps to protect the beneficiaries from themselves. For example, the settlor may wish to make sure that, upon their death, young children, a spouse who is inexperienced in financial matters or irresponsible heirs do not make bad short-term decisions with newfound wealth. The trust can provide the necessary safety rails.
By definition, all trusts must have one or more trustees. A trustee manages the assets, distributions and other obligations under a trust agreement. But who should the trustee(s) be?
Some settlors decide to choose an individual, such as a family member to be the trustee of their testamentary trusts. Some choose to select two or three co-trustees. The most commonly stated reason for naming one or more family members as a trustee is that the family members know one another and are thus best equipped to serve in that role. While this sentiment is admirable, it may not always be the best route to ensure an effective and efficient option.
Instead, settlors setting up a trust should consider hiring a corporate trustee. A corporate trustee is an entity, such as a bank-owned or independent trust company. There are many reasons why using a corporate trustee instead of using a family member as a trustee may be wise.
First, a good corporate trustee can serve as the coordinator of a person’s or family’s financial well-being. A corporate trustee is uniquely positioned to understand a wide range of issues, including estate planning, tax strategies, laws and investments, while also administering the legal intentions of trust documents. And while a trust company can’t draft legal documents, it can provide a variety of corporate trust services. For example, it will work with the family and other professionals (attorneys, accountants, etc.) by coordinating and providing perspective on the real issues that families face. To use a sports metaphor: a corporate trustee is like a good general manager for a baseball team.
An oft-overlooked benefit of hiring a corporate trustee is its use of complex trust accounting systems. These systems are important for the proper accounting of principal and income across multiple beneficiaries. Many wealthy families overlook this facet and inadvertently create accounting nightmares that are often hard to unwind. Record keeping alone can save families valuable time and money, as well as reduce family stress.
A corporate trustee is not only accountable to beneficiaries, but to the government as well. A trust company is approved and overseen by federal or state regulatory bodies. It undergoes routine audits and/or exams. A trust company also has legal requirements for capital, bonding and insurance. Family members may not always be up-to-date on the latest laws, understand complex legal language or follow legal documents as written.
While some like the idea of family members as trustees, they must remember that people age, become distracted or become incapable of serving as a trustee. Because a trustee must outlive the settlor, the settlor must remember it’s unwise to name a family member who is their age or older as a trustee. Plus, the family member may develop a difference in opinion from the settlor. In those situations, a good corporate trustee can serve in an objective, consistent manner, minimizing rifts within the family.
Whether it be the loss of a loved one or a family member that no longer has the health to manage their financial affairs, hiring a corporate trustee can relieve those burdens. This is particularly comforting when emotions run high and differences among family members present problems. In those situations, a third-party decision maker like a trust company can lead to a positive outcome and protect family balance.
There are several concerns to consider before hiring a trust company. Factors such as expertise, chemistry and costs are some of the main considerations. For corporate trustees, fees can range from 1% to 2.5% per year, depending on the size of the trust.
There is also the concern that a corporate trustee may be less likely to make the same decisions than the settlor would have made in the same circumstances. This can be addressed in a number of ways. One solution is to name two or three trustees, one of which is a corporate trustee, and the others who are family members.
Aside from whether or not to hire a corporate trustee, there are several other issues to consider before setting up a trust. As mentioned above, a testamentary trust does not avoid probate. Rather, the descendant’s property must pass into the trust through a will. This requires the probate court process.
Also, the concept of revocability is not important in the context of a testamentary trust, because such a trust does not even come into existence before the trustor’s death. Thus, the settlor can change their mind about such a trust before they die.
On the other hand, a funded living trust (or inter vivos trust) is different from a testamentary trust, because it avoids probate. In addition, the concept of revocability is extremely important in the context of a living trust. An irrevocable living trust is one in which the settlor relinquishes control over the trust. Such trusts can provide significant benefits related to tax and asset protection by protecting assets against the claims of potential future creditors.
If you are considering setting up a trust, the first step is to consult your lawyer or financial advisor. It can be a complicated process since there are a variety of factors at play, including determining the type of trust that best fits your needs. A financial advisor or lawyer can also provide guidance on if hiring a corporate trustee is the right move for you. They may also be able to refer you to a trust company that they work with, or who they are familiar with, alleviating the search for a company on your end.
©All Rights Reserved. January, 2021. DailyDACTM, LLC d/b/a/ Financial PoiseTM
Reed serves as the Chief Investment Officer to Calamos Wealth Management, overseeing all aspects of the firm’s investment platform, including internal and external solutions, and working with the firm’s biggest clients. Calamos is an industry leading wealth and investment management organization with a national presence.
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