What Is the Main Purpose of a Trust?
The answer to that question depends on the type of trust, even though there are commonalities amongst the different kinds of trusts. There are literally well over one hundred different types of trusts. Also, usually, a trust is established for more than just one purpose. This short article will address the main purposes of two particular kinds of trusts: the “revocable living trust” and the “irrevocable living trust“. Note that both of these types of trusts are called “living trusts” because they are created during your life. These are different from a “testamentary trust” which is created in your Last Will and Testament (which becomes irrevocable by default when you die).
Although testamentary trusts definitely have their place as in an estate planning attorney’s toolbox, they are not discussed here. Only living trusts (revocable and irrevocable) are addressed in this article.
Keep in mind that I am painting with some very BROAD BRUSHES here, and each case is different. That is why you should talk to a qualified estate planning attorney about your particular situation.
COMMON FEATURES OF ALL LIVING TRUSTS. As a general rule, both the revocable living trust and the irrevocable living trust share several things in common. They are (1) Probate Avoidance; (2) Ease of Administration of Assets During Life and After Death; and (3) Protection of Assets After Death (Occasionally). Each of these are briefly discussed below:
Probate Avoidance. Probate avoidance may be more or less important depending on your state of domicile. The judicial system in many states is effectively funded in part through the probate cases that are adjudicated through the judicial system of those states. This operates, in effect, almost like a tax. In those states, probate avoidance is a main purpose of a living trust (both revocable and irrevocable) because the costs of probate and the time involved can be so overwhelming. In those states, it almost (but not quite) borders on malpractice to not suggest a living trust to a client to avoid probate. I am licensed in Louisiana, and in my state, probate avoidance is not usually as important a motivator as it might be in other states.
Nevertheless, even in Louisiana, you want to avoid probate if you can. That is because probate is not exactly cheap even here. In other words, even though probate avoidance is not often the main motivator to creating a trust in Louisiana, it is nevertheless what we call “lagniappe” (an extra benefit) for an estate plan. This “lagniappe” (probate avoidance) often pays for the estate plan by itself in savings while getting the other benefits of a trust (discussed below).
Ease of Administration of Assets During Life and After Death. A main purpose of a living trust (both revocable and irrevocable) is the ease of administration. A properly established living trust is considered an extension of yourself for tax purposes. You would not need a separate tax ID number for the trust, nor would you have to file a separate tax return. Further, once you die, your successor trustee would “step into your shoes”, so to speak, and manage the trust property. Most clients who are married name both spouses as “co-trustees” who manage the property of the trust jointly. Once one spouse passes away, the surviving will manage the trust property as the surviving sole trustee. Then, once the survivor passes, the successor trustee (who is usually a child), manages the trust property to distribute the assets of the trust to the ultimate heirs (usually the children). Administration of a properly established trust is almost seamless. The successor trustee usually only needs to show a bank that he or she has been appointed successor trustee and provide a death certificate of the parents who have passed away. This is much simpler than the probate process (even in Louisiana) as discussed above.
Protection of Assets After Death (Occasionally). Note that a “revocable trust” is called “revocable” for a reason. You are able to revoke it during your life. Because you can revoke it, a revocable trust generally DOES NOT protect your assets during your life. You have to die (at which point it becomes irrevocable) for it to be able to protect your assets. Even then, most revocable living trusts (which become irrevocable at death) do not protect your assets after death. Why? Because the attorney that drafted the trust often is not thinking that far ahead. For him or her probate avoidance if often the main purpose of a living trust (which, as discussed above, usually should not be in many states, most especially Louisiana). If your trust is established by a good estate planning attorney, a main purpose of your trust is that it can protect your assets after you die. In other words, if one of your children have a creditor hounding them, and if the trust was properly created with proper provisions in it, the trust will protect the assets that the child stands to inherit. Again, keep in mind that that most trusts don’t have these asset protection features built into them. You have to ask for these features, and your attorney has to be skilled enough to build them into your trust. Most attorneys don’t draft trusts. Of the ones that do, many must find it challenging to build effective asset protection features into their trusts because many of the trusts I review that are produced by other attorneys have few to no asset protection features built into them. They often focus almost exclusively on probate avoidance and trust administration (which are important, but which should be the least important of your concerns).
COMMON FEATURES OF ONLY IRREVOCABLE LIVING TRUSTS. In general, the irrevocable living trust has these additional main purposes: (1) Protection of Assets During Life (and Occasionally After Death); and (2) Qualification for Medicaid Long-Terms Care Benefits. Each is discussed briefly below:
Protection of Assets During Life (and Occasionally After Death). A main purpose of an irrevocable living trust is to protect your assets during your life. Once you establish an irrevocable living trust you have effectively made a “gift” of your property to protect your assets. However, if you are the trustee of the trust, the property really does not leave your hands. You still control the property (albeit on behalf of the beneficiaries, the persons you made the gift to). It is not put into or controlled by the beneficiaries (often your children). In this way, if the trust is properly established by a good estate planning and asset protection planning attorney, the property in the trust is put in a sort of “way station” where you continue to control it, but creditors and predators can’t get at it (within certain limitations). Again, however, just like with a “revocable living trust” (discussed above), protecting assets after your death requires good drafting by your attorney. This is often not done, and unfortunately, is often an afterthought or is ignored. Don’t let the protection of your assets be an afterthought or be ignored. Make sure your estate planning attorney makes the main purpose of your trust protection of your hard earned assets.
Qualification for Medicaid Long-Term Care Benefits. This is a very specialized area of estate planning. If your irrevocable living trust is properly established, it can get the “5-year lookback” period running for Medicaid Long Term Care, and other important periods that are key to qualifying for Medicaid. This is important because MEDICARE does not pay for your nursing home costs beyond about 100 days. If you need to stay in a nursing home after that, you need to have private long term care insurance, or you can “private pay”. Private payment of long term care costs can set you back at least $6,000 per month (even in rural parts of Louisiana), to well over $10,000 per month in many areas of the United States. That is $72,000 to $120,000 per year. Will your savings last if you have to stay a year or two in the nursing home? The irrevocable living trust is meant to get you qualified for Medicaid Long Term Care benefits, but this is not a simple document. It is quite specialized and is usually drafted by specialists.
There are other (ancillary) purposes of most trusts that usually are not the main purposes for a trust. Also, if life, there is almost nothing perfect. As you might expect, there are certain drawbacks or costs to each option. I hope to address those secondary purposes and drawbacks/costs to each option in a future blog post.
For now, keep in mind that when it comes to an irrevocable living trust, there are advantages and disadvantages, and you’ll want to be fully informed before taking steps that may be costly to undo, explains the article “Understanding your trust” from The Sentinel. If your home is deeded to an irrevocable trust, you may not be able to make changes without getting permission from the principal beneficiaries named in the trust. Certain rights of ownership are transferred to the trust when you deed it to the trust. An irrevocable trust is usually a good advanced estate planning strategy for middle income clients, but you have to be aware of what you are doing. It is the responsibility of a good estate planning lawyer to explain the strategy in detail based upon your individualized concerns.
You can always maintain the right to live in the home using some peculiarities under Louisiana law if that is a purpose of the trust, but if you want to change a principal beneficiary, they may have to agree. Accordingly, an irrevocable trust is usually not a good idea if you want to keep open the option to switch beneficiaries. For example, some clients frequently switch out who will be the heirs or legatees under their will or trust. For them, an irrevocable trust would not be advisable.
However, if you are certain, for example, that you want to treat all three (3) of your children equally (give them 1/3 each), and you won’t deviate from that decision come hell or high water, then this “drawback” of irrevocable trusts is really no big deal. It’s not a drawback at all. The main purpose of the trust will not be affected.
Also consider the case of a home deeded to a trust with a mortgage on it. There was a time when lenders inserted clauses into mortgages that any time a sale or transfer of the deed occurred, full payment of the mortgage would be due. This changed, and today the mortgage is not due just because of a change in the deed. However, it may be a challenge to refinance, if the home is held in an irrevocable trust.
For most people, the main purpose of a trust is to protect the home into an irrevocable trust is to prevent the home from being lost to a creditor, including protecting the home’s equity from the cost of nursing home care, during life or after death.
The move to put a home into an irrevocable trust is often a great strategy, as long as the trust remains intact, even if the homeowner applies for Medicaid long term care before the five year “lookback period” expires. A complex calculation would have to be performed to ascertain if transferring the home to a irrevocable would be worthwhile and whether other important conditions apply. Sometimes, depending on the calculations, it will benefit the client, and other times it will not.
In Louisiana, when it comes to taxes, you are able to keep your property tax homestead exemption as long as certain conditions apply (it meets a certain purpose under Louisiana law), and the trust would allow you to qualify for certain income tax benefits. However, a poorly drafted trust could cause you to lose the homestead exemption and certain federal and state income tax benefits. In other words, if the trust is prepared by an experienced elder law attorney, it is likely that the capital gains on the sale of the home by the trust after the homeowner’s death will be taxed based on the home’s value at the time of sale, rather than the value at the time it is placed into the trust or on the day of death. If you think that you are not rich enough to be subject to estate taxes after you pass, think again. A poorly drafted trust can cause certain assets in your trust to be taxed very similarly to an estate tax.
If the home is the only asset in the trust, and other important conditions apply, the taxpayer ID of the trust will be the homeowner’s Social Security number, and no annual tax return is required. In other words, the main purpose of the trust will not be affected by income taxes, at least during your life.
An experienced estate planning attorney can explain the numerous strategies that can be used to protect your assets and your home from the high cost of long-term care. There are many Medicaid compliant techniques and tools, depending upon the situation of the individual and the family.
To learn more about more topics, read these articles: Will a QTIP Trust Work for a Blended Family? and Do Stepchildren Inherit? and What Is the Social Security Increase for 2022? and Some of Most Famous Estate Planning Mistakes
BOOK A CALL with me, Ted Vicknair, Board Certified Estate Planning and Administration Specialist, Board Certified Tax Law Specialist, and CPA to learn more about estate planning and asset protection.
Reference: The Sentinel (April 23, 2021) “Understanding your trust”