One question I often hear from farm families as they discuss their estate-planning needs is whether they should establish a trust.
This is a great question, because there are many types of trusts. Forming a trust can be complicated, especially when you are trying to find the best way to move forward with your estate planning.
The first thing I typically ask a farm family who brings up the trust issue is, “Why are you asking?” or “What have you heard about trusts?” I do this because there are many opinions or thoughts on trusts and trust planning that seem to get passed around. I want to understand what potential roadblocks may be surrounding the topic. Some comments I have heard are, “My uncle had a trust, and it didn’t matter, we had to probate anyway,” or “My neighbor has a trust and says everyone should have one.”
I understand where these questions come from, because there are so many different types of trusts and different uses for them. Let’s discuss some of the common types of trusts and some practical tips for how to use them.
Revocable “living” trusts
One of the most common types of trusts is the revocable trust, oftentimes referred to as a “living trust.”
One of the main benefits of trust planning is that probate may be avoided if the trust has been properly funded and assets retitled appropriately.
“Funding” a trust means that all assets that are titled in your individual name should not be titled in the name of your trust. This enables the trust to have ownership over that asset and, thus, avoid probate.
For example, let’s say you have a bank account with $100,000 in just your personal name and you set up a trust. When you die, there may be a need for probate because that bank account was not properly titled in the name of your trust. Most banks are familiar with this process, and your attorney can help you with the titling process.
A revocable trust also can be amended, changed or revoked at any time during the life of the grantor of the trust. Revocable trusts also are confidential and, if properly drafted, help avoid potential family conflicts.
Typically, in Iowa, it is common to see each spouse have their own trust, just like each spouse would have their own will. We do see joint revocable trusts (where there is one trust covering both a husband's and wife’s lives), but attorneys seem to be trending away from using that type of structure. Several factors, including tax issues, may pop up.
The best way I can explain a revocable trust is that it essentially creates a “shell” around your estate. A revocable trust is not a taxable entity, meaning that you still file your own individual tax returns under your Social Security numbers. It is only upon your death that the revocable trust becomes irrevocable — or not changeable — and a separate tax identification number may come into play.
Irrevocable trusts are not changeable
Revocable trusts often are confused with irrevocable trusts. One common type of irrevocable trust is a revocable trust that has become irrevocable because of the death of the grantor. Typically, this is when the trust is being administered, and assets are being distributed to the heirs of the grantor.
Some types of irrevocable trusts are less common and often used to hold an asset that has been gifted for purposes of federal estate and gift tax. They also may be used to hold life insurance policies (sometimes referred to as irrevocable life insurance trusts or ILITs) that are meant to be kept separate from a person’s estate. An irrevocable trust typically cannot be changed, amended or revoked without court and beneficiary approval.
Testamentary trust
Another common type of trust is a testamentary trust. These trusts are established after a person’s death, and usually the terms are laid out in a person’s will.
One example is a family trust or marital (spousal) trust. Typically, these trusts are used to protect the assets of the first spouse to pass and keep them separate from the surviving spouse’s estate. The spouse or family usually is entitled to income, and sometimes principal, and may be set up for tax purposes.
Other uses for trusts
Testamentary trusts also may be used to place restrictions on specific assets, such as land or a business, to ensure the land will continue to be held or the business continue. A special-needs or supplemental-needs trust also may be set forth in a person’s will to establish a trust after death. This is a benefit for someone who needs a monthly supplemental income but qualifies for government assistance due to a disability or other issue.
What does all of this mean?
Understanding legal tools available to you before you start planning is a good idea. This enables you to confidently walk into your attorney’s office with the beginning of a vision for your estate plan consistent with your family’s goals.
Trusts are not for everyone. There may be a particular reason your family situation calls for the use of a will or other planning approach. In all of the families I have spoken with on the topic of succession and estate planning over the years, I can confidently say that not one of those families has the same exact plan. Your plan needs to be tailored to your unique farm business and family dynamics.