Essay Non-Fiction posted November 30, 2022

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A basic education on trusts

The Problems with Trusts

by Patrick Astre

The Problems with Trusts

            I’ve had a lot of experience with trusts over my last four decades in practice. I’ve helped plan them, create them and put them in place.  I have also encountered many trusts that accomplished nothing, weren’t even needed, and created tax problems and many other issues.  

This series of articles is designed to give you a basic education on trusts so you can understand the need if you have any, the kind of trusts needed, and the pitfalls associated with trusts. I want to emphasize that the entire purpose of this series of articles is to give you a basic understanding of the kind of trusts there are, what they can or cannot accomplish, and how you may use trust to solve your own problems.  You will still have to deal with a financial and/or legal professional to create, and manage a trust.  But at least you will not go into this blindly, not knowing what is going on.

            Make no mistake about this, folks.  This is not textbook, theoretical studies, even though it is all based on current law.  This is real life with practical ideas and solutions, as well as avoiding the many pitfalls along the way.

            We will break this series into three parts:

            FIRST: Trustee Issues

            TWO: The many types of trust, their purposes and how to choose the right one for you.

            THREE: Maintaining the trust and accompanying problems, including tax issues.

            So let’s get started:

            TRUSTEE ISSUES:

All trusts are composed of six parts, or issues.

  1. The Grantor: That’s the person, persons, group or entity that creates the trust.
  2. The Contributor: This is the person, persons, groups or entities that fund the trust, put money into the body of the trust.
  3. The KIND of trust it is, and also controlling languages and action, beneficiaries, when and how benefits may be paid, etc…
  4. The body of the trust, also known as the “Corpus” which is the properties and funds placed in the trust.
  5. The Trustee.  This is the person, persons, entities, even committees that control the trust, including how, when, under what circumstances and to whom benefits are paid.
  6. Maintenance, continuing reviews and tax issues.  Laws change al the time, some laws may render a trust incapable of achieving its purpose. Every trust should be reviewed annually to be sure it is in compliance with changing laws. Tax issues and filings must also be handled annually.  These things for he most part are above the abilities of the average person and should be handled by professionals, including CFP’s, CPA’s and Attorneys.

Hold on to this article as we will refer to it throughout this series. Right now we will look at what I have encountered as the largest trust problem. No matter whether you are setting up a new trust or managing an existing trust, Trustee issues can be the biggest problem encountered. Let’s start with a real life problem with existing folks and their trust. As the Police TV shows will say, “Only the name have been changed to protect the innocents!”  But we’re running out of room for now, folks, so we will tackle the trustee issues in a column by itself next week.  However, one issue comes up often:  Who monitors trust to prevent the trustees stealing from the trust.  The answer is NO ONE!  Such actions are investigated only when a trust member or relative reports it to law enforcement.  Read the next Q&A for an example:

QUESTION:  My uncle and his wife passed away, leaving a trust for his handicapped son, my nephew.  My other nephew is now the trustee.  This nephew has a history of dishonest behavior and other problems.  I suspect he has been using the trust for his own purposes.  Does anyone like the IRS monitors these trusts?

ANSWER:  No.  The IRS only gets involved when the trust does not file or pay taxes.  They don’t monitor if the trust is used properly.  No one does.  This only happens when people or family involved with the trust complains.  If you have an idea with some evidence to back it up that he is misusing trust fund, you must report it to the police who will investigate by accessing bank and brokerage accounts to determine if the money was used for trust purposes.

The Problem with Trusts – Part II

            In our last column I stated that one of the biggest problems encountered with trusts was selecting a suitable trustee. That will apply to all sorts of trusts with few exceptions. This is especially true when you are creating a trust to protect or care for someone in the future.  Let me give you a real life example.  The only thing I changed was the names to protect their privacy.  - Joe and Jane had their first child, Joe Jr. in their late twenties.  Joe Jr. was born with autism.  Even though he was high-functioning, he will need care with daily living for the rest of his life.  Their second child, Janet, was thankfully born without problems.  At that point someone advised them to get a Special Need Trust and referred them to an attorney.  The lawyer set up the trust but failed to properly explain to them how to manage it.  That’s how I met Joe and Jane some twenty years later when the IRS was after them because they had not filed taxes for the Special Needs Trust (SNT.) Even though they did not like to pay the back taxes due, (who does?) that was actually the easy part. They asked me to explain how the trust works, which I did, then came the tough question: “I notice you don’t have a Successor Trustee named.  Who is going to be trustee when you die?”  They had no answer because no one had mentioned it to them before even though it is one of the most important issues in such a trust.

            The Trustee of a Special Needs Trust, (and all other trusts designed to take care of family members) must manage all investments, and that’s the easy part. The trustee is also responsible for filing taxes, but the most important part of the trustee’s duty is to know and understand the beneficiary and his/her needs. The trustee must know when money must be dispersed to handle an expense that the beneficiary needs. And of course there is the need for honesty.  It’s too easy to take money out of a trust (which the trustee can do) and spend it on something other than the needs of the beneficiary.  That’s also called stealing.  I call people who steal money designed to take care of a handicapped person, “dirtbags.” (Not a technical term.) So here are the common sense requirements for an effective Successor Trustee:

First: Must be younger than beneficiary, such as a sibling or cousin. In Joe’s case, Joe Jr. is

physically healthy and expected to live a long life.  When Joe Jr. reaches age 60, he will still need care, paid through the Special Needs Trust, but the current trustee, his dad, will be 88, if he lives that long.  Who takes over then?  Must be someone who cares for the beneficiary and will look out for his needs through the SNT. Relatives are preferable.

Second:  The trustee must have some sort of smarts when it comes to investing and taxation. I’m not saying the trustee needs to be a CFP or CPA, but he/she should know enough to understand when to call in the professionals to help.

Third: The trustee must be honest. (Duh!) But not as easy to determine as someone who may have been honest is suddenly confronted with the ability to take tens of thousands with little chances of getting caught.

So you see folks, its not as easy to figure out successor trustees as it first seems.  In Joe and Jane’s case, we lucked out with their daughter Janet.  She’s a fine young lady finishing high school and planning for college.  She will make a great trustee and is proud that she will be the one to take care of her brother if anything happens to the parents.  Remember folks, something ALWAYS happens, it’s called death, and whether you make it to 100 or die early at forty, death always comes calling, and we must be prepared for it.  That’s why we have wills and trusts.

In our next column we will examine how to determine if you need a trust and what kind of trust is needed.  One final warning, this column is just meant to give you ideas and a basic understanding of trusts. Always – Always consult a professional such as a lawyer or CPA.  Attorneys will create the trust and advise on what is needed.  CPA’s can manage taxation and other issues.

Please read the Q&A, it was actually asked of me a few years ago, but it is appropriate for this subject.

QUESTION:  I am a beneficiary of a family trust from my grandparents.  The trustee is my first cousin, and I have reason to believe he may be stealing from the trust.  Does anyone or any authority monitor trusts and what can I do about this?

ANSWER:  No one monitors such trusts except the family and other interested parties.  If you suspect the trustee is doing something wrong, you must consult with a trust litigation attorney.  Sometimes these issues are very hard to prove.  You also should be sure of your accusations as you can cause a lot of resentment if you are wrong.  

The Problem with Trusts – Part III  (The Living Trust-1)

            They came to see me in early March two years ago to get their taxes done. “When we pick up our taxes,” they said, “we want to talk to you about setting up a trust.” When I asked the first and most necessary question, why?  What are you trying to accomplish? Both looked confused, and finally he said that his friend and golfing buddy has one, and he says he is saving on taxes. He may say that, but I doubt that’s the case.  Trust income tax is higher than taxes on individuals, especially seniors like those folks. I told them that they should no more emulate his friend’s trust than take his medicine because it works for him!  As it turns out, what his friend has is called a “Living Trust,” probably one of the most used (and misused) trust instrument around, and the subject of this column.

            They met with me a week later, and said his friend told him that he got the trust to “avoid probate” and admitted that he did not save on taxes at all.  He further explained that he attended a seminar about Living Trusts and all who attended the seminar were given 20% off the creation of a trust, $4,000 instead of $5,000 – Great if you need a trust, $4,000 down the drain if you don’t! Remember a simple will costs between $400 to $1000.) Problem is, most people getting a trust through a public selling event called a seminar may not even need one.  Usually, the same thing can be established with TOD (Transfer On Death) accounts or jointly held property and bank accounts with ROS (Rights of Survivorship.)  In the case of this couple, their main retirement asset is a large IRA from when he retired and rolled over his 401K into an IRA. IRA’s do not go through probate, they are distributed to the beneficiary named on the account, thus probate is bypassed and not an issue.  Their bank accounts, house and automobile are all jointly held.  If anything happened to either one, the survivor would simply take over the accounts.  All you need to do is present the death certificate and the clerical staff at the financial institution will take care of it. So lets take a look at a Living Trust, what it is, what it can do and what it cannot do.

            A Living Trust replaces your will.  Everything goes into the trust including your final directives such as Living Will (I know the name is almost the same, but it isn’t the same thing.) A Living Will is your final directive for how you want to be taken care off when you are dying and there is no hope.  Do you want to be hooked up to machines, kept comfortable and pain free, what kind of treatment would you allow, etc…  Those are your final directives called a Living Will and is incorporated into your Living Trust.  Health Care Proxies, Durable Power of Attorney when you cannot make decisions and you appoint someone else to make those decisions for you.  Then we have the issue of who gets what, the distribution of your assets to whoever you choose, same as your will would provide.  The big difference is that you appoint a trustee to carry out the requirements you have placed into the trust.  This is like naming an executor or executrix on your will. Another important difference is that when you have completed your will, and you’re happy with it, there’s nothing else to do.  Just record the will, put it in a safe place and be sure to let your family know.  The will goes through probate, a Living Trust does not.  The trust provides continuity.  When you die, the trustee takes over and carries out your wishes as directed in the trust.  There are also things you must do such as changing title of all property that you want in the trust.  For example, your account may read as: John Doe.  That would be changed to: The Living Trust of John Doe. Anything that is not re-titled in the trust name must go through probate thus bypassing the purpose of the trust. So if you can bypass probate by owning property jointly, why would you need a Living Trust?  Certain conditions make it necessary, and in our next column we will take up the specifics so you can see if it applies to your personal situation

QUESTION:  I wanted to give each of my seven grandchildren $1,000 each, and their parents, my son and two daughters each $5,000.  That would be a total of $22,000 and my accountant told me I can only give up to $14,000.  How can I get around this ridiculous rule? Its my money after all.

ANSWER:  Your accountant is wrong.  First you can give ANY amount to ANYBODY you want.  Yes, it is your money and you have that right, but if you give over $14,000 per person you must file a gift tax return.  Not a big deal, easy information return and you will pay no taxes unless you have given over eleven million.  This is to prevent wealthy folks from giving away their fortune and escaping the estate tax.  Second issue is that it is $14,000 PER PERSON.  So go ahead, give it as planned, you will not need to file anything as no one person is getting $14,000.

The Problem with Trusts – Part IV (The Living Trust-1)

            In our last column we looked at one of the most common trusts, The Living Trust.  The most popular thing about a Living Trust is that it bypasses probate when a person dies.  However, a Living Trust is expensive, anywhere from five to ten times the cost of a will, and it doesn’t end there. Properties must be re-titled into the trust for it to be effective and one must keep up with it, as much, or more than with a will. On the other hand, there are plenty of situations when a Living Trust will solve potential problems.  Let’s take a look at them now, as well as some of the issues to handle when you have such a trust. 

ONE - You have property in multiple states.  Let’s say you have a home in Long Island, and a condo in Florida.  When you die, a probate estate is opened in Long Island, but it can only handle property in New York State.  A second probate must be opened in the state of Florida.  This is expensive and time consuming, paying for another crew of lawyers to handle the Florida probate.  This is called Ancillary Probate. There are ways to handle it, probably the easiest one is to put your kid’s names on the deed with rights of survivorship. However, this may not always be possible. Certain family situations may prevent such actions.  Remember that when you put your child’s name on the deed, he or she will own part of that property. Lawsuits, bankruptcy and other court actions may put your property at risk, so think carefully first.  One solution would be a Living Trust. Upon death the trustee would dispose of the property as per the directions you outlined in the trust.

TWO- Continuity of affairs.  If you have a complex business situation, or if your business would vanish if you passed away, a living trust would provide continuity of business through the trustee.  No probate, no delays.

THREE- Complex family situations. Estranged family members, hostile ex-spouses, a variety of difficult family situations that would become a disaster if you died.  A will can be challenged in probate.  A living trust theoretically can also be challenged, but it’s much more difficult, and if the trust is written up properly, such efforts are usually not successful.

FOUR – Avoidance of capital gains taxes in certain cases. That little house on the beach you bought fifty years ago for $20,000 is now worth one million. If it goes by probate and is inherited through the will, the property receives a “stepped up basis” to current value. If your kid sells it, no capital gains. You decide to put your kid’s name on the deed with rights of survivorship to avoid the delays of probate, or you do it because you fear you may lose it through long term care, or senility. That’s where the tax issue comes in. The IRS Regulations state that “The cost basis of the donor is transferred to the donee.” In other words, you lose the “stepped up basis” and your kid now has to deal with a capital gain created by a transferred cost basis of $20,000 resulting in a capital gain tax that could be as high as $300 to $400,000.

If it is held by a Living Trust probate will be avoided and the “stepped up basis” is not lost.  A living trust is revocable so the property is deemed to be held by you, and your heirs are the beneficiaries. 

FIVE – A Living Trust can do anything your will can do. You name the heirs and what you want them to receive. You place your final directives in the trust just as you would in a will – Where and how you want to be buried, your instructions for end of life care, you name your health care proxies, and your trustee.  The trustee will act as an executor would do for a will, and can also step in and handle issues if you are incapacitated.

FIVE – A living trust must have many things in place to be effective.  Any properties you own must be transferred to the trust, and retitled to read something like: The Living Trust of John Doe, instead of just having John Doe on the title. Failure to do this for existing properties and properties acquired in the future, will cause them to go through probate, thereby negating the effectiveness and purpose of the Living Trust.

SEVEN – The Living Trust is revocable. You remain in control at all times.  You can remove or add heirs as you wish, replace the trustee whenever you want, change your directives, and change just about anything you want until the day you die or become incapacitated.

EIGHT – The Living Trust must be maintained.  Your situation may change, you may get married, reconcile with a child you previously removed, perhaps put in special language for changing situations.  The point is that it is a living document that can be changed according to your wishes.

NINE – The Living Trust must be reviewed annually. Laws, and especially tax laws may change.  Your family situation may change.  It is important to have your attorney review the trust to be sure it is current with state and federal laws.  It is not a “set it and forget it” type of instrument.

            Be sure to read my column for next week where I will give you a methodology to determine if you need a trust and what kind of trust is needed.  I promise not to turn you into a lawyer, CPA or CFP, but you will have enough knowledge to understand the process. We are all afraid of the dark, those things we do not understand.  Having a basic knowledge of the issues takes the fear away and makes us more effective when dealing with professionals.     

Trusts & Occam’s Razor

Occam’s Razor is also known as the Law of Parsimony, it is a problem solving principle that states when you have competing theories or solutions, the simpler solution always works best.  This idea is generally attributed to the Franciscan Friar, William of Ockham (1287 – 1347.)  Over the years the name was misspelled to “Occam,” and the “razor” was added since using this problem-solving technique “shaves” complications from the problem.  In modern financial issues such as estate planning and trusts, it does very well when applied.  Here’s a real life example:  A widower wanted to be sure his assets would go to his son and that his ex-wife could not challenge the will through probate. To achieve this goal, his attorney created an irrevocable trust, and transferred his assets into the trust. Aside from the expense of creating the trust, he must now file taxes for the trust and when he needs something from the trust, he must go to his son since the trust is irrevocable and the son is the trustee.  In doing all this he created needless complications and Occam’s Razor would certainly apply.  All he had to do was put his son on the deed for the house with rights of survivorship and change his CD’s and other accounts to TOD (Transfer on Death.) The whole thing would be under $100 cost and require no tax filings or other types of complications.  Of course such solutions are not always available.  There are many instances where more complex solutions are needed, but we always look for the simple solution first.  Occam’s Razor!

With all that in mind, lets go directly to what I promised you in my last column: A method of determining if you need a trust, or other estate planning instruments. It’s a four step process, and its widely used in the medical field If you approached a physician with a medical issue, this is the process they would use.  We will use the same process.

            STEP ONE – Gather information. In the medical world your doctor would ask you many questions about your condition, then order tests.  CT Scans, X rays, blood pressure, blood tests, EKG, this is all gathering of information.  In financial planning it would be questions and examination of documents.  Are there special family circumstances or problems that must be considered?  What assets do you own and how are they titled?  What are your desire for disposition of such assets?  Do you have wills, trusts, etc… We often use a six page questionnaire to be sure we don’t miss anything.

STEP TWO – Analyze the information and recommend certain action to be taken.  Your doctor would basically do the same thing.  After analyzing the information gathered from all the tests and examinations, he or she would recommend a specific procedure or medication to alleviate the condition.  Same thing in financial planning.  After we analyze the information, then we chart a course of action.  Now is the time to remember Occam’s razor.  Perhaps a trust is needed, but maybe there is a certain way to minimize what will work.  It’s going to be different for everyone because we are all different and have different situations.

STEP THREE - Implement the solutions.  Your doctor may recommend anything from surgery to minor procedures and/or intervention by taking certain medicines.  Either way this will be a result of information gathering, and diagnosis.  Its not much different for financial issues. There are a wide range of financial and legal instruments that can be used to get the results we want, whether its medicine or finances, the methodology is the same.

STEP FOUR – Monitor the results.  You go back to your doctor monthly, annual or how often it is judged necessary.  The results of the medical procedures/medicines taken is monitored to be sure they are effective. So it is in financial planning.  We monitor the results and also keep an eye on changing situations.  Remember that the economic environment will change, tax laws will change and the various laws regulating financial instruments will also change. Equally important YOU may change or your family situation may change. Will your goals still be reached under those changing conditions? Monitoring is an important part of the process.

WORKING WITH A FIDUCIARY.  Imagine if your doctor worked for a certain pharmaceutical company and recommended only the medicine the company he worked for manufactures.  No matter what your condition is, that’s what you get!  Such a doctor would have a lot of patients in one place; the cemetery! And so it is in the financial world, but the difference is in finances your advisor may not work for you if he or she does not have a fiduciary responsibility.  CFP’s, CPA’s, all have a fiduciary duty. That means they must always act in your best interest, and not the interest of a company they may represent.  A perfect example of this is a life insurance agent. Their job is to sell life insurance even if you do not need it, or if something else may be more beneficial for you.  A CFP may tell you that life insurance is not needed, but something else is that would be better suited for you.  Please understand I am not disparaging life insurance or life insurance agents.  They are needed and generally do a great job, but they are not fiduciaries, and will always recommend buying a policy, because, well…that’s what they do!  So whenever you deal with an advisor, always ask, are you representing a company that sells a product? Are you a Fiduciary and will only recommend what is in my best interest?  Important question, folks.  In the Certified Financial Planner world we call that “doing your due diligence.” Be sure and do yours.     


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