What we are concerned with here is what is called an express trust, which is specifically created in documents for estate planning purposes, as distinguished from a constructive trust, which is a trust inferred by the law from the conduct or dealings of the parties.
As the name implies, a trust is created or declared in express terms for specific purposes by the direct and positive acts of the parties. The person(s) who creates the trust is called the settlor(s), grantor(s), or trustor(s) (which are interchangeable terms). The trustee holds and manages the property in the trust for the benefit of the grantor and others. The person(s) who creates the trust serves as the initial trustee(s) and, where two people create a trust, they serve as initial co-trustees. The initial trustee(s) names a successor trustee who takes over upon the death or incapacitation of the initial trustee(s). Beneficiaries are those who have the right to benefit from the property as specified in the trust agreement.
To be effective, a trust must be properly funded. That is, assets must be transferred into the trust, which transfers the asset from the grantor’s personal ownership to the trustee who holds the property for the grantor. Although the trustee has legal title to the property, he or she also has a legal duty to use the property as provided in the trust agreement. The beneficiaries of the trust hold what is known as equitable or beneficial title.
The Purposes of Trusts and the Advantages of Incorporating a Trust Into One’s Estate Plan
A common estate planning tool, trusts can serve many purposes, the most common of which is the avoidance of probate and the elimination or reduction of estate taxes. Assuming assets have been properly transferred into the trust, those assets will be transferred automatically under the terms of the trust at the grantor’s death, and will not be subject to a probate proceeding.
Although there are many misconceptions regarding probate, and the procedure is not as complicated as most think in many cases, as a general rule the avoidance of probate will help reduce legal fees and will keep a person’s estate from becoming public record.
A revocable living trust also offers the ability to provide for management of assets in the event the grantor becomes incapacitated, thereby avoiding the need for a conservatorship, the process of which is complex and costly. Although a person could rely solely on a power of attorney to avoid a conservatorship, a revocable living trust offers a few advantages over a power of attorney. Under Arizona law, guidelines for agents are exceedingly strict, and agents risk exposure for even technical misuse of their powers. Many institutions are more comfortable working with trustees so administration in the event of incapacitation runs more smoothly, and a revocable living trust provides the chance for more specific directions and guidelines as to how one’s assets are to be managed in the event of their incapacity.
In certain situations, the use of a trust, whether testamentary or living, can reduce estate taxes. A typical situation, and probably the most common, is that of a married couple with combined assets in excess of the unified tax credit exemption. With proper planning, estate taxes can be greatly reduced or even eliminated.
Both a living trust and testamentary trust can serve to protect beneficiaries by delaying or controlling distributions they may otherwise receive outright. There are a number of trusts available to accomplish this, the most basic of which are trusts created for children or young adults. Trusts also have the ability to protect a beneficiary’s inheritance from creditors, and can protect a beneficiary’s interests in the case of a divorce or other marital property dispute.
The Difference Between a Living Trust and a Testamentary Trust
A living trust becomes effective immediately upon signing, and a testamentary trust, which is created in one’s will, does not become effective until that individual’s death. Testamentary trusts are useful if one wants to set up a trust for a minor child or children without creating a separate revocable living trust.
A testamentary trust is an irrevocable trust once it is created, since the person who created it is deceased. To be clear, while the testator is still alive, he or she may revoke a testamentary trust at any time.
Revocable Living Trust
A revocable living trust is the most commonly used trust in estate planning. It can be amended, changed, or completely revoked, at any time, by the person or persons who created the trust.
Revocable living trusts may, in some cases, become irrevocable living trusts. This is typically the case where a married couple creates a trust agreement that provides after a certain party’s death, a new sub-trust is created which is irrevocable once it is formed. A few examples of this type of trust are the Marital QTIP Trust, the Credit Shelter Trust, and the Generation Skipping Trust. So be aware that a trust agreement that begins as a revocable living trust may ultimately create, under its language, a future irrevocable trust.
Generally, a trust is created and governed by a trust instrument, which could be a trust instrument created during life, a will creating a testamentary trust, a court order, or some other instrument. The instrument is an actual document that contains the terms of the trust.
The Arizona Trust Code provides the default rules for Arizona trusts. However, the terms of the trust may prevail over all provisions in the Arizona Trust Code with the exception of the mandatory provisions which include the requirements for creating a trust, the duty of the trustee, and the power of the court to modify or terminate a trust, among many others.
Irrevocable Living Trust
As the name indicates, an irrevocable living trust cannot be amended, changed, or revoked once it is created. Upon its creation, it is immediately irrevocable. Irrevocable living trusts are rigid and are usually used when they can offer some advantage with respect to estate, gift, or income taxes. A few examples of this type of trust are the Irrevocable Life Insurance Trust, the Charitable Remainder Trust, and the Qualified Personal Residence Trust.
Revocable living trusts may, in some cases, become irrevocable living trusts. This is typically the case where a married couple creates a trust agreement that provides after a certain party’s death, a new sub-trust is created which is irrevocable once it is formed. A few examples of this type of trust are the Marital QTIP Trust, the Credit Shelter Trust, and the Generation Skipping Trust. So be aware that a trust agreement that begins as a revocable living trust may ultimately create under its language a future irrevocable trust.
A Bypass Trust, also known as a Credit Trust, Credit Shelter Trust, or Exemption Equivalent Trust, is a type of trust where a deceased spouse’s estate passes to a trust rather than to the surviving spouse. It reduces the likelihood that the surviving spouse’s subsequent estate will exceed the estate tax threshold, saving what could be a substantial amount in estate taxes.
Upon the first spouse’s death, the trust assets are split between a Survivor’s Trust and a Credit Shelter Trust. Under this type of trust agreement, all of the surviving spouse’s property is allocated to the Survivor’s Trust. The Credit Shelter Trust is funded by the deceased spouse’s assets, up to the estate tax exemption amount applicable for the deceased spouse’s year of death. Any of the deceased spouse’s assets that are in excess of the estate tax exemption are added to the Survivor’s Trust and qualify for a marital deduction. This type of trust is useful when a decedent’s share of assets would not exceed the estate tax exemption amount, but a couple’s combined assets may exceed the estate tax exemption amount.
Irrevocable Life Insurance Trust
The Irrevocable Life Insurance Trust is one of the more common irrevocable living trusts. A separate entity is created, and a trustee other than the grantor holds life insurance on the grantor’s life. Upon the grantor’s death, the life insurance proceeds will not be included in their estate for estate tax purposes. To accomplish this, the Irrevocable Life Insurance Trust must be irrevocable, the insured may not possess any incidents of ownership in the life insurance policy within three years of death, the life insurance proceeds cannot be payable to the estate of the insured, and if the insured purchased the policy initially and then transferred the policy to the trust, the insured must be alive for three years following the transfer.
An Irrevocable Life Insurance Trust offers a number of advantages. It offers a supply of cash to pay for expenses, has a large value at the time of death, and is easy to give away as life insurance is not an asset typically relied on by people during their lifetimes. The major disadvantage to an Irrevocable Life Insurance Trust is that the insured must relinquish control over the life insurance policy. For example, the insured cannot borrow against the cash value of the policy, and the beneficiaries of the policy cannot be changed once the trust is established. There are also gift tax considerations to be aware of.
Providing For Adult Supervision of Property Left to Children
An important part of preparing your will is arranging for responsible adult supervision of any property your minor children might own. This can be accomplished in a number of ways including the creation of a child’s trust, a family pot trust, or utilization of the Arizona Uniform Transfers to Minors Act.
An advantage of creating a child’s trust is that it allows you the flexibility to choose the age at which each child receives outright the property you leave them. The trust only becomes operational if you die before a child has reached the age at which you’ve specified for him or her to receive the trust property outright. Until then, a trustee manages the trust property, spending it for the child’s “health, support, maintenance, and education.” A different trustee can be named for each child’s trust.
Another option is to create what is called a family pot trust, in which all property left to your children goes into one trust. One trustee is named to manage the property for the benefit of all the children, and is not required to spend the same amount for each child.
Arizona’s Uniform Transfers to Minors Act authorizes you to appoint an adult custodian to supervise property you leave to a minor. Trust property left in a will must be released to the minor child when he or she reaches the age of twenty-one. You can name a custodian for as many children as you wish, and you can name different custodians for different children. Pursuant to Arizona statute, the custodian may use as much of the custodial property as he or she considers advisable “for the use and benefit of the minor.”
Arizona is one of the few states that allows for the creation of trusts to benefit pets. A “pet trust” may be created for the benefit of one or more animals that were alive during the settlor’s lifetime. Animals may be added before the settlor’s death, and the trust may last until the death of the last surviving animal.