Trusts

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A trust is a useful and flexible estate planning tool that can be tailored to meet the needs of the grantor and his family. A competently drafted trust can accomplish many objectives. To find out whether a trust is right for your family, consult with an estate planning attorney. A trust is a legal arrangement where the grantor transfers legal ownership of property to a trustee to hold and manage for the benefit of named beneficiaries. Trust terms and definitions Reasons to set up a living trust Reasons to set up a testamentary trust Decisions of the grantor The beneficiaries The trustee Distribution of the trust funds Shares of the beneficiaries Duration of the trust Remainder of the trust Taxes Special trusts in North Carolina Professional services

Trust terms and definitions

Grantor. The person who creates the trust is the grantor. Other names for the grantor include: settlor, trustor, creator, or maker.

Beneficiaries. The persons who benefit from the property held in trust are the beneficiaries.

Trustee. The trustee manages the trust fund. Two or more trustees are called co-trustees. The trustee holds legal title to the trust property. The trustee is legally required to use the trust property for the exclusive benefit of the beneficiaries.

Trust Fund. The trust fund refers to the money or property in the trust. The property that is placed in the trust by the grantor is the principal. It is also called the corpus. The amount of interest or other investment earnings produced by the principal is the income. To insure income from the trust, trust principal should consist of investment assets, such as mutual funds, stocks and bonds, interest bearing accounts or certificates, and other income-producing assets. As a general rule, the ideal trust investment will yield high income, provide safety of principal, and have growth potential.

Trust Agreement. The trust agreement is signed by the grantor and the trustee. It tells the trustee how to manage the trust and how to distribute the trust funds to the beneficiaries. The provisions contained in the trust agreement are called "the terms of the trust."

Declaration of Trust. A declaration of trust is a type of trust agreement where the grantor is also the trustee. The grantor signs a formal written statement that he no longer owns the property personally, but instead holds it as a trustee for the benefit of the beneficiaries under the terms and conditions written in the declaration.

Trust Administration. The trustee's management of the trust is called the administration of the trust.

Trust Term. The trust term defines how long the trust administration is to continue. It could last for a set number of years, or for the lifetime of one or more beneficiaries, or until a certain event happens, or a combination of these.

Testamentary Trust. A trust established under the Last Will and Testament of the grantor is known as a "testamentary trust." It has no legal effect until the grantor dies.

Living Trust. A trust established during the lifetime of the grantor is called a "living trust" or an "inter vivos trust."

Revocable Trusts. The grantor may change or terminate a revocable trust. He has the right to ask the trustee to return all or part of the trust fund.

Irrevocable Trusts. The grantor may not change or terminate an irrevocable trust.

Life Insurance Trusts. A trust funded by life insurance is a life insurance trust. The grantor names the trust fund as the beneficiary of the life insurance policy or the trust may own the policy. When the insured dies, the trust is funded by the policy proceeds. The trustee manages the proceeds according to the trust terms. A life insurance trust is particularly useful when minor children would otherwise be the beneficiaries of the life insurance policy.

Remainder. At the end of the trust term, the balance of the fund is called the remainder. The beneficiaries who receive the remainder are called remaindermen or remainder beneficiaries.

Reversion. If the trust fund returns to the grantor after a period of time or on the happening of an event, the grantor holds a reversion.

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Reasons to set up a living trust

A trust established during the lifetime of the grantor is called a "living trust" or an "inter vivos trust." Some of the most common reasons for establishing a living trust are as follows.

• A trust provides financial management for the grantor's own benefit. A trust frees the grantor from time-consuming financial management decisions, allowing more time for a busy career or other interests. It also provides financial security for the grantor who fears he may become incompetent in the future and unable to manage his own finances.
• A living trust may serve as a "will substitute." After the grantor dies, the trustee continues to manage the trust assets. The trust assets are not tied up in probate and may be distributed to the beneficiaries without court supervision. However, the trust assets are typically subject to taxes, expenses, and claims of creditors, so beneficiaries may have to wait to receive their shares until all claims against the estate have been settled. A trust also provides privacy because the terms of the trust are not open for public inspection. A will, on the other hand, becomes a public document after it is filed in court.
• A trust provides financial support to others without giving them control of the trust property. For example, Mother and Father want to give financial help to Daughter. Daughter is married to Son-in-law, a compulsive gambler. Mother and Father are certain that Son-in-law will gamble away money given directly to Daughter. A trust may provide financial support to Daughter, while protecting the principal and income from Son-in-law.

Note: Beware of living trust scams that promise to solve all your tax, financial, and probate problems. Marketing information about living trusts is often incomplete, inaccurate, or misleading. Be careful of "prepackaged" living trust plans. Although some are prepared and sold by competent professionals, many are not. If you are interested in a living trust as a will substitute, see a competent attorney who concentrates his or her practice in trusts and estate planning.

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Reasons to set up a testamentary trust

A trust established under the Last Will and Testament of the grantor is known as a "testamentary trust." It has no legal effect until the grantor dies. Some of the most common reasons for establishing a testamentary trust are as follows.

• A trust may provide financial support to the surviving spouse while preserving assets for children. A trust is particularly useful in a second marriage where one or both spouses have children from a prior marriage.
• A trust provides financial security for others who cannot manage their inheritance. Minor children lack the maturity to handle money and property. Incompetent family members may lack the mental or physical ability to handle money or property. Others may be irresponsible with money. A trust preserves the assets by placing management of the funds in the hands of a trustee.
• A trust may provide a fund for the benefit of charity. Charitable trusts may exist indefinitely.
• A carefully designed trust or combination of trusts may reduce or eliminate federal estate taxes in both spouses' estates while providing lifetime benefits to the surviving spouse.

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Decisions of the grantor

The grantor must make some important decisions before setting up a trust.

• Who will be the beneficiaries?
• Who will be the trustee?
• When and how will amounts be given to the beneficiaries?
• How long will the trust continue?
• Who will receive the balance at the termination of the trust?

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The beneficiaries

The grantor must decide who will benefit from the trust. The trust may have one or more beneficiaries, including the grantor. Usually, a trust benefits the grantor or members of the grantor's family. However, a charity may be a beneficiary of a trust. Some trusts are designed to benefit both family members and one or more charities.

Current beneficiaries receive benefits from the trust currently. If the trust continues beyond a beneficiary's lifetime, a successor beneficiary may begin to receive benefits. Whatever is left over in the trust when it terminates goes to the remainder beneficiaries (or returns to the grantor).

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The trustee

The grantor may name an experienced financial adviser to manage the trust, or he may name himself, his spouse, a relative or a friend. The grantor should choose someone who is knowledgeable and trustworthy and who is available to handle administration of the trust. The grantor may name more than one trustee (co-trustees) to serve at the same time. The grantor may name an alternate trustee (successor trustee) to serve if the grantor's first choice cannot or will not serve as trustee.

Naming a corporate trustee, such as a trust company or a trust department in a bank, has some advantages.

• A corporate trustee will not die, get sick, go on vacation, become incapacitated, or move away.
• A corporate trustee has substantial experience in investing and managing money and property.

There are also some possible disadvantages to naming a corporate trustee.

• The services may be impersonal. This depends upon the individuals who work for the corporate trustee.
• Quality of services may vary among corporate trustees. Before choosing a corporate trustee, investigate the quality of the services. Look at the quality of their personnel and the success of their trust division. Try to find out whether their overall investment strategy produced a profit or loss.

In choosing a trustee, a grantor has many alternatives.

• Choose both an individual trustee and a corporate trustee. The individual trustee provides personal interest and the corporate trustee provides the expertise.
• Appoint an individual trustee and permit him to hire a corporate trust company for specific services.
• Give a beneficiary or a majority of beneficiaries the power to change the trustee if the one chosen proves unsatisfactory. Be aware of any possible legal and tax consequences of this provision. Also, the removal right gives a beneficiary more power than the grantor may want to give him.

The grantor decides how much power and responsibility to give the trustee. The trustee is under a legal duty to act in the best interests of the beneficiaries. If he misuses the trust property, he is personally liable. The grantor may require the trustee to post bond or file regular accountings with the court, or he may waive these requirements.

The grantor may set the amount of pay the trustee will receive. Professional trustees usually have an established fee schedule. Unless the grantor provides for a different method of payment, the law entitles the trustee to a minimum amount of pay based on a percentage of the trust income and on a percentage of the value of trust property. The clerk of court may authorize the trustee to be paid more than the minimum amount, as long as the trustee's total annual pay does not exceed the maximum allowed by law.

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Distribution of the trust funds

The grantor must decide how the trust funds will be distributed to the beneficiaries. This decision includes the treatment of the trust income and the trust principal.

Trust income may be distributed or accumulated in several different ways.

• All income may be distributed at regular intervals, such as quarterly or annually.
• All income may be accumulated for distribution at a later time.
• Part of the income may be distributed currently and part may be accumulated.
• All income may be accumulated and added to principal for a specified period and thereafter distributed. For example, the income may be accumulated and added to principal until the beneficiary reaches age 21. After the beneficiary reaches age 21, the income may be distributed as it is earned.

A trust that distributes all income currently is a simple trust. A trust that accumulates income is a complex trust. The tax consequences are different, and the taxation of a complex trust may be quite complicated. The grantor should ask his accountant or attorney to explain the difference in tax treatment.

Trust principal also may be distributed in several different ways.

• No principal is distributed until the trust terminates.
• Specific amounts of principal are distributed at designated times or intervals.
• The trustee may have discretion to make distributions of principal before the trust terminates. The grantor may place limitations on the exercise of this discretion.
• A beneficiary may have the right to make withdrawals from the principal of the trust. The grantor may place restrictions on the withdrawal right. Unless properly limited, a withdrawal right may have unwanted tax consequences for the beneficiary.

The directions to distribute trust funds may be mandatory or discretionary. If the directions are mandatory, the trustee has no choice but to distribute the funds according to the trust terms. If the directions are discretionary, the trustee may decide whether to distribute the trust funds. Your choice between a mandatory provision and a discretionary provision may have far-reaching consequences. Ask your attorney for more information.

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Shares of the beneficiaries

The grantor must decide when the beneficiaries are to receive their shares. The grantor has many options. For example, each beneficiary may receive his or her share upon reaching a certain age or after a specified number of years. The shares may be distributed when the youngest beneficiary reaches a specified age. Or, a beneficiary may receive part of his share at a certain age, and the rest later. For example, each beneficiary receives one-half of his share of trust principal upon reaching the age of 21. He receives the other half upon reaching age 25. At this point, he is no longer a beneficiary of the trust. The trust terminates when the youngest beneficiary reaches age 25.

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Duration of the trust

In North Carolina and most states, a trust cannot last forever (except charitable trusts). The grantor must decide how long the trust will continue. The grantor may set a specific period, such as ten years. The trust term may last for one or more lifetimes. For example, it may last for the lifetimes of the surviving spouse and all the children.

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Remainder of the trust

At the end of the trust term, the balance of the fund is called the remainder. The beneficiaries who receive the remainder are called remaindermen or remainder beneficiaries. The grantor must decide who will receive whatever is left in the trust when the trust terminates. The trust fund may return to the grantor or go to a remainder beneficiary. The remainder beneficiary may be someone who currently receives benefits from the trust or someone else.

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Taxes

A trust may have tax consequences for everyone associated with the trust, including the grantor, the beneficiaries, and the trustee. To a large extent, the grantor controls the tax consequences by the choices he makes when he creates the trust. Each decision affects the tax consequences. Here are a few questions a tax adviser must ask to determine the tax consequences of a trust.

• What powers and rights are held by the grantor or the grantor's spouse?
• Is the trust revocable or irrevocable?
• Is the income of the trust currently distributed or accumulated?
• Is the grantor or the grantor's spouse a trustee?
• What powers are held by the beneficiaries?
• What powers are held by the trustees?
• Does the trust benefit someone more than one generation younger than the grantor, such as a grandchild?
• How long will the trust continue?

A trust may incur the following taxes.

• Gift tax
• Income tax
• Estate tax
• Generation skipping transfer tax

The terms of a trust must be drafted cautiously to achieve the desired tax savings and to avoid unexpected tax results. No one should attempt to establish a trust without competent professional advice.

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Special trusts in North Carolina

North Carolina Trust Accounts. A trust account is a standard form of a revocable trust. A depositor (the trustee) may establish an account that he may use without limitation during his lifetime. On his death, the account passes to a named beneficiary. The trust account can be established by only one trustee for only one beneficiary. The trustee may change the beneficiary. Check with your bank for details.

Custodial Trusts. A person may create a custodial trust of property under the North Carolina Uniform Custodial Trust Act. There may be only one beneficiary to the trust. The beneficiary, if not incapacitated, directs the trustee in the management, control, investment, or holding of the custodial trust property. If the beneficiary is incapacitated, the trustee manages the trust on behalf of the beneficiary. Transfers to the trust are limited to $100,000, not counting a personal residence. Only the beneficiary, or his legal representative if he is incapacitated, may terminate the trust. If not previously terminated, the trust terminates on the death of the beneficiary. See your lawyer for more information.

Trusts for Pets. A person may create a trust for the care of one or more domestic or pet animals alive when the trust is created. The trust ends at the death of the animal or last surviving animal. Upon termination, the trustee must transfer the property as directed by the trust, or under the transferor's will, or if there is no will, under the laws that determine who inherits someone's property without a will.

Trusts for Cemetery Lots. A person may create a trust for the care of a cemetery lot, grave, crypt, niche, mausoleum, columbarium, grave marker, or monument.

Honorary Trusts. A person may create a trust for a noncharitable corporation or unincorporated society or for a lawful noncharitable purpose for 21 years.

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Professional services

Trusts involve a host of issues, including legal, tax, accounting, financial, and investment. A team of professionals is helpful throughout administration of the trust. In addition to providing legal advice, an attorney drafts the trust documents. Choose an attorney who concentrates his or her practice in trusts and estate planning. To handle tax and accounting issues, hire a certified public accountant who concentrates in trusts and estate accounting. Other professionals on the team may include a trust company, trust department of a bank, or a certified financial planner.

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References from the North Carolina General Statutes:
Chapter 32. Fiduciaries.
32-2. Definition of terms.
32-27. Powers which may be incorporated by reference in trust instrument.
32-34. Restriction on exercise of power for fiduciary's benefit.
32-50. Compensation.

Chapter 33B. North Carolina Uniform Custodial Trust Act.
33B-1. Defintions.
33B-2. Custodial trust; general.
33B-6. Single beneficiaries; separate custodial trusts.
33B-7. General duties of custodial trustee.
33B-8. General powers of custodial trustee.
33B-9. Use of custodial trust property.
33B-10. Determination of incapacity; effect.
33B-13. Declination, resignation, incapacity, death, or removal of custodial trustee; designation of successor custodial trustee.
33B-14. Expenses, compensation, and bond of custodial trustee.
33B-15. Reporting and accounting by custodial trustee; determination of liability of custodial trustee.
33B-17. Distribution on termination.
33B-18. Methods and forms of creating custodial trusts.

Chapter 36A. Trusts and Trustees.
36A-1. Definition.
36A-2. Investment; prudent man rule.
36A-3. Terms of creating instrument.
36A-52. Gifts, etc., for religious, educational, charitable or benevolent uses or purposes.
36A-53. Charitable Trusts Administration Act.
36A-54. Charitable trusts tax exempt status.
36A-59.3. Definitions. (charitable remainder trusts)
36A-60. Definitions. (Uniform Trusts Act)
36A-73. Powers exercisable by one or more trustees.
36A-78. Power of settlor.
36A-79. Power of beneficiary.
36A-80. Power of the court.
36A-81. Liabilities for violation of Article.
36A-107. Trustees in wills to qualify and file inventories and accounts.
36A-120. Discretionary revocable trust accounts in financial institution.
36A-136. Powers of a trustee.
36A-145. Honorary trusts.
36A-146. Trusts for cemetery lots.
36A-147. Trusts for pets.
36A-148. Termination of small trusts.

53-146.2. Trust accounts.
54-109.57. Trust accounts.
54B-129. Joint accounts.

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Prepared by Carol A. Schwab, J.D., LL.M., Professor and Extension Specialist, NC State University.

This publication is provided as a public service and is designed to acquaint you with certain legal issues and concerns. It is not designed as a substitute for legal advice, nor does it tell you everything you may need to know about this subject. Future changes in the law cannot be predicted, and statements in this publication are based solely on the laws of North Carolina in force on the date of publication.

Date: July 2000