Trusts can be incredibly useful planning tools. They prevent property from passing through probate, preserve the privacy of the decedent and the beneficiaries, and depending on the type of trust, even can protect against creditor claims.
However, trusts also can fail, leaving beneficiaries with a bad impression of trusts and bitterness against the person who set one up, who is known as the grantor. The primary reason why trusts fail is because the grantor fails to properly fund them.
First, although there are a wide variety of types of trusts, they can be categorized a couple of different ways.
One way to classify trusts is according to when the trust is set up. Trusts that are set up during the grantor’s lifetime are called “inter vivos” trusts, while trusts that are set up only through an after-death document are called “testamentary” trusts.
Another way to classify trusts is according to the grantor’s ongoing relationship with trust property.
Trusts can be revocable or irrevocable. Revocable trusts mean that the grantor retains the power to change terms, can use property directly for his own benefit and claims any income on his own income taxes.
Irrevocable trusts generally mean that the grantor does not retain the right to change the terms of the trust and usually cannot use the property directly for his own benefit. Irrevocable trust terms determine whether income is taxable to the grantor or to the trust itself.
When setting up an inter vivos trust, the grantor takes action during her lifetime to make the trust a hybrid instrument that will work both during life and after death. Because the primary purpose of any trust is to be a vessel for property, neither aspect can work well unless the grantor legally transfers property into the trust name.
Inter vivos trusts distribute property without probate because the trust is the owner of the property and the trust does not die with the Grantor. For that reason, trusts must actually own the property.
The transfer of property into trust is called “trust funding.” Which property should be funded depends on the type of trust, but how property is funded depends on the type of property.
For example, real estate usually needs a simple Quitclaim Deed to transfer property into the name of the trust. Because real estate can cause delays in probate, it is nearly always transferred into trust, and can be placed in either a revocable or irrevocable trust.
Transferring bank accounts into trust, however, depends on the type of trust and how much access the grantor wants to retain.
For example, personal checking accounts never should be transferred into an irrevocable grantor trust because the grantor would need direct access to the accounts. However, certificates of deposit often are placed in the name of either revocable or irrevocable trusts.
Investment accounts are somewhat more complicated because qualified retirement accounts are often mixed with personal investment accounts. Qualified retirement accounts are only funded into inter vivos trusts that are set up specifically for the purpose of retirement accounts. If funded into the right type of trust, the tax advantages can be significant, but if the account is funded into the wrong type of trust, the tax liability could be unnecessarily costly.
Because retirement accounts in Kentucky are generally safe for Medicaid purposes and can have their own beneficiaries, it is uncommon to fund retirement accounts into trust. However, personal investment accounts are regularly funded into either revocable or irrevocable trusts with very little difficulty.
When properly funded, trusts are powerful tools for handling property during life and after death.
Transferring property into trust up front can lead to savings of time and money upon death.
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