August 27, 2018
Author: David A. Semmelman
Organization: Semmelman & Semmelman, Ltd.
I. Definition of Basic Terms.
At English common law the concept of ownership of an asset was fairly simple. A person who held legal title to property was the owner of the property. During the Middle Ages a need arose for a more nuanced understanding of ownership. The English courts of equity began to develop a concept whereby legal title to property could be separated from equitable title - the right to benefit from that property.
A. Trust - A trust is created when legal title to property is separated from equitable title.
Sometimes legal and equitable title to property becomes separated either fraudulently or circumstantially. When that happens a court of equity will impose a constructive trust on that property and will typically order the party holding legal title to the property to transfer said title to the party holding equitable title.
Constructive trusts are not administered in the common sense of that word. Rather, constructive trusts are imposed to correct a situation where one party has an unfair advantage over another party in regard to certain property.
Unlike a constructive trust, an express trust is not created by fraud or accident. An express trust is typically created by an individual (the \"settlor\") transferring legal title to property to an individual or company (the \"trustee\") subject to the duties and obligations set forth in a written agreement (the \"trust agreement\") for the benefit of another (the \"beneficiary\").
B. Settlor. In Illinois, an individual who transfers property to one person to be held for the benefit of another is typically known as the settlor of the trust. Such an individual may also be referred to as the \"grantor\", especially in the context of income and transfer taxation. The term used for the individual who transfers the property to the trust varies from state to state. A trust can have more than one settlor.
C. Trustee. The individual or company to whom naked legal title to property is transferred for the benefit of another is known as the trustee. If the trustee is a natural person, he or she is referred to as an individual trustee. A company who is acting as a trustee is known as a corporate trustee. In Illinois, the corporations that are qualified to accept trusts are banks and trust companies. In some circumstances the settlor of the trust is the initial trustee. A trust can have more than one trustee.
D. Trust Agreement. A trust agreement is a written agreement between the settlor and the trustee regarding how the trust estate will be managed and distributed.
E. Trust Estate. The trust estate consists of the property held by the trustee. The first asset(s) in the trust estate is the property transferred from the settlor to the trustee when the trust is created. The trust estate may change over time as a result of additional contributions, distributions, and the trustee's investment activities.
F. Beneficiary. A person who currently or prospectively has a right to the income and/or principal of the trust estate is a beneficiary. A settlor can be, and often is, a beneficiary of the trust.
1. Income Beneficiary. A person who has the current right to the income generated by the trust is the income beneficiary. Trust income may include interest, dividends, rents and royalties, etc. For trust accounting purposes, capital gains are not income - they are additions to principal.
2. Remainder Beneficiary. A person who has a future interest in the income and/or principal of the trust estate is a remainder beneficiary. A remainder beneficiary's interest arises after the interest of the current beneficiary is terminated.
II. Types of Trusts. There are three types of trusts: revocable; irrevocable; and testamentary. In this outline we will discuss revocable trusts in depth and touch on irrevocable and testamentary trusts.
A. Revocable (Living) Trust. Revocable trusts are basic building blocks in estate planning.
Why are Revocable Trusts Called Living Trusts? A trust that is established during the settlor's lifetime is known as an inter vivos trust (as opposed to a testamentary trust that arises from a will). Inter vivos is Latin for between the living, from which we get \"living trust.\" Even though a trust does not have to be revocable to be an inter vivos trust, the term \"living trust\" has become synonymous with revocable trust in the mind of the public.
Advantages of Using Trusts in Estate Planning. Revocable trusts are commonly used in estate planning because they accomplish the purpose of avoiding probate without restricting the settlor's right to change the terms of the trust as his or her financial and relational circumstances change. As long as a trust is revocable it can be amended by the settlor (provided that the settlor retains testamentary capacity). A trust with only one settlor typically becomes irrevocable on the death of the settlor. Another advantage of a revocable trust arises if the settlor becomes disabled. In the event of disability, the successor trustee can step in to manage the assets in the trust estate on behalf of the settlor.
What Are Some Characteristics of a Revocable Trust?
1. Part of Taxable Estate. Because the settlor has a right to withdraw assets from the trust estate at any time, those assets will be included in his or her taxable estate for estate tax purposes.
2. Settlor as Beneficiary. During the lifetime of the settlor, the settlor is typically the sole beneficiary of the estate with the power to direct the distribution of income and principal. In the event the settlor becomes disabled, the trustee may be given the discretion to make distributions to or for the benefit of the settlor's spouse and/or dependent children as well as the settlor. See Appendix A for an example of the disposition of a trust during the settlor's lifetime.
3. Settlor as Trustee. It is not unusual for the settlor to be the initial trustee of the revocable trust. By serving as the trustee, the settlor keeps control over the management of the trust assets. Any trustee, including the settlor, typically has authority to engage agents to assist in the investment and management of trust assets.
4. Grantor Trust. Every revocable trust is a grantor trust for income tax purposes. The income and losses of a grantor trust flow through to the settlor regardless of who is acting as the trustee. When the settlor is the trustee the trust uses the settlor's social security number as its taxpayer identification number. This makes the trust invisible to the IRS and no separate tax return is required. If the trustee is not the settlor the trust will have to get its own taxpayer identification number and will file a federal tax return. Irrevocable trusts can also be grantor trusts.
5. Successor Trustee. Whenever the initial trustee is an individual, whether it is the settlor or any other natural person, it is crucial that the settlor name a successor trustee in the trust agreement. People are prone to dying, resigning or becoming unable to perform the duties of a trustee at the most inconvenient times. It is only prudent to have a back up to an individual trustee.
A corporate trustee is a good option when choosing a successor trustee if the settlor was the initial trustee. Most settlor's understand that one of the advantages of a trust is the ability to choose who will manage their assets after they are unable or unwilling to do so. Naming a corporate trustee as the successor trustee makes it more certain that the chosen trustee will be ready, willing and able to step in. See Appendix B(1) for an example of a clause naming a corporate fiduciary as successor trustee. When a corporation is named as a successor trustee the beneficiaries of the trust are often given the right to replace the corporate trustee with another corporate trustee. Such a provision is particularly important where the trust is likely to continue for a number of years after the demise of the settlor. See Appendix B(2) for an example of a trustee removal clause. When crafting a trustee removal clause it is important to specify which beneficiaries have the right to vote to remove the corporate trustee. A trustee removal clause is also important if a corporate trustee is the initial trustee.
If a settlor has a spouse and/or children, it is not uncommon to name family members as successor trustees before naming a corporate trustee as the ultimate successor trustee. See Appendix B(3) for an example of a clause naming individual successor trustees. In that example the settlor is married and has two adult children. The clause names the surviving spouse as the first successor trustee. The second successor trustee is the two adult children as co-trustees. At such time as the only living member of the family is an adult child, he or she is named to act as the sole successor trustee.
If it is possible that the trust will continue after the death of the last child (for the benefit of grandchildren, for example) a corporate trustee could be named as the next successor trustee. If the possibility that the trust will continue is remote, the beneficiaries of the trust could be given the power to elect a successor trustee. See Appendix B(4) for an example of a clause providing for the election of a successor trustee. If there is a reason why the settlor does not want a particular beneficiary to serve as trustee, then we can disallow beneficiaries who are not specifically named in the document from being elected to be trustee.
B. Terms of Revocable Trusts. The two primary factors which influence how a revocable trust will be administered and distributed after the death of the settlor are estate taxes and family dynamics.
1. Estate Taxes. For 2014 the federal estate tax exemption $5,340,000 million. For a married couple, if the first spouse to die does not use all of his estate tax exemption the surviving spouse can elect to use the unused portion of the exemption of the first spouse to die plus her own exemption. In order for the surviving spouse to use the unused portion of the exemption, an estate tax return needs to be filed in the first spouse's estate to preserve the election. The ability of the surviving spouse to use the remainder of the estate tax exemption of the first spouse to die is known as portability.
The Illinois estate tax exemption is $4,000,000. There is no portability in regard to Illinois estate tax. If the first spouse to die does not use all of his Illinois exemption it can not be carried over to the surviving spouse's estate.
Illinois estate tax is based on the State Death Tax Credit Table. That table was part of the instructions for the federal estate tax return when a credit against the federal estate tax was granted for state estate taxes. State estate taxes are now treated as a deduction from the gross taxable estate rather than a credit against the estate taxes. The change from a credit to a deduction caused the way Illinois calculates estate tax to become a complex circular equation. Fortunately, the Office of Illinois Attorney General, the agency responsible for administering the Illinois estate tax, provides an easy to use estate tax calculator on its website.1
Failing to take the Illinois estate tax into account and relying entirely on federal portability can be quite costly. For example, lets look at a hypothetical married couple, Mary and Tom, who have spent their entire married life as residents of Illinois. There 1 http://illinoisattorneygeneral.gov/publications/calculator/2013calc/calculator2013.html combined estate on January 1, 2013 was $10,500,000. Mary and Tom held all of their assets as joint tenants. Tom died on February 1, 2013 and everything passed to Mary. There is no tax due on Tom's death because federal and Illinois law both provide for an unlimited marital deduction (anything going to the surviving spouse passes estate tax free). Mary's attorney prepares a federal estate tax return for Tom to preserve his unused federal estate tax exemption (which was $5,250,000 in 2013). Mary died on November 15, 2013 with an estate of $10,500,000. There was no federal estate tax on Mary's death because her personal representative can use Mary's $5,250,000 exemption and Tom's $5,250,000 exemption on Mary's estate tax return.
What will the Illinois estate taxes be on Mary's death? There is no portability in Illinois, so the Illinois estate tax exemption that is available on Mary's death is her $4,000,000 exemption. The Illinois estate tax on Mary's death will be $992,708. With proper planning Tom's $4,000,000 Illinois exemption could have been used at the time of his death. Doing so would have reduced Mary's taxable estate to $6,500,000. There would still be no federal estate tax as a result of Mary's $5,250,000 exemption and the unused portion of Tom's exemption. The Illinois estate tax on Mary's death would have been reduced from $992,708 to $509,643 (a savings of $483,065).
Federal portability, therefore, does not mean that estate taxes are no longer an issue for combined estates of less than twice the federal exemption amount. In states that have an estate tax and do not have portability, estate tax planning is still important. In Illinois and other common law jurisdictions, the traditional approach to basic estate tax planning for a married couple is for each spouse to have a credit shelter trust.
A credit shelter trust works by splitting the trust on the death of the first spouse to die into two portions - a marital portion and a credit shelter portion. The size of the two portions is determined either by pecuniary formula or a fractional formula. See Appendix C for an example of a fractional formulas.
The fractional formula looks more complicated than it is in practice. At the end of the day, an amount equal to the settlor's unused exemption amount (either federal or state) ends up in the credit shelter portion and the rest goes into the marital portion.
Using a fractional formula does not mean that the trustee needs to split every asset in accordance with the fraction. The trustee can pick and choose which assets to allocate to the respective portions. The disadvantage of using a pecuniary formula is that the potentiality that the use of the formula will trigger the premature recognition of income if the trust is the beneficiary of a retirement asset (such as an IRA or a 401(k)). The use of a fractional formula insulates the trust against that potentiality.
The purpose of a credit shelter trust is to use the exemption amount of the first spouse to die without incurring an estate tax on his death. The exemption amount is used by funding the credit shelter portion. As we discussed earlier, the federal exemption is $5,340,000 and the Illinois exemption is $4,000,000. To what extent can the credit shelter portion be funded without incurring estate tax?
It appears that the answer to the question is $4,000,000, the amount of the Illinois exemption but there is a twist. Illinois provides for a QTIP election regarding the difference between the federal exemption and the Illinois exemption in the credit shelter portion. If the QTIP election is made that amount will qualify for the unlimited marital deduction for Illinois purposes. That means that we can fund the credit shelter portion to the extent of the federal exemption, if the settlor chooses to do so. If the value of the taxable estate of the first spouse to die exceeds the available federal exemption then the remainder needs to pass estate tax free in order to avoid paying estate taxes on the death of the first spouse. For married couples that can be accomplished by qualifying the remainder for the unlimited marital deduction.
2. Family Dynamics. As was mentioned earlier, the two factors that have the most impact on estate planning are estate taxes and family dynamics. We have been looking at how estate taxes shape the foundation of the trust in our discussion of credit shelter planning. From an estate tax planning perspective we know that we want to use at least the Illinois exemption of the first spouse to die. The way to make sure that happens is to set aside an amount which will use the Illinois exemption of the first spouse by splitting the trust between a marital portion and a credit shelter portion. Family dynamics come into play when we look at how those portions will be administered.
a. Marital Portion. For the plan to be effective the marital portion needs to qualify for the unlimited marital deduction. To qualify for the marital deduction the marital portion must be an outright gift to the surviving spouse or be incudible in her taxable estate. Generally speaking, everything the surviving spouse controls at her death will be includible in her taxable estate. How we qualify the marital portion for the unlimited marital deduction depends on how much access we want to give the surviving spouse to those funds. The least restrictive method is to distribute the marital portion to the spouse outright. If the marital portion is used to fund a marital trust the least restrictive method is to give the surviving spouse the unrestricted right to withdraw funds from the principal of the marital trust during her lifetime.
Another option is to give the surviving spouse a general power of appointment over the assets in the marital trust. A general power of appointment is one which is unrestricted or which allows the power holder to appoint to herself, her creditors, her estate or the creditors of her estate. A general power of appointment will qualify the marital portion for the unlimited marital deduction if it is effective during the surviving spouse's lifetime or at her death. If the power of appointment is effective at the death of the surviving spouse it is referred to as a testamentary power of appointment. A testamentary power of appointment can only be exercised in a will. See Appendix D for an example of testamentary general power of appointment.
b. QTIP. In some instances, the spouse that controls the finances may be concerned that when he dies his wife will get remarried and/or waste all of \"his\" money on an extravagant lifestyle.
In second marriages there is often a concern that the surviving spouse be supported while preserving funds for the children of the first marriage. One way to address those concerns would be to limit the surviving spouse's interest in the marital portion to a life estate. If the surviving spouse only has the right to receive the income from the marital trust she would have less of an opportunity to spend her deceased husband's money on her new lover and the estate would be protected for the husband's children. When she dies the marital portion would pass to the children without fail.
The problem with the life estate solution is that common law life estates do not qualify for the marital deduction. To qualify for the marital deduction the surviving spouse needs to be able to control the disposition of the assets. A life estate does not give the surviving spouse that control.
Section 2506 (7) of the Internal Revenue Code2 was enacted to resolve this dilemma. By virtue of that Section a personal representative of the decedent (the executor of the will or the trustee) can elect to treat a life estate to the surviving spouse as qualified terminable interest property (QTIP) as long as all of the income is payable to the surviving spouse for life. QTIP property qualifies for the marital deduction. See Appendix E for an example of QTIP trust language.
i. Invasion of Principal. Although it is not required to qualify a QTIP trust for the marital deduction it is common practice to give the trustee the discretion to invade the principal of the marital trust for the surviving spouse usually on the basis of an ascertainable standard. If the surviving spouse is the trustee of the QTIP trust, the decision to invade principal should be made by an independent trustee. Since the purpose of a QTIP trust is to restrict the surviving spouse's access to the marital portion it is less likely that she would be named as the trustee of that trust.
2 26 U.S. Code §2506(7)
ii. Termination. The QTIP trust terminates on the death of the surviving spouse. It is not uncommon to give the surviving spouse a limited testamentary power of appointment over the remainder of the marital portion. See Appendix E for an example of a limited testamentary power of appointment. If the surviving spouse is not given a limited power of appointment or to the extent that the limited power of appointment is not exercised, the remainder of the marital portion passes in accordance with the default provision established in the trust agreement. Generally the remainder is added to the credit shelter portion. See Appendix E for an example of a default provision.
c. Credit Shelter Portion. The credit shelter portion is usually used to fund a trust that can have any number of designations. This outline will refer to it generically as the Credit Shelter Trust.
i. Spousal Provisions in the Credit Shelter Trust. The purpose of credit shelter planning is to take advantage of the estate tax exemption of the first spouse to die. By doing so, we can pass more assets to non-spousal beneficiaries estate tax free. If the surviving spouse is to be a beneficiary of the Credit Shelter Trust care must be taken not to give the surviving spouse an interest in the trust which would make it includible in her taxable estate. Credit shelter planning fails if the assets of the Credit Shelter Trust are includible in the surviving spouse's estate.
One way to benefit the surviving spouse without jeopardizing the credit shelter planning is to give her the right to the income from the trust for life. The trustee can have the right to invade the principal of the Credit Shelter Trust for the benefit of the surviving spouse based on an ascertainable standard (health, education, maintenance and support). See Appendix F for an example of a Section in the Credit Shelter Trust that benefits the surviving spouse.
In addition to the right to receive income the surviving spouse is sometimes given a limited a withdrawal right of principal from the Credit Shelter Trust. Such withdrawal right is generally limited to an annual right to withdraw up to the greater of $5,000 or 5% of the trust. The advantage of giving the spouse a limited withdrawal right is that it makes her feel more confident that she will have enough money. The disadvantages are the possibility that the value of the assets that will pass to the children estate tax free will be reduced; and the amount that is subject to the withdrawal right in the year of the surviving spouse's death will be includible in her taxable estate. See Appendix G for an example of a limited withdrawal right.
ii. Provisions for Children in the Credit Shelter Trust. If the settlor has children, upon the death of the surviving spouse, if she is a beneficiary of the Credit Shelter Trust, otherwise upon the death of the settlor the Credit Shelter Trust is usually held for the benefit of the children. The trust can be held as a common fund for the benefit of the children until the youngest child attains a certain age or some other triggering event or the trust can be divided into shares on the death of the surviving spouse or the settlor. See Appendix H for an example of language creating a common fund.
When the trust is divided into shares the trustee can be directed to make immediate distribution or the shares can be held as separate trusts for the benefit of each child. The trustee is generally only directed to make immediate distribution if each child is an independent adult when the trust is drafted.
iii. Shares Held as Separate Trusts. When the shares are held as separate trusts the child usually has the right to the income from the share. That right may be restricted while the child is under an age specified by the settlor (usually 21). The trustee is generally given broad discretion to invade the principal of the share for the benefit of the child. See Appendix J for an example of language concerning income and principal from a child's share.
When the child reaches the age specified by the settlor the trustee is directed to distribute the share to the child or the child is given the right to withdraw principal from the share. The advantage in giving the child the right to withdraw as opposed to directing the distribution is that the assets in the child's share are protected from his or her creditors as long as they remain in the trust. The creditor of a child can not force the child to take a distribution from the trust. The trust agreement should explicitly state that a creditor cannot force a child to take a distribution. See Appendix K for an example of \"spendthrift\" creditor protection language.
Depending on the value of the trust assets, the right to withdraw can be staged. Staging works by giving the child the right to withdraw a portion of the share at a specified age and the remainder at some later age. When the right to withdraw is staged there are usually two or three stages. See Appendix L for two examples of staging. Unless the settlor intends to create a dynasty trust, the children should be given a testamentary general power of appointment over the share to make sure that those assets will be includible in his or her taxable estate. The reason it is desirable to have the assets includible in the child's taxable estate is that it allows the child's interest to pass to his or her children without triggering generation skipping tax (\"GST\"). GST is a tax imposed on transfers that skip a living generation. GST is a flat 50% of the value of the assets that are subject to the tax. There is a GST exemption. It is the same amount as the applicable estate tax exemption.
If the child does not exercise the testamentary power of appointment there is a default provision that distributes the balance of the share to the descendants of the child, if any. If the child has no descendants, then the balance of the share is distributed to the descendants of the settlor. See Appendix M for an example of a general testamentary power of appointment and the default provision.
iv. Provisions for Others in the Credit Shelter Trust. The beneficiaries of the Credit Shelter Trust do not need to be the children of the settlor. They could be other relatives or friends.
C. Other Revocable Trusts. A Credit Shelter Trust is just one of many types of revocable trusts. In this Section we will look at some other types.
1. Single Fund Marital. The Single Fund Marital Trust is similar to the trust that holds the credit shelter portion of the Credit Shelter Trust except the trustee is given the discretion to qualify a portion of the trust for the marital deduction by making a QTIP election as to that portion. See Appendix N for an example of the Single Fund Marital language. The advantage of a Single Fund Marital over a Credit Shelter Trust is that a Single Fund Marital Trust has a simpler structure. If the taxable estate of the first spouse to die is likely to be less than the estate tax exemption a Single Fund Marital Trust may be a good option.
2. Disclaimer Trust. Before the estate tax exemption began to ramp up at the turn of the century Credit Shelter Trusts were a good option for most married couples that were doing trust planning. With the rising exemptions planners began seeing more couples whose combined estates did not exceed a single exemption (i.e.- a combined estate of less than $4,000,000). With a Credit Shelter Trust if the trust estate does not exceed the exemption amount when the first spouse dies, the marital portion is not funded. That was not the intent of many couples that had Credit Shelter Trusts drafted in the 1980s and 90s. As exemptions increased, flexibility became an important feature in estate tax planning.
A Disclaimer Trust provides that flexibility. A Disclaimer Trust leaves everything to the surviving spouse on the death of the first spouse but provides the surviving spouse with an option of disclaiming a portion of that gift. The disclaimed portion goes into a the a trust similar to the trust that holds the credit shelter portion. See Appendix O for an example of the disclaimer language. That trust provides income to the surviving spouse for life. The disclaimed portion uses estate tax exemption of the first spouse to die and is not includible in the taxable estate of the surviving spouse. By using a disclaimer approach instead of the formulaic approach of the Credit Shelter Trust the estate tax decision is deferred until the death of the first spouse. By deferring the decision a more informed choice can be made.
3. Joint Trust. A joint trust is a trust agreement with two or more settlors, usually a married couple. Joint trusts are popular with married couples who are used to holding their property jointly.
The rising estate tax exemptions have added the joint trust to the tool box of estate planners in common law states. Illinois is a common law state. Joint trusts have been long been a staple in community property states because the way spousal ownership is understood in those states made it clear that the estate tax exemption of the first spouse to die could be used even if the property was held in a joint trust.
Now that the relatively high estate tax exemptions have made estate tax planning less relevant for many couples, joint trusts have become an option in common law states even though it may be problematic to use the estate tax exemption of the first spouse to die.
D. Irrevocable Trusts. Where revocable trusts are basic building blocks of estate planning, the an irrevocable trust is more situational. The settlor generally should not be the trustee of an irrevocable trust but a relative of the settlor can usually serve in that capacity.
1. Life Insurance Trust (ILIT). One of the most common irrevocable trusts is a trust designed to hold an insurance policy on the life of the settlor. Most people that have life insurance, other than employer provided life insurance, are the owners of that policy. On the death of the insured, the proceeds of the policy are includible in his or her taxable estate. An alternative to owning the policy is to establish an irrevocable trust to be the owner of the policy. Having the trust own the policy allows the proceeds to pass estate tax free. If an existing policy is transferred to an insurance trust the transferor needs to survive the transfer by three years to avoid estate tax.
2. Grantor Retained Interest Trust (GRIT). The purpose of a grantor retained interest trust is to reduce the value of a taxable gift. Instead of making an outright gift of property, the settlor transfers the property to an irrevocable trust which names the settlor as the beneficiary for a term of years and then distributes the property to the remainder beneficiaries. If the settlor does not survive the term of years the property reverts to the settlor's estate. The gift tax value of the property is reduced by the deferral of the gift for the term of years and the possibility of reversion. It is possible to design certain types of GRITs so that the value of the property for gift tax purposes is reduced to zero.
3. Charitable Trust. A charitable trust is an arrangement which benefits the settlor and the charitable beneficiary. The most common charitable trust is the Charitable Remainder Trust. In a Charitable Remainder Trust, the settlor retains an interest in the trust either for her life (or the life of the settlor and another named individual) or a term of years with the remainder interest passing to a named charity. The settlor is entitled to take a charitable deduction for the present value of the gift to the charity. The present value\" of the property will be less than its fair market value on the date it is added to the trust. Present value is a function of the deferral of the gift.
4. Gift Trust. A gift trust is used to make a gift to a minor beneficiary. By establishing a gift trust rather than making an outright gift that could be used to fund a Uniform Transfers to Minors Account, the settlor can specify how the gift will be used for the benefit of the child. For a gift in trust to qualify for the annual exclusion, the trust agreement needs to state that the beneficiary will have a withdrawal opportunity at the age of 21 years.
E. Testamentary Trusts. A testamentary trust is a trust established in the will of a decedent. Other than the lifetime provisions of a revocable trust, a testamentary trust can have virtually the same terms as any revocable trust. A testamentary trust could also be a charitable trust.
III. Funding the Trust. An important, and often overlooked, aspect of using a trust in an estate plan is the funding of the trust. Funding is not usually an issue with irrevocable trusts because of the focused nature of irrevocable trust planning. However, many revocable trusts are not properly funded. If a revocable trust is not properly funded the advantages of revocable trust planning are generally lost.
A trust is funded by re-titling assets in the name of the trustee. Real estate is retitled by deed. Other assets are re-titled by changing the name on the stock certificate, brokerage account, etc. from the individual to the trustee. If Jane Smith executed a trust on July 1, 2013 the proper titling of her property, other than real estate, would be \"Jane Smith, or her successor, as Trustee of the Jane Smith Trust under trust agreement dated July 1, 2013.\"
There is no restriction on the assets the settlor can contribute to the trust. A settlor who is serving as the trustee has no duty to hold or invest assets in a particular manner.
A. Appropriate Trust Investments. A trustee, other than the settlor, has a duty to invest the trust's assets in accordance with the Prudent Investor Rule. The prudent investor rule requires the trustee to consider the needs of the beneficiaries, to maintain a source of regular income, and to preserve and grow the trust's assets while avoiding excessively risky investments.
Not every prudent investment will turn out to be a good investment. The prudent investor rule requires the trustee to follow a balanced, common sense investment plan. The trustee needs to make good investment decisions based on the information available when the investment is made.
IV. Amendment and Restatement. A trust agreement establishing a revocable trust is a flexible document that can be amended over time.
Amendments are often initiated because of a change in the settlor's circumstances. For example:
It is often appropriate to amend a trust after a divorce; As children get older restrictions on distributions are sometimes loosened or, depending on the child, the ages of distribution are sometimes increased; Individuals named as trustee die or otherwise become unfit to serve as trustee; or The settlor's financial circumstances change.
Sometimes amendments are initiated because of a change in the law, particularly in estate tax law.
A restatement of a trust is a total amendment of the trust agreement. The only thing that stays the same is the date that the trust agreement was executed. A trust agreement is typically restated when there have been a number of previous amendments, when the amendments that the settlor wants to make are very broad, or if the trust agreement that is being amended is so old that it makes sense to refresh its terms. The advantage of restating a trust as opposed to revoking the old trust and starting over is that any assets that have been transferred to the trust stay in the trust if it is restated. If the trust were revoked those assets would need to be transferred from the old trust to the new trust.
V. Termination. A trust can be terminated by a written revocation of a revocable trust by the settlor. See Appendix P for an example of a revocation. A trust can also be terminated by the distribution of all of the assets of the trust. For a trust to exist it must have assets.
APPENDIX A
PROVISIONS FOR DISABILITY
FIRST: Directed Payments. During my lifetime the trustee shall pay so much or all of the income and principal of the trust estate to me or otherwise as I direct.
Disability. If at any time or times I shall be unable to manage my affairs, the trustee may use such sums from the income and principal of the trust estate as the trustee deems necessary or advisable for the health and maintenance in reasonable comfort of myself and any person dependent upon me, or for any other purpose the trustee considers to be for my best interests.
For purposes of this agreement, I shall be considered to be unable to manage my affairs if I am under a legal disability or by reason of illness or mental or physical disability am unable to give prompt and intelligent consideration to financial matters. The determination as to my inability at any time shall be made by my then attending physician and the trustee may rely upon written notice of that determination. Any income of the trust that is not paid at my direction, or for my benefit at such time or times as I am disabled shall be added to principal.
APPENDIX B
SUCCESSOR TRUSTEE
(B)(1) Corporate Successor Trustee.
SECTION ____: Trustee Succession. Any trustee may resign at any time by written notice to each beneficiary then entitled to receive or eligible to have the benefit of the income from the trust.
At such time as I am unwilling and/or unable to continue to act as trustee, XYZ TRUST COMPANY shall be successor trustee.
(B)(2) Trustee Removal.
At any time or times after my death and during the continuance of the trust estate, a majority of all of the beneficiaries of the trust estate may jointly remove or cause the removal XYZ TRUST COMPANY and any subsequent successor corporate trustee as trustee and may designate, at their own discretion, another corporate trustee to serve as successor trustee hereunder. The beneficiaries who shall have the right to vote on whether a corporate trustee is to be removed shall be limited to those beneficiaries who would be entitled to a share of the trust estate if complete distribution of the trust estate were to be made on the date of the vote.
(B)(3) Individual Successor Trustee
SECTION ____: Trustee Succession. Any trustee may resign at any time by written notice to each beneficiary then entitled to receive or eligible to have the benefit of the income from the trust.
At such time as I am unwilling and/or unable to continue to act as trustee, my wife shall be successor trustee. At such time as both my wife and I are unwilling and/or unable to act (or continue to act) as trustee, RONALD TIMM and PEGGY TIMM shall be successor co?trustees. If my wife and I and either RONALD TIMM or PEGGY TIMM are unwilling and/or unable to act (or continue to act) as trustee, the other shall act as sole trustee.
(B)(4) Election of Successor Trustee
At such time as each of the trustees named herein are unwilling and/or unable to act (or continue to act) as trustee, and at such time as any subsequent trustee is unwilling and/or unable to continue to act as trustee, a successor trustee shall be appointed by the beneficiary or a majority in interest of the beneficiaries then entitled to receive or eligible to have the benefit of the income from the trust (or if their interests are indefinite, by a majority in number of the oldest generation of such beneficiaries) [,but no beneficiary or person legally obligated to a beneficiary shall be a successor trustee, unless specifically named herein as trustee].
APPENDIX C
FRACTIONAL FORMULA
ARTICLE ____: Marital Trust. If my wife survives me, the trustee as of my death shall set aside out of the trust estate as a separate trust for her benefit (undiminished to the extent possible by any estate or inheritance taxes or other charges) a fraction of the trust property of which (i) the numerator is the smallest amount which, if allowed as a federal estate tax marital deduction, would result in the least possible federal [or state] estate tax payable by reason of my death, and (ii) the denominator is the federal estate tax value of the assets included in my gross estate which became (or the proceeds, investments or reinvestments of which became) trust property. In determining the amount of the numerator the trustee shall consider the credit for state death taxes only to the extent those taxes are not thereby incurred or increased and shall assume that none of the Credit Shelter Trust hereinafter established qualifies for a federal estate tax deduction.
APPENDIX D
TESTAMENTARY GENERAL POWER OF APPOINTMENT
SECTION ____: Testamentary Power of Appointment. If my wife dies before the complete distribution of the Marital Trust, then upon the death of the my wife the remainder of the principal of the Marital Trust shall be held in trust hereunder or distributed to or in trust for such appointee or appointees, with such powers and in such manner and proportions as my wife may appoint by her will making specific reference to this power of appointment.
APPENDIX E
QTIP
SECTION 1: Income. Commencing with my death the trustee shall pay the income from the Marital Trust in convenient installments, at least quarterly, to my wife during her lifetime.
Principal. The trustee may also pay to my wife such sums from principal as the trustee deems necessary or advisable from time to time for her health and maintenance in reasonable comfort, considering her income from all sources known to the trustee. SECTION 2: QTIP Election. The legal representative of my estate (or if no representative is acting, the trustee) may elect to have a specific portion or all of the Marital Trust, herein referred to as the \"marital portion,\" treated as qualified terminable interest property for federal estate tax purposes. If an election is made as to less than all of the Marital Trust, the specific portion shall be expressed as a fraction or percentage of the Marital Trust and may be defined by means of a formula. I intend that the marital portion shall qualify for the federal estate tax marital deduction in my
estate.
SECTION 3: Limited Power of Appointment. Upon the death of my wife the principal of the Marital Trust shall be held in trust hereunder or distributed to or in trust for such one or more charitable, scientific or educational purposes, with such powers and in such manner and proportions as my wife may appoint by her will making specific reference to this power of appointment.
Default. Upon the death of my wife any part of the principal of the Marital Trust not effectively appointed shall be added to or used to fund the Credit Shelter Trust, except that, unless my wife directs otherwise by her will or revocable trust, the trustee shall first pay from the principal of the marital portion, directly or to the legal representative of my wife's estate as the trustee deems advisable, the amount by which the estate and inheritance taxes assessed by reason of the death of my wife shall be increased as a result of the inclusion of the marital portion in her estate for such tax purposes. The trustee's selection of assets to be sold to pay that amount, and the tax effects thereof, shall not be subject to question by any beneficiary. Notwithstanding any other provision of this agreement, all income of the Marital Trust accrued or undistributed at the death of my wife shall be paid to her estate.
APPENDIX F
CREDIT SHELTER SECTION FOR BENEFIT OF SURVIVING SPOUSE
SECTION ___: If my wife survives me, then commencing with my death the trustee shall pay the income from the Credit Shelter Trust in convenient installments, at least quarterly, to her during her lifetime.
The trustee may also pay to my wife such sums from principal of the Credit Shelter Trust as the trustee deems necessary or advisable from time to time for her health and maintenance in reasonable comfort, and for the health, support in reasonable comfort, and education (including postgraduate), considering her income from all sources known to the trustee, but shall make no invasion of the Credit Shelter Trust for my wife so long as any readily marketable assets remain in the Marital Trust. A disclaimer by my wife of any part or all of the Marital Trust shall not preclude her from receiving benefits from the disclaimed property in the Credit Shelter Trust.
APPENDIX G
SPECIAL WITHDRAWAL RIGHT
SECTION ___: Special Withdrawal Right. My wife may withdraw at any time or times from the principal of the Credit Shelter Trust not to exceed in the aggregate during any calendar year the greater of $5,000 and 5 % of the value of the principal of the Credit Shelter Trust. For purposes of this withdrawal right, the value of the principal of the Credit Shelter Trust shall be its value on December 31st of the prior calendar year.
The trustee shall make payment without question upon her written request. The right of withdrawal shall be a privilege which may be exercised only voluntarily and shall not include an involuntary exercise.
APPENDIX H
POOLED FUND
SECTION ___: Until the time hereinafter fixed for distribution, the trustee may pay so much or all of the income and principal of the Credit Shelter Trust to any one or more of my children and the descendants of a deceased child of mine from time to time living, in equal or unequal proportions and at such times as the trustee deems best, considering the needs, other income and means of support, and best interests of my children and those descendants, individually and as a group, and any other circumstances and factors which the trustee deems pertinent, adding to principal any income not so paid.
APPENDIX J
INCOME AND PRINCIPAL FROM CHILD'S SHARE
SECTION ___: Income. The income from a child’s share shall be paid in convenient installments, at least quarterly, to the child until complete distribution of the share or his or her prior death; except that while the child is under the age of 21 years, the trustee may pay to or for the benefit of the child so much or all of the income from his or her share as the trustee deems necessary or advisable from time to time for his or her health, maintenance in reasonable comfort, education (including postgraduate) and best interests, adding to principal any income not so paid.
Principal Invasion. The trustee may also pay to the child such sums from the principal of his or her share as the trustee deems necessary or advisable from time to time for his or her health, maintenance in reasonable comfort, education (including postgraduate) and best interests, considering the income of the child from all sources known to the trustee.
APPENDIX K
CREDITOR PROTECTION
SECTION ___: Spendthrift. The interests of beneficiaries in principal or income shall not be subject to the claims of any creditor, any spouse for alimony or support, or others, or to legal process, and may not be voluntarily or involuntarily alienated or encumbered. This provision shall not limit the exercise of any power of appointment. The rights of beneficiaries to withdraw trust property are personal and may not be exercised by a guardian, conservator, attorney in fact or others.
APPENDIX L
STAGED WITHDRAWAL
Two Stages
SECTION ____: Right to Withdraw. After division of the Credit Shelter Trust into shares and after a child has reached the age of 25 years, the child may withdraw any part or all of the principal of his or her share at any time or times, but not to exceed in the aggregate 1/2 in value thereof prior to reaching the age of 30 years. The value of the share shall be its value as of the child’s first exercise of his or her withdrawal right, plus the value of any subsequent addition as of the date of addition. The trustee shall make payment without question upon the child’s written request. The right of withdrawal shall be a privilege which may be exercised only voluntarily and shall not include an involuntary exercise.
APPENDIX L
STAGED WITHDRAWAL
Three Stages
SECTION _____: After division of the Credit Shelter Trust into shares and after a child has reached any one or more of the following ages, he or she may withdraw from the principal of his or her share at any time or times not to exceed in the aggregate: One?third (1/3) in value after 25 years of age; One?half (1/2) in value (after deducting any amount subject to withdrawal but not actually withdrawn) after 30 years of age; and The balance after 35 years of age. The value of the share shall be its value as of the first exercise of each withdrawal right, plus the value of any subsequent addition as of the date of addition. The trustee shall make payment without question upon the child's written request. The right of withdrawal shall be a privilege which may be exercised only voluntarily and shall not include an involuntary exercise.
APPENDIX M
POWER OF APPOINTMENT & DEFAULT
SECTION 5: Testamentary Power of Appointment. If a child dies before receiving his or her share in full, then upon the death of the child his or her share shall be held in trust hereunder or distributed to or in trust for such appointee or appointees, with such powers and in such manner and proportions as the child may appoint by his or her will making specific reference to this power of appointment.
Default. Upon the death of a child any part of his or her share not effectively appointed shall be distributed per stirpes to his or her then living descendants, or if none, then per stirpes to my then living descendants, subject to postponement of possession as provided below, except that each portion otherwise distributable to a descendant of mine for whom a share of the Credit Shelter Trust is then held hereunder shall be added to that share.
APPENDIX N
SINGLE FUND MARITAL
SECTION 1: Income. If my wife survives me, then commencing with my death the trustee shall pay the income from the trust estate in convenient installments, at least quarterly, to her during her lifetime.
Principal Invasion. The trustee may also pay to my wife such sums from principal as the trustee deems necessary or advisable from time to time for her health and maintenance in reasonable comfort, considering her income, and the liquidity of her other holdings from all sources known to the trustee.
For purposes of this will, my wife shall be deemed to have survived me if the order of our deaths cannot be proved.
SECTION 2: Election. My executor may elect to have a specific portion or all of the trust estate, herein referred to as the “marital portion,” treated as qualified terminable interest property for federal estate tax purposes. If an election is made as to less than all of the trust estate, the specific portion shall be expressed as a fraction or percentage of the trust estate and may be defined by means of a formula. I intend that the marital portion shall qualify for the federal estate tax marital deduction in my estate.
My wife shall have the right by written notice to require the trustee to convert unproductive property in the marital portion to productive property within a reasonable time.
APPENDIX O
DISCLAIMER PROVISION
ARTICLE _____: Distribution. As of my death the balance of the trust estate shall be held and disposed of as follows:
(a) The trustee shall forthwith distribute the balance of the trust estate to my wife if she survives me. For purposes of this agreement, if my wife is not living on the 30th day after my death, she shall be deemed not to have survived me.
(b) If my wife does not survive me, or if my wife survives me but disclaims a part or all of the distribution to her, the balance of the trust estate (or the disclaimed part of it) shall be held as a separate trust designated the “Credit Shelter Trust.”
APPENDIX P
REVOCATION
REVOCATION OF THE
JEFFREY HOLMES TRUST AGREEMENT
DATED MAY 22, 1997
On May 22, 1997, I, JEFFREY HOLMES, as settlor, executed a certain trust agreement with XYZ TRUST COMPANY as trustee, wherein I reserved the right at any time or times to amend or revoke the trust agreement in whole or in part by instrument in writing (other than a will) delivered to the trustee.
I hereby revoke the trust agreement and direct the trustee to deliver the entire principal of the trust estate and any income accrued thereon to me.
IN WITNESS WHEREOF I have signed this revocation this 5th day of April, 20014
____________________________________
JEFFREY HOLMES
Received and Acknowledged:
XYZ TRUST COMPANY
By: _______________________
Its: _______________________
Note: The names used in the foregoing Appendixes are the names of relatives of the author and are used with permission. They are not the names of actual clients.
1. http://illinoisattorneygeneral.gov/publications/calculator/2013calc/calculator2013.html