Lately I have written a number of difficult posts that relate to trusts. A reader asked me why I hadn’t written anything that simply explains what a trust is. I was surprised to see that I hadn’t, so . . . .
First, let me set this up. I’m going to start with trusts and pickup trucks. One particular yellow Nissan Frontier pick-up truck operated by my son Bobby. He thinks he owns it.
BWAHAHAHAHA! No. He doesn’t. I do.
He thinks he owns it because he is the only one who drives it (his Mom doesn’t know how, it being a manual transmission, and I don’t care to because people would wonder why a 63 year old gray-haired guy was driving a canary yellow pick-up truck with a little wiggly hulu girl stuck on the dashboard – I do have my pride).
He is the only person who operates the truck because I, the legal owner, allow him to operate it.
And there you have a good model to think of as I explain what a trust is.
A trust is simply an arrangement in which the legal title of an asset is separated from the right to benefit from the asset either now or in the future. There are two types of ownership interests: a beneficial interest (sometimes called an equitable interest . . . what my son has) and legal title (what I have).
Legal Title
A legal title demonstrates apparent ownership of property. Legal title does not, however, necessarily demonstrate full or complete title to property. Legal title may evidence that certain property is shown to be legally owned by a person, yet that legal title owner may be required to hold the property for the benefit or use of some other person (which, dear readers I am decidedly not required to do for my son . . . thus no trust). For example, an automobile or real property may be titled in the name of a certain individual as the trustee of a trust, which would require that individual to hold the property pursuant to the terms of the agreement that set up the trust . . . even though the trustee’s name is shown as the legal title owner.
Beneficial Interest
In many cases, a person need not have legal title to property in order to enjoy the use or benefits of the property. For example, if a trustee is the legal title owner of certain property (say, a truck), but the terms of the agreement that set up the trust require the trustee to allow a person to use the property in some manner (as long as he drives responsibly!), or perhaps to distribute the property at some future time to that person, that person is said to have a beneficial ownership interest.
Same People . . . Or Different?
Most often the legal title holder and the beneficial owner are the same person. If a person has legal title to an automobile but also has the automobile’s keys in his pocket and the right to use the automobile as he wishes, that person owns both the legal title and the beneficial interest in the automobile.
The two ownership concepts can be split between two or more people . . . which is what a trust is all about.
A History Lesson
The English may be credited with inventing trusts, but they received much inspiration from the Romans.
Five or six hundred years ago the English nobility and the church realized that splitting legal title and beneficial interests had great advantages.
In feudal England legal title to real property (what amounted to what us 21st century types think of as “outright ownership”) had all sorts of obligations and other prohibitions on how the property could be used. For example, the legal owner of land may have been prohibited from conveying the land to his heirs by Will. Also, the amount of taxes due to the crown was largely determined by the amount of land to which someone had legal title. Also, legal title carried with it other obligations owed the crown by a nobleman.
At that time, the church depended in large measure on the income from huge tracts of land, yet there were laws that prohibited the church from holding legal title to land.
Both the nobleman and the church had some incentive to figure out how to put legal ownership of land in other people, yet at the same time enjoy the benefits of the land.
This raised immediate practical issues. For example, a duke may have found it useful to divide his 100,000 acres into smaller tracts and have some of his friends and family, perhaps some barons and some of his children, hold legal title for him. He would have simply conveyed the land to these persons with a “little side agreement” that they would hold the land for His Lordship.
Similarly the church may have prevailed upon certain individuals to hold legal title to land for the benefit of the church because the church could not directly own the land.
In the end, the duke and the church “trusted” (get it?) some other person to hold legal title and to “do the right thing” on behalf of the duke or the church. Of course, human nature being what it is, the people who were trusted with holding legal title would often times “forget” that they had been trusted by the church or the duke to do the right thing. Forgetfulness could be very convenient.
Unfortunately for the duke or the church in those cases, the old courts of law were interested in enforcing legal concepts only, and one of those legal concepts was legal title. A court would look to legal title only and pronounce that the legal owners were the legal title holders (presumably the now ex-friends of the duke and the presumably now excommunicated church members!).
In that case the only recourse for the now-frustrated duke or the church was an appeal to the crown or the king’s or queen’s council. The chief lieutenant to the crown was usually someone referred to as the chancellor. The chancellor was a learned individual trained in the law (and quite often a church official such as a bishop or a cardinal). The chancellor could (and often did) look “beyond the law” to fashion an equitable remedy that seemed to be right and fair for all parties concerned. And thus came about the early law of trusts.
In such cases, the legal title holders would be ordered to hold the property for the use of the duke or the church, who were said to hold a beneficial interest in the property.
As will be seen, splitting legal title from beneficial interests continues to be useful to this day and forms the basis of modern trust law.
The Key Players
Learning the terms applied to key personnel is essential to a good understanding of trust basics.
Settlor or Grantor
Sometimes called a Trustor, the Settlor is the individual who establishes a trust. A Settlor may, or may not be, the person who transfers legal title of property to a trust. Although the term Grantor is also used more or less interchangeably with Settlor and Trustor, in the purest sense, a Grantor is the one who conveys property to the trust. Unless the facts call for a clear distinction, this study guide uses the terms Grantor, Settlor, and Trustor synonymously.
Trustee
The Trustee is the person (or entity . . . a trustee can be, and often is, a bank or trust company) to whom legal title is transferred. The Trustee holds legal title strictly subject to the terms and conditions specified in a document called the trust agreement.
Beneficiaries
A beneficiary is the person or entity to receive the direct or indirect use of trust property, presently or in the future. The term traces its origins to the Latin terms bonus (“good”) and beneficium (a “favor” or a “privilege”).
Fiduciaries
A Trustee is a type of Fiduciary. A Fiduciary is an individual or entity who stands in a unique position of trust with respect to some other person, persons or entities. A whole body of law, called “fiduciary law,” applies to that relationship.
In summary, a fiduciary must conduct herself with the utmost due diligence, good faith, fair dealing, and reasonableness in regard to her dealings with those to whom she owes a fiduciary duty.
Trust Agreement
A trust agreement can be a simple document that names the trustee, specifies one or more beneficiaries and provides some sort of rudimentary instruction to the trustee with respect to holding and distributing the trust property.
Rarely, however, is a trust agreement so simple. Carefully prepared Trust Agreements will contain provisions that address such issues as:
Successor Trustee
Provision usually should be made for a trustee to serve in the event the named trustee under the Trust Agreement is unable or unwilling to serve. Restrictions on who (or what) may serve are not uncommon.
Beneficiaries
Certainly some provision must be made for those individuals who will receive the benefits of the trust property. Will beneficiaries receive income only? Perhaps principal? Will the Trustee have discretion with respect to distributing? What happens if a Beneficiary dies?
Manner of Holding Property
A Trust Agreement may contain provisions restricting the type of property that may be held or the type of investments the trustee may make.
Tax provisions
Very often trusts are used for tax planning purposes and contain elaborate tax provisions.
Administrative Provisions
Finally, a Trust Agreement will often contain various administrative provisions governing what law will apply, how (if at all) the Trustee will be paid, whether the Trustee may hire additional administrative assistance, and the like.
Trust Uses
There may be any number of reasons that a Grantor may wish to benefit an individual (including himself) but insure the Beneficiary does not hold legal title.
Spendthrift Trusts
A trust used to protect the assets from the Beneficiary’s careless ways.
Asset Protection Trusts
A Grantor can protect an asset from the creditors or other liabilities that a Beneficiary may have presently or in the future (including the Grantor’s own liabilities). Trusts are particularly useful in the Medicaid planning context. I write more about those here.
Minors’ (or Holdback) Trusts
Trusts are particularly useful for safely holding assets for a minor until she reaches a certain age.
Disability Trusts
A properly designed trust for the benefit of a disabled beneficiary can be the difference in a subsistence life style and a more generous life style in which public benefits are maintained. I write more about those here.
Marital Trusts
Often a person may wish to establish a trust for the benefit of a spouse, but use the trust to insure that assets will exist to pass on to future generations.
Avoiding Probate
A nice side benefit is usually assets in a trust will avoid probate. I write about those here.
Trust Types
Trusts may be classified according to any number of descriptive criteria. Understanding a number of the main classifications will provide a useful “short hand” method of describing various trust characteristics.
Irrevocable
An irrevocable trust is a trust that the Grantor is unable to revoke, amend, or force a return to him of legal title to trust assets. Other persons, however, may have the authority to amend or even terminate the trust. Further, the Grantor may retain certain other limited powers (perhaps, for example, the right to exercise a Special Power of Appointment or the right to appoint future trustees).
Revocable
A revocable trust is a trust in which the Grantor has retained full authority to amend or terminate the trust or to revest legal title to trust assets in himself.
Testamentary
A trust under a Will (anytime you hear the word “testamentary” you can be sure a Will is involved).
Inter Vivos
From the Latin, literally “between the living.” These trusts are established and funded by a very-much-alive Grantor.
And now that you’re an expert on trusts, I hope you’ll come back and check this article every-so-often when you need a little “refresher.”
PS I’m just going to give the truck to my son.
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