Types of Trusts
Inter vivos “living” trust:
Revocable inter vivos “living” trusts (as will substitutes)
A revocable inter vivos (“living”) trust is created during the settlor’s lifetime. The written document accompanying the trust states who controls the assets while the settlor is alive (typically that person is the settlor himself) and what happens to those assets once the settlor dies. It is "revocable" because the settlor can make changes at any time. It is called “living” because the settlor creates and funds (usually) the trust during his lifetime. It is called a will substitute, because a living trust is an alternative to a will, thereby avoiding the probate process. Instead, the assets pass directly to the beneficiaries.
EXAMPLE: Lionel owns a house in a Philadelphia suburb. He wants to create a living trust and have the trust hold the title to his home (and other assets), for the benefit of his daughter, Lydia. After he establishes the trust, Lionel would record a new deed that would list the owner of the house as “Lionel Jefferson, trustee for the Lionel Jefferson Revocable Living Trust.” At Lionel’s death, the home would pass directly to Lydia.
The settlor is usually the sole trustee during his lifetime and maintains full control over the trust property. The trust becomes irrevocable upon the settlor’s death. One attractive feature of a living trust is that upon the death of the settlor, a co-trustee or successor trustee can take over administration of the trust property without waiting for probate of the will.
Yet, a living trust is not without costs. After all, someone has to draft the trust and implement it. Thus, in deciding whether a living trust is worthwhile, it is necessary to evaluate the total estimated value of the estate, which will determine if probate is even necessary. If the total estate is more than the statutory maximum for informal administration, it would probably be worthwhile for the settlor to establish a living trust.
Irrevocable life insurance trusts (ILITs)
Insurance policies are very useful in estate planning. Usually, an individual takes out a policy on his life, designating the beneficiary to receive the proceeds. As an alternative, a person can take out an insurance policy on his life and create a trust consisting of the policy and its proceeds. This can be accomplished in various ways:
- Making the policy payable to a designated person as trustee to hold in trust;
- Making the policy payable absolutely to a designated recipient who in turn agrees with the insured to hold the proceeds in trust;
- Assigning the policy to a third party as trustee; or
- Declaring himself trustee of the policy.
EXAMPLE: Efrem makes his life insurance policies payable to Marion, as trustee. At the same time, Efrem and Marion execute a trust agreement that spells out Marion’s duties and obligations towards the insurance proceeds. Although Efrem reserved the right to terminate or amend the trust or change the beneficiaries, a trust rises immediately. This is so even though the beneficiaries only enjoy the benefits of the trust after Efrem’s death.
The goal of an irrevocable life insurance trust (ILIT) is to hold life insurance insuring the settlor, without such insurance proceeds being included in the settlor’s taxable estate. For an ILIT to be effective, the settlor can have no power to change, modify or otherwise affect the life insurance owned by the trust. Otherwise it will be includible in the settlor’s taxable estate.
The trust is funded with the life insurance policy and/or cash. If the settlor uses an existing policy, the settlor must survive a three-year period in order to prevent the insurance proceeds from being included in the settlor’s estate. See IRC § 2035(d) and IRC § 2042. Rather than worry about surviving for this period, the settlor can transfer cash to the trust and have the trustee pay the premiums on a new insurance policy.
Resulting (implied) trusts
A resulting trust involves a reversionary interest (i.e., an interest remaining in a prior owner) when the equitable (or beneficial) interest in property was not completely or effectively disposed of. Like a constructive trust, it arises by operation of law rather than a settlor’s express intent.
Generally, a resulting trust is established where:
- The settlor did not completely dispose of all the equitable interests, especially if there is excessive trust res;
- Unanticipated circumstances arise for which the trust does not cover; or
- The expressed trust is unenforceable, due to some flaw in its drafting.
EXAMPLE (1): Reginald conveys his South Carolina home “to Ryan in trust to pay such amounts of income as are necessary for the support of Adam, and on Adam’s death to convey the home to St. Matthew’s Church.” Given its prime location, the income from the home greatly exceeded the amount reasonably necessary for Adam’s support. The court can determine that the surplus was not disposed of and impose a resulting trust, payable to Reginald or his heirs.
EXAMPLE (2): Reginald bequeaths “to Ryan in trust to pay the income to Adam for life, and on Adam’s death to transfer the principal to Adam’s then living issue.” Adam died without having any children. Since the trust did not take into account this situation, the property reverts (i.e., Ryan holds the corpus by way of a resulting trust for Reginald or his heirs at law).
EXAMPLE (3): Reginald bequeaths “to Ryan, as trustee” but fails to name any beneficiaries. As such, the trust fails and Ryan holds a resulting trust for Reginald’s estate or heirs at law.
A constructive trust is a remedial device, created by operation of law, when property is improperly acquired by someone who is not entitled to the property (e.g., acquired by the trustee when the trust is unenforceable); and is usually imposed to cure wrongdoing or prevent unjust enrichment. If the trustee refuses to carry out an oral trust agreement, the court steps in to apply a constructive trust to prevent unjust enrichment of the trustee.
Another reason a court may impose a constructive trust is when there is a breach of fiduciary duty.