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FREQUENTLY ASKED QUESTIONS

Are there different kinds of trusts?
Yes, there are different kinds of trusts. First, there are testamentary trusts and there are living trusts. A "testamentary trust" is a trust created under a Last Will and Testament. As such, a testamentary trust becomes effective only after the testator’s death and, even then, the will must be approved and admitted to probate.
A "living trust," on the other hand, is a trust created during the grantor’s lifetime, and the trust becomes effective immediately upon its creation. Living trusts are created by a written instrument, called a "trust instrument." If the grantor is also the sole trustee, then the trust instrument is called a "declaration of trust," because the grantor simply declares his or her intentions to the world. However, if someone other than the grantor is a trustee, then the trust instrument becomes a "trust agreement," because the grantor and the trustee must agree on the terms of the trust.
Since living trusts are created during one’s lifetime, they can be either revocable or irrevocable. A "revocable trust" or "revocable living trust" is one that can be amended or changed, or even terminated, during the grantor’s lifetime. In almost all cases, it is the grantor who reserves this right when the trust is created. Even so, the trust becomes irrevocable upon the grantor’s death because only the grantor retains the right to amend or terminate the trust.
An "irrevocable trust" or "irrevocable living trust" is one that cannot be amended or changed, or even terminated, during the grantor’s lifetime. Once created, an irrevocable trust is governed exclusively by the terms of the trust instrument without any control by the grantor. For this reason, irrevocable trusts are created almost exclusively to obtain favorable income tax and/or estate tax benefits for the grantor, although irrevocable trusts are also created by the courts in divorce cases and property settlement cases involving minor children. A Life insurance trust is an example of an irrevocable trust that is often created to exclude the death benefits of a life insurance policy from federal estate taxation.
How do living trusts avoid probate?
First, we have to digress for a moment. One of the greatest benefits of living in this country is our right to own property and to be able to transfer that property to our intended beneficiaries upon our death. Not all countries allow that privilege to their citizens.
We not only have that privilege, we also have a system of laws and regulations that are designed to bring that privilege to fruition. First, we have the right to designate the person or persons who will receive our property upon our death. We can exercise that right through a Last Will and Testament if we wish. If we choose not to exercise that right, then the state will still try to get our property to the "natural objects of our bounty." Second, whether we choose to designate the beneficiaries of our property through a Last Will and Testament or not, the transfer of property to our beneficiaries is made possible by the probate court system of the state in which we live.
The probate court system is designed to settle decedents’ estates and transfer property to designated beneficiaries. However, it is important to know that all property does not pass through probate. Property that is owned jointly with another person, when there are rights of survivorship, does not go through probate. Jointly-owned property passes automatically to the surviving joint owner. Married couples often own their property jointly, such as bank accounts, cars, even their home. When one spouse dies, the surviving spouse automatically becomes the sole owner of the property without going through probate. Death benefits payable under life insurance policies also avoid probate if a valid beneficiary designation is on file. Upon the death of an insured, the insurance company issues a check directly to the designated beneficiary. The same is true with annuity contracts and retirement plans, including IRAs. As long as a valid beneficiary designation is on file, the death benefits payable under those properties are paid directly to the designated beneficiaries. There is no need for probate with these types of properties because a procedure to determine the intended beneficiary is already in place. Of course, if a valid beneficiary designation is not on file, or if the designated beneficiaries do not survive the owner, then these types of property will be paid to the owner’s estate, which then passes through probate.
For all practical purposes, the only property that does pass through probate is property that was owned solely by a deceased person at the time of his or her death. Think about it for a moment. Let’s assume that you are married and both you and your spouse are retired. You own your home, your car, your bank accounts, and everything else in joint name. Let’s assume further that you die and your spouse survives you. All of your jointly-owned property automatically becomes owned solely by your spouse as a matter of law. There is no probate of that property. Now let’s assume that your spouse dies. Who gets her property? How do we transfer the house, and the car, and the bank accounts when your spouse is the sole owner and she’s no longer here? We would have a real problem if it weren’t for the probate court system. First of all, your spouse has the right to designate the beneficiary of all her property under a Last Will and Testament. If she fails to make a valid Last Will and Testament, then the state will determine the beneficiary based upon existing laws. Finally, the probate court will appoint someone to represent your estate (most likely a child or other relative, if available) and authorize that person to identify your assets, pay your bills, and then transfer your property to the proper beneficiaries. The authority of the probate court allows for the orderly transition of property upon death. Without it, there would be total chaos. As vital as the probate court system is - and as good as the probate court system is - it is not always perfect. There are administrative delays and there are costs. In too many cases, the delays seem to go on forever and the costs eat up a good portion of the estate. It is these delays and these costs that have caused many people to seek alternatives to the probate court system.
So, how does a living trust avoid probate? Earlier we mentioned that certain types of property do not pass through probate because they already have a designated beneficiary. Life insurance policies, annuity contracts, retirement benefits, and jointly-owned property all fall into this category. Property held in a living trust also falls into this category because the trust instrument provides for a designated beneficiary of the trust property upon the death of the grantor. Living trust are recognized as legal entities in every state, and laws of every state exempt property in a living trust from probate.
If I have a living trust, do I still need a will?
Yes! A will is still necessary because it is very unlikely that you will have all of your property in a living trust upon your death. There may be a bank account in your own name or there may be debt owed to you by someone. There may be an income tax refund or a stock dividend paid to you. Whatever property is not in your living trust will pass through probate if it is owned solely by you. A will is the only way that you can designate a beneficiary for that property.
As a practical matter, a Last Will and Testament and a revocable living trust go hand in hand. The revocable living trust is set up to hold property during your lifetime and it serves as an excellent vehicle for the management of your property in the event of incapacity. It also serves to avoid probate on any property in the trust upon your death. Furthermore, it becomes an excellent vehicle to hold and manage your property for any beneficiaries that are minors or spendthrifts, etc. Although it is highly recommend that you fund your trust as soon as possible, you can fund it at any time. Once the vehicle is in place, then the decision is up to you. The Last Will and Testament is a fail-safe devise to pick up any property that did not get into your living trust during your lifetime and "pour it over" to your living trust after your death. In that way, your living trust becomes the sole vehicle for disposing of your property after your death.
So, if you have a living trust, make sure you also have a Last Will and Testament.
Are there tax benefits with a revocable living trust?
No! With a revocable living trust, the grantor retains the right to amend or change the trust instrument or to revoke or terminate the trust at any time. Because the grantor retains that much control over the property, the federal tax laws hold that the grantor still owns the property. Therefore, the grantor must report the income of the trust on his or her tax return, and must pay the taxes on that income, the same as if the property had never been transferred to the trust.
If the grantor is also acting as the sole trustee, then the grantor reports the income from the trust as though the trust did not exist. In that case, the trust is not considered a separate entity for tax purposes and there is no requirement that a separate employer identification number (EIN) be obtained for the trust. The grantor's social security number is used for all trust investments.
On the other hand, if someone other than the grantor is acting as trustee, then the trust is required to obtain its own EIN, and all trust investments will be listed under that EIN. In that case, also, the trust will file its own federal and state income tax return. The federal income tax return for trusts and estates is filed on Form 1041. If distributions are made to trust beneficiaries during a taxable year, then trust income for that year will be deemed distributed to those beneficiaries pro rata. The federal tax laws provide a rather complicated formula for determining the amount of income that is deemed distributed to beneficiaries during a tax year based upon the distributable net income (DNI) of the trust. The allocable share of trust income distributed to beneficiaries during any taxable year is reported to the beneficiaries on Form K-1, which is similar to a W-2 form or a 1099 form. The information on the K-1 form will then be reported by each beneficiary on his or her own federal income tax return for that year.
Most revocable living trusts that are established for estate planning purposes will not have a trustee other than the grantor. In that case, the income tax reporting of income earned by the trust during the grantor's lifetime will not present any particular problems. However, once someone other than the grantor is serving as trustee, then the federal and state tax laws become quite complicated and beyond the abilities of most grantors. For that reason, professional tax preparation and advice is highly recommended.
Can a living trust reduce estate taxes?
A revocable living trust does not reduce estate taxes, per se. That's because the grantor retains the right to amend or terminate the trust and to take back the property at any time. Under the tax laws, the grantor's right to take back the property means that he or she still owns it. And, if you own property, then you're going to be taxed on its income while you're alive and it's going to be subject to the estate tax when you die.
However, it’s important to realize that a living trust can - and often is - used as a vehicle to take advantage of certain estate-tax saving techniques available under the estate tax laws. These techniques are perfectly legal and are fully sanctioned by the tax laws and the Internal Revenue Service. Examples of these techniques include the Credit Shelter Trust to take advantage of the Unified Credit, the Generation-Skipping Trust to take advantage of the Generation-Skipping Tax (GST) exemption, and the Q-Tip Trust to take advantage of the unlimited marital deduction while preserving the right to pass property on to children from a previous marriage. There are others, too, but these are the most utilized techniques to achieve estate-tax savings through a trust.
It is important to note, too, that these estate tax saving techniques can be utilized through a testamentary trust as well. So, it is not necessary that you have a living trust in order to achieve these tax savings. Still, a living trust is generally preferred over a testamentary trust for other non-tax reasons.
Will a revocable living trust protect my property from creditors?
No, creditors can reach the property in a revocable living trust during the grantor’s lifetime since the grantor is still considered the owner. Even if the trust is irrevocable, creditors will be able to reach the property if the debt was incurred prior to the property being transferred to the trust. As a general proposition, if the grantor has any rights to the property in the trust, the creditors will be able to reach it. Upon the death of the grantor, creditors may or may not be barred from filing a claim against a living trust. So, a living trust will not provide any greater protection against creditors than if you continued to hold the property on your own.

Can I qualify for Medicaid (Title XIX) with a living trust?
The property in a revocable living trust is a "countable resource" for purposes of Medicaid qualification. Property in a revocable living trust is treated just the same as if it was owned by the grantor. So, in terms of qualifying for Medicaid, there is no advantage or disadvantage to a revocable living trust.
There is an exception for irrevocable living trusts. Under current Medicaid rules, any property transferred to an irrevocable living trust more than five (5) years before application for Medicaid benefits is not considered a "countable resource." However, you should consult a competent elder-care attorney if this situation is applicable to you.
For additional information on the medicaid program, including qualification requirements, see CMS, the Centers for Medicare and Medicaid Services.
Do I need an attorney to set up a living trust?
No, but it's a good idea. Living trusts are complicated, legal arrangements that require considerable knowledge and expertise. Qualified, estate planning attorneys have the skill and the legal training to advise you along the path to a sound estate plan that may or may not include a living trust.
Don't be fooled into believing that any of the off-the-shelf documents sold by a door-to-door salesman or by an internet web site will be just as good. The final documents for your estate plan, including a Last Will and Testament, a revocable living trust instrument, and possibly other legal documents, must be the product of a thorough analysis of your goals and objectives, your personal and financial circumstances, and your personal tolerances for risks and rewards. Moreover, a successful estate plan will often include the valuable input of an accountant, a trust officer, a banker, an insurance advisor, and an investment manager. If required by your particular circumstances, these professionals can mean the difference between a very successful estate plan and one that is not.