There are many issues to consider when forming a trust through your estate planning. A couple of the more common issues being the trustee of the trust and creditor protection to the beneficiary of a trust are discussed in general below.
Trusts create a fiduciary relationship with a trustee to hold property for the benefit of beneficiaries. This allows the creator of the trust to control how assets are distributed without dealing with the probate process while simultaneously protecting the assets through a legal instrument. Creating a trust can range from a simple allocation to a more complex distribution depending on each person’s needs. Regardless of the details within a trust, all private trusts require some formality, including naming a trustee, identifying appropriate beneficiaries, and transferring trust property. While most trusts do not require a formal writing and may be oral, some trusts require the transfer of legal title to be in writing. This requirement applies to trusts where the property conveyed is land.
All trusts need a trustee, but failure to appoint one will not terminate the trust. Rather, the court will appoint a trustee. There must be named beneficiaries for a private trust to ensure that the formal trust requirements are met. In other words, the beneficiaries can be particular individuals, or there may be a class of individuals as long as the group is relatively certain. Finally, there must be some form of property to satisfy the trust requirements. The policy behind the property requirement is to hold the trustee accountable for managing the trust. Trust assets by definition are broad and may include cash, legal interests in property (both present and future), and other intangible property.
Another consideration when forming a trust is whether it should become valid during the settlor’s life time or upon the settlor’s death. “Living trusts” (inter vivos) allow for the settlor to form a trust while he is alive as long as there is trust property and also allow the settlor to serve as trustee for his lifetime. Creating a revocable inter vivos trust allows for more control and provides a way to amend the trust to adjust to changing circumstances. On the other hand, testamentary trusts are typically created in a will, but may be created either before or after the will is created.
In general, depending on the type of trust, a beneficiary’s interest may be accessible to creditors. Essentially, the beneficiary has the ability to transfer his interest in the trust prior to receipt of the property. There is an important distinction between the actual trust property and the beneficiary’s interest. Creditors generally are unable to reach the trust assets, but may be able to reach a beneficiary’s particular interest absent a restraint on the property distribution.
For example, a beneficiary may have an interest in the trust income but not the principal. In a normal trust, the beneficiary’s creditor may be able to attach its rights to the trust income by compelling the trustee to distribute the income to the creditor. However, the creditor would not be able to require a distribution from the principal since the beneficiary has no legal interest in that specific trust property.
There are other ways to restrict a creditor’s access to personal property. The three most common ways to limit creditor’s rights are through a spendthrift trust, discretionary trust, or a support trust. A spendthrift trust limits a beneficiary’s ability to transfer his interest in property before he receives it. These types of trusts are typically created as a way to shield the beneficiary and limit his ability to overspend or provide protection for those with less financial accountability. While creditors are not able to reach the beneficiary’s share prior to receipt, once there has been a distribution, then the creditor’s may attach rights if they are aware of the distribution and act quickly enough. Creditors suffer from the risk that the beneficiary may spend the income or transfer the property prior to the creditor attaching its interest.
Discretionary trusts vest the power in the trustee to decide when and what property to distribute. By name, the trust is subject to the trustee’s discretion. While the trustee is subject to acting in good faith, he may choose how to allocate the property held in trust. However, a discretionary trust may limit a trustee’s power, thereby catering the trust towards the settlor’s and beneficiary’s needs. A discretionary trust makes it more difficult for creditors to attach to a beneficiary’s interest until a distribution is made since there is no definite way to determine what a beneficiary’s rights are in the property until the trustee acts. Any interest a creditor may have is limited solely to the trustee’s discretion.
Finally, a support trust may be created to avoid a creditor reaching assets. The trustee has an obligation to provide necessary funds or make appropriate distributions to support the beneficiary. Creditors are unable to reach the support trust’s assets due to the nature of the trust itself.
You can contact the McGuire Law Firm to discuss questions related to your estate planning, tax and business matters.