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Trusts

In Texas, there is a growing trend to use Trusts as a part, or in place of, traditional estate planning.  While attorney-drafted Trusts can be utilized effectively in a variety of situations, many questions exist for most clients about the nature of Trusts.  On this page, we attempt to respond to some of the general questions about Trusts.  However, please take advantage of our free consultation so that we can address your specific objectives.  

What is a Trust?

A Trust is a legal entity created by a Grantor by using a valid Trust formation document or agreement.  The purpose of a Trust is to transfer some sort of benefit to the designated Beneficiaries.

Who are the Parties to a Trust?

Trustee: The person designated in the Trust Agreement to take possession of the trust assets and manage those assets. They must also preserve and manage the assets according to the provisions in the Trust agreement.

Trust Agreement: The Trust Agreement is the document that creates the Trust and sets out the provisions related to the Trust. For instance, it will generally designate the trustee, the beneficiaries, and the purposes of the Trust. It will also typically include provisions designed to guide the trustee in fulfilling his duties.

Grantor: The person(s) who creates the Trust Agreement. In order for the Grantor to create a valid trust, he must designate a trustee and a beneficiary. He must also transfer assets into the Trust.

Beneficiary: The Trust Beneficiary is the person(s) who receives the benefit of the assets in the Trust.

Corpus:  The property that is transferred by the Grantor to the Trust.

What are the General Types of Trusts?

Testamentary Trusts: The concepts of Wills and trusts combine when you consider the creation of a Testamentary Trust.  These trusts are created under your Will and will control the management of your assets after your death. These trusts have a wide array of uses, but they are very often used to provide for the management of assets for minors and young children in the event they might become entitled to receive property under a Will.

Revocable Living Trusts: In recent years, the use of Revocable Living Trusts as a substitute to traditional estate planning has exploded in many states. In Texas, however, the uses of these trusts as effective estate planning alternatives have limited usefulness. The effective use of these trusts is discussed, but also we discuss many of the myths and misconceptions related to the uses of these Trusts.

Educational Trusts: One of the primary concerns that many parents and grandparents have is setting aside money to provide for education for their children and grandchildren. In spite of this desire, those same parents and grandparents recognize that the best interests of their children is not served by giving large sums of money to minors or young adults who might rather buy a car than pay for an education. As a result, the use of an Educational Trust becomes a very appropriate option for providing money for education while ensuring a mechanism to make sure the money is used appropriately.

Spendthrift Trusts: Another concern of people creating trusts is that they want the assets of the trust to be protected from the attacks of potential creditors of either the Grantors or the Beneficiaries of the Trust. Spendthrift provisions can be incorporated into a Trust, which will then protect the trust assets from attack.

Irrevocable Life Insurance Trusts: Life insurance policies can very often present estate tax problems for the person who owns the policy. To combat the estate tax complications, the Irrevocable Life Insurance Trust provides an alternative to own a life insurance policy while completely excluding the proceeds from the estate for tax purposes.

Questions and Issues as to Specific Types of Trusts

1. Revocable and Irrevocable Trust Questions

For whom are living trusts most appropriate? What are the pros and cons?

For starters, while it is true that probate can be expensive and time-consuming in some other states, in Texas, we have a streamlined system of probate. As long as you hire a lawyer with experience in probate court, you have a well-written Will, and nobody files a lawsuit after your death, then probate is typically not so bad.

The stories you read in the paper may lead you to believe otherwise. The heirs of multi-million dollar estates frequently fight it out in court for a larger inheritance. Also, bookstores carry dozens of books which talk at length about the delays and high costs associated with probate.

Even so, living trusts are useful estate planning tools, and they do have their place in many people’s estate plans. If you find any one of the following benefits appealing, then a living trust may be appropriate for you.

  • Benefit #1: No Court Involvement. When a person dies, most properties pass either under a person’s Will or under a living trust. Some properties–such as life insurance, IRAs, and certain types of bank and brokerage accounts–pass directly to named beneficiaries. If the property passes under a Will, then the Will must be probated at the courthouse. Probate typically entails hiring a lawyer, filing a number of papers with the court, attending one or more hearings, and providing a written inventory to the court valuing the properties which passed under the Will. (Note, though, the filing of an inventory can be waived under current Texas law, and instead, the executor is permitted to file a document called “Affidavit in Lieu of Inventory” which states that an inventory was prepared and given to the estate’s beneficiaries, but that inventory does not need to be filed with the court.)  Some people don’t want this type of involvement with the court, so they opt for a living trust. By transferring all properties which would otherwise pass under your Will to a living trust, you can avoid the court entirely. For estates that do not owe estate taxes, there is usually less work for the lawyers, and that translates into reduced estate administration costs.
  • Benefit #2: Privacy. As mentioned above, when a person dies with a Will, an inventory must be filed with the court (unless an Affidavit in Lieu of Inventory is filed, as discussed above). You may not want your friends, neighbors, or the media to be able to read a listing of what you own and what it is worth. After all, an inventory is a public record. With a living trust, your properties and their values are all kept private.
  • Benefit #3: Plan For Future Incapacity. You may be worried that one day you won’t be able to manage your own finances, and you may want to name someone to handle these types of matters for you. You can address this potential problem with a power of attorney or with a living trust. A power of attorney will usually be accepted by banks, title companies and the like, but there is always the risk that an institution’s legal department will reject it. The same person who may be denied the ability to use a power of attorney will likely be allowed to do anything he or she wants when acting as trustee of a living trust.
  • Benefit #4: Harder to Challenge. If you are planning to disinherit one of your children or grandchildren, you may be better off with a living trust because there is nothing filed at the courthouse. Also, it is a little harder to contest a living trust than a Will. Many people are interested in doing as much as possible to prevent a successful challenge to their estate plan.
  • Benefit #5: Avoid Out-of-state Probate. If you own property in another state, you can avoid a costly probate proceeding in that state by transferring the property to a living trust.

Before you establish a living trust you need to understand the downsides, which include the following:

  • Disadvantage #1: Time-consuming to Set Up. Depending on how many different types of properties and accounts you own, it can take quite some time to switch everything over to the name of your living trust. Also, some financial institutions in Texas are not geared up to handle living trusts, so you can expect a little trouble and frustration in getting the trust fully established.
  • Disadvantage #2: Complicated. Wills are usually shorter and simpler to understand than living trusts. Also, with a Will, you can sign it and forget about it. But with a living trust, you need to put your property into the trust and run your life out of it for as long as you live. For many people, this downside outweighs all the potential benefits.
  • Disadvantage #3: Time-consuming to Revoke. A year after you set up the living trust, you may decide you don’t want it any more. At this point, you will need to return to every bank and brokerage house, and undo everything you had done to establish the trust. You can expect more lawyers’ fees too.
  • Disadvantage #4: Post-Death Costs Not Eliminated. If you have a taxable estate (which is generally an estate over $11,200,000.00), there will be a lot of work to be done after death regardless of whether probate is required. Typically, there are tax returns to file, trusts to establish, assets to value, and more. Avoiding probate will only marginally reduce the cost of administering a taxable estate.
  • Disadvantage #5: May Still Need to Probate Will. If you leave just one bank account or one piece of real estate out of the trust, probate will still be necessary. And probate takes about as long when there is one asset as when there are twenty.

2.  What is the difference between a Living Trust and a Bypass Trust?

A Living Trust is a revocable trust created while a person is alive, whereas a Bypass Trust is typically an irrevocable trust created at death. A Bypass Trust can be created by a Living Trust or by a Will. (Yes, a Living Trust can create a Bypass Trust, but a Bypass Trust would never create a Living Trust.)

A Living Trust is simply an ownership arrangement where the property is held in the name of a “trustee” rather than in the name of the person who really owns the property. People almost always create Living Trusts for their own benefit, with the goals of avoiding probate, addressing the possibility of future incapacity, and keeping matters private.

Normally, the person who creates a Living Trust names himself or herself as trustee and as beneficiary. Upon that person’s death, all or a portion of the property that remains in the Living Trust passes according to the terms specified in the trust agreement.

Bypass Trusts are most often created when a spouse dies in order to save taxes when the other spouse passes away. When a married person dies and leaves everything to his or her spouse, that surviving spouse may then be too wealthy to pass everything to their beneficiaries tax-free. Being “too wealthy” typically means the married couple is worth over $11,200,000.00. The Bypass Trust is a way to shelter the first spouse’s $11,200,000.00 exemption from taxation when the surviving spouse dies, thereby doubling the amount that can be left tax-free to $22,400,000.00.

Bypass Trusts do have non-tax benefits though, and for some people, saving taxes is not the motivating factor in creating one. For instance, Bypass Trusts protect the trust property from creditors’ claims, and they allow the deceased spouse to direct where the trust property passes when the other spouse dies.

There are some exceptions to the statements contained in this answer. For instance, Bypass Trusts are not always created at death. Some wealthy people create them during life, and other people use their estate tax exemptions for different purposes rather than the creation of a Bypass Trust. Also, in answering your question, I have assumed that when you said “Living Trust,” you meant the standard type of revocable trust people across the country regularly create and not another unusual type of trust which may be created while someone is living.

3.  What is a Miller Trust (Qualified Income Trust), and how does it work?

A Miller Trust is a written trust agreement that makes it possible for people to obtain Medicaid nursing home coverage even though they actually make too much money to qualify for Medicaid. Importantly, they are not actually called Miller Trusts anymore. Instead, they now go by the name Qualified Income Trusts.  While we do not draft these types of Trusts, this information is provided so that you can determine what your specific needs are for your estate plan.

The rule in Texas is that you must have both limited resources and limited income in order to qualify for Medicaid coverage. These are two distinct tests that must be met, and if you don’t satisfy both of them, then Medicaid nursing home coverage will not be available.

The first of the two requirements–that you must have limited resources–has nothing to do with Qualified Income Trusts. Basically, if you have more than $2,000.00 worth of assets, you are too wealthy to qualify for Medicaid no matter how little money you earn.

Cash, stocks, bonds, retirement accounts, non-homestead real estate, and other investments are included in the $2,000.00 figure, but your homestead (no matter how much it is worth), $2,000 of personal property, a burial plot, a small amount of life insurance, and a car are generally not counted.

People with more than $2,000.00 can give away properties or convert them into properties that are not counted. However, depending on the date of the transfer, there may be a 36 month or 60-month look-back period. The lookback period is a way to keep you from giving away all your property and then applying for Medicaid the next day. For transfers made prior to February 8, 2006, the 36-month look-back period continues to apply unless the transfer was made to a trust, in which case the longer 60-month look-back applies. For transfers on or after February 8, 2006, a 60-month look-back applies to all transfers.

Also, there are rules which generally allow the spouse of someone trying to qualify for Medicaid to retain about $3,022.50 worth of property. A spouse’s property is not counted when determining the total value of assets for the $2,000.00 resources test.

The second of the two requirements–that you can earn no more than a certain dollar amount of income per month–is where Qualified Income Trusts enter the picture. Under current law, the monthly dollar limit is $2,205.00. People who earn more can’t qualify for Medicaid unless they have a Qualified Income Trust.

What you do is assign your income to the Qualified Income Trust, and the wording of the trust limits how much of the income can be distributed. This way, a person who makes more than the monthly limit will be treated as earning less than that amount, thereby satisfying the Medicaid income test. The trust can allow for certain payments, including insurance premium payments, other payments to support a spouse, and $60.00 each month for the beneficiary’s personal needs.

Money remaining in the trust after those payments are made must be paid to the nursing home for the beneficiary’s care, with Medicaid picking up the balance. With Qualified Income Trusts, people can get the government to cover the portion of the nursing home costs that they can’t afford.

Lawyers prepare Qualified Income Trusts. Therefore, everyone who needs one must first meet with a lawyer to discuss the specifics of the trust and all the other planning that goes with it.

To learn more about Qualified Income Trusts, search the internet for the words “Texas qualified income trust.” You can also call the Texas Department of Human Services at 888-834-7406 or visit their website at www.dads.state.tx.us. They have a summary of Qualified Income Trusts, and they also publish a “Medicaid Eligibility Handbook” which contains other helpful information.

4.  What are the tax advantages to setting up an irrevocable trust to own an insurance policy?

Although life insurance is generally not subject to income taxation upon the death of the insured, it is subject to estate taxes if the insured owns the policy (or has other ownership rights).

Owning a life insurance policy results in all or a portion of the insurance proceeds being included in the insured’s estate and therefore taxed when death occurs, thereby substantially defeating the purpose of buying the life insurance.

While it is true that life insurance which is received by a spouse is not subject to estate or inheritance taxes because of the unlimited marital deduction (assuming the surviving spouse is a citizen of the United States), those same proceeds will be included in the spouse’s estate later on when he or she dies. Therefore, life insurance trusts are often a good idea even when there is a surviving spouse to receive the proceeds.

Life insurance trusts offer a number of significant advantages over outright ownership. For starters, the trust will insulate the proceeds from the claims of creditors and from spouses in a divorce.

Also, life insurance trusts can be written to last for children’s lifetimes and then pass without estate taxes to additional trusts for grandchildren. This is a feature commonly referred to by estate planning lawyers as “generation-skipping planning.” Your children shouldn’t be alarmed by the words “generation-skipping” because you are not skipping them. Your children can serve as trustees of their trusts, and they can be given the power to make distributions to themselves or their children according to fairly liberal standards. Normally, trusts like the ones being described would allow your children to make distributions for their health, education, maintenance, and support. And your children would be the ones determining how much money it takes to maintain and support themselves. Even though the life insurance proceeds will be held in a trust, your children would not be prevented from using the trust funds.