Funding your trust: a crucial step in achieving the benefits of a sound estate plan

The situation we’re about to describe sounds like modern-day folklore, but it is painfully true and far more common than one might realize.

Consider the story of John and Jane. Because of some recent changes in their family and business situations, they wisely scheduled a meeting with an estate planning attorney for a review of their 10-year-old trust and related documents. The review revealed that, while their trust otherwise seemed to be in order, it was missing a key element: assets.

Imagine their dismay when they learned that the estate plan in which they had invested so much thought and legal fees a decade earlier was an empty shell:

• If either John or Jane (or both) had passed away, most of their personal property, bank accounts, vehicles, collectibles, securities, business assets, and other investments would have been subject to probate, defeating their primary objective in creating their trust.
• If either had become incapacitated, there would have been no assurance that John or Jane’s assets would be properly managed or deployed for their care.
• The “spendthrift” provision that they had included to restrict their irresponsible adult child’s access to his inheritance would have been totally ineffective.

Fortunately, their story had a happy ending. As an unintended benefit of initiating their estate plan review, their new attorney inventoried their assets and retitled them as appropriate, ensuring that everything that belonged in their trust was actually conveyed to it.

Happy endings are not typical in these situations. The defects in do-it-yourself trusts, trusts prepared by a third party for a low fee, and other estate planning shortcuts are often exposed only when the trust is belatedly put to the test.

FUNDING YOUR TRUST

The following discussion covers various methods of conveying the types of assets most commonly owned by trustors (also known as "settlors").

Personal Property. Since tangible personal property, such as household furnishings, jewelry, etc., is without any recognized documentation of title, funding of this property is approached as a simple assignment from the settlors to the trustees. However, since this property might change frequently, and continuous additional assignments would be impractical, the initial assignment should cover “any and all tangible personal property now owned or hereafter acquired.”

Bank Accounts/ Taxable Investment Accounts. All retail bank accounts, such as checking and savings, and fully taxable investment accounts should be retitled into the trust. This is typically accomplished by presenting the bank or account custodian with a “Certification of Trust” that lists the minimum information that such institutions need in order to deal with the client as a trustee instead of an individual.

The vast majority of trusts are grantor trusts, meaning they are associated with the owners’ social security numbers, so there is no legal necessity to close existing accounts and open new ones for the trust. Nevertheless, in recent years, many banks and credit unions have resisted simply retitling existing accounts into a trust, so the opening of new accounts may be unavoidable.

Life Insurance. In most cases, insurance on the settlors’ lives will be made payable to the trust. If the settlors are the owners of the insurance, no changes other than the change of beneficiary need be made, and the settlors retain all ownership rights.

Retirement Benefits. Qualified accounts, such as a IRAs, 401(k)s, SEPs, etc., cannot be transferred into a trust while the owner is still alive; therefore, such assets have to be addressed through beneficiary designations.

Certain types of trusts can be named as the beneficiary, though transferring a qualified asset that way is complicated for both the successor trustee and the account custodian, so it is typically done only to address certain situations (e.g., beneficiaries who are minors, spendthrifts, or incapacitated adults, or who rely on needs-based government benefits).

If your beneficiaries do not fall into one of those categories, it is much easier to pass a qualified account to them outside of the trust via direct beneficiary designation.

Real Estate. Transferring real property into a trust occurs in one of two ways:

• a present transfer of interest via some form of warranty deed; or
• a transfer on death via a beneficiary deed.

The former is generally preferred, as it allows the successor trustees to easily manage the property in the event of the owner’s incapacity or unexpected death, but the latter can be a better option in the presence of complicating factors.

For instance, transferring a property into a trust almost always triggers the due-on-sale clause under a mortgage. Therefore, for real estate that is not owned free and clear, a beneficiary deed may be the better option to avoid probate without risking foreclosure.

Other sorts of property interest, such as a leases or rights of first refusal, are typically transferred into a trust via assignment, but real estate law is complicated, so be sure that your attorney is qualified to handle such transfers and has a full picture of what you own.

CONCLUSION

As this article hopefully has made clear, there are two essential steps related to setting up a trust: creating it and properly funding it.

By the time your trust is ready to execute, you will have invested a great deal of thought and effort in its creation. Do not sabotage your thoughtful planning by ignoring or taking shortcuts in the funding process.