Basics of Estate Planning: Trusts and Subtrusts

This is another in a series of blogs on the basics of estate planning. In the last blog in the series, we looked at the income taxation of trusts. This week, we’ll look at the different types of sub-trusts that may be created under a trust (or a Will).

A trust may be created during life, either as a revocable trust or an irrevocable trust. Or a trust may be created under a Will. Regardless of the attributes of the instrument creating the trust, different sub-trusts may be created under the trust. If the assets start in the Will, the Will could name the revocable trust as the beneficiary, this is a “pourover” Will. Or, the Will could set up trusts directly.

If the assets start off in a trust, it may be called a Revocable Living Trust or some other name. There is no magic to the name of the trust. It just cannot be confusing or violate a copyright. Upon death, a temporary Administrative Trust may be created to pay expenses prior to splitting as directed by the instrument.

After the death of a married person, a trust is often set up under either the RLT or a Will to hold the applicable exclusion of the deceased spouse. That trust may be called many different names, such as the Family Trust, B Trust, Bypass Trust, etc. The rest of the assets of the deceased spouse may go into a Marital Trust. But, you should use caution, as sometimes different names are used, especially in trusts drafted decades ago.

Typically, the Family Trust and Marital Trust will terminate at the death of the surviving spouse, but this is not always the case and the terms of the trust always should be examined with care. After the termination of the intervening trust, or at some other time set forth in the instrument, such as the death of the grantor, one or more trusts may be set up for the beneficiaries.

A Pot Trust is a trust set up for several beneficiaries, typically children. The purpose of a Pot Trust is to keep the funds in one “pot” until a later event. For example, at the death of the parents, the assets may be kept in one pot until all the children have graduated from college or reached age 25. By doing this, parents can ensure that each child has a sufficient amount to go get a good start in life. Let’s say that there are 2 children ages 18 and 22 at the death of the parents and there are $400,000 in assets. Let’s assume that the 22-year old went to a school costing $50,000 per year and has now graduated. If the 18-year old went to the same school, without a pot trust, their entire inheritance would go toward their education. With a pot trust, once they are both out of college, the trust would split and each would get $100,000. Once the pot trust terminates, the remaining balance could be distributed outright or in further trust.

If there is no Pot Trust, the assets could be distributed outright to the beneficiaries or held in some type of trust. There are several common types of trusts into which a beneficiary’s share could go. First, it could go into a trust which allows the beneficiary to withdraw the assets at any time. This “Divorce Protection Trust” merely keeps the assets from being comingled with a spouse. It would be included in the beneficiary’s taxable estate and would be subject to their creditors. The effectiveness of this type of trust to shield assets in the event of divorce depends on the jurisdiction.

The next type of trust is a support trust, distributing for a beneficiary’s health, education, maintenance, and support. Such a trust would keep the assets separate from a spouse’s assets but may be subject to creditors, depending upon the state and whether the creditors fit within the ascertainable standard outlined in the trust. This type of support trust would not normally be included in the beneficiary’s taxable estate.

Another type of trust is the Sentry or Asset Protection Trust. This trust has a completely discretionary standard and a third-party trustee. Since a creditor “stands in the shoes of” the debtor/beneficiary, a creditor only has the ability to compel distributions which the beneficiary has. In the Sentry / Asset Protection Trust, the beneficiary has no such ability.

In upcoming blogs, I’ll cover more on the Basics of Estate Planning.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com