August 01, 2016 Feature

The Basics of Inter Vivos Trusts

Aastha Madaan

Inter vivos trusts, also known as “living trusts,” sometimes can seem like mythological legal documents. Clients hear about them in passing but are unsure of what they are and why they are created. Rumors about living trusts abound, and estate planning attorneys often are tasked with dispelling clients’ misconceptions and clarifying the truth about these documents.

An inter vivos trust is one that is created during the trustor’s lifetime and becomes effective upon creation. There are other types of trusts, including a testamentary trust (i.e., one created through the will of a deceased person), a charitable trust, and many more. The inter vivos trust, however, is the most common trust that estate planning attorneys encounter in practice.

There are many reasons to create an inter vivos trust, but the main benefit is that it is the best way to avoid probate. Probate is the formal process that dictates the distribution of assets of a deceased person. All 50 states have some form of procedure for distribution of assets, whether codified or judicial. States also have varied thresholds for circumstances under which probate is required. In most states, both small and large estate probates have to go through the court system; this can prove expensive, complicated, and time consuming. An inter vivos trust can allow clients to avoid these problems.

The Anatomy of an Inter Vivos Trust

In simple terms, a trust is similar to a contract. The trust creates a vehicle that holds a person’s or a family’s property during their lifetimes and allows for the property to pass seamlessly on to the beneficiaries afterward. Similar to a contract, a trust identifies the parties, the clauses that the parties agree upon, contingencies in case of a breach, definitions of words used in the documents, and instructions for the implementation of the document.

The main parties in an inter vivos trust are (1) the trustor or settlor, (2) the trustees, and (3) the beneficiaries.

The trustor or settlor is the creator of a trust. An individual can create a trust for himself or herself. Most often, married couples create a trust together. For an inter vivos trust, the persons who make the trust can serve as the trust’s managers, also known as trustees. The settlors also can choose successor trustees to succeed them after the death of the initial trustees. In a simple inter vivos trust, couples often name their adult children or their siblings to serve as trustees, but settlors can name any individual or even a professional fiduciary to serve as a trustee. The beneficiary is anyone who benefits from assets held in the trust. The beneficiary can be a person, a group of people, a charitable organization, or even pets.

The property that is held in the trust is called trust principal or trust corpus. One of the misconceptions about trusts is that once they are made, there is no need for the settlors to take any further action. It is imperative, however, for the settlors to “fund” the trust with assets. Earlier in this article, a comparison was made to a trust being a vehicle. The vehicle of a trust is only useful when it is carrying precious cargo, such as homes, rental properties, bank accounts, and other assets.

In addition to naming the parties, a trust must include the rights that the settlors are giving to the trustees. When the settlors are the initial trustees of an inter vivos trust, the settlors grant themselves all the powers they hold as individuals, so as trustees, they are not restricted in the actions they can take. By their nature, inter vivos trusts allow the settlors to amend or revoke them during their lifetimes. Similarly, because inter vivos trusts are made during the settlors’ lifetime, they should provide for disposal and distribution of the trust principal after the deaths of the settlors. In doing so, settlors can include a monthly allowance for beneficiaries or can allow for asset liquidation and complete distribution of trust property to the beneficiaries. If the beneficiaries were minor children when the trust was made, the settlors can specify the age until which the beneficiaries must receive a monthly allowance from the trustee and the age at which they receive ownership of the trust principal. An inter vivos trust also can provide ways to care for settlors and their property in case the settlors become disabled.

An inter vivos trust is usually accompanied by an abstract or a certification of trust. This is a summary of the trust that is signed and notarized alongside the trust. Some states have requirements for what should be included in the certification, such as the name of the trust, the date when the trust was formed, the names of the settlors and trustees, the powers of the trustee, and more. Banking institutions and county recorders accept abstracts or certifications as proof of the existence of a trust, and they use the abstract to transfer the assets from the settlors to the trust.

Pour-over wills are another instrument that can accompany the inter vivos trust. Where the abstract or certification can assist a settlor in transferring equitable title to assets that have title, such as real property, pour-over wills assist executors in seamlessly transferring property under the probate threshold amount into the trust at the death of the settlor.

Other documents that are often prepared along with an inter vivos trust are advance health care directive, powers of attorney for finances, and nominations of guardianships for minor children.

Requirements for Creating an Inter Vivos Trust

The probate code or equivalent thereof in each state delineates the requirements for creating inter vivos trusts. The basic requirements that must be fulfilled for an inter vivos trust to be valid are (1) the settlor must have capacity to create a trust; (2) the settlor must have intended to create a trust; (3) the trust must be funded; and (4) the trust must have ascertainable beneficiaries. These are formal requirements and come into play if there is a challenge to the trust during its administration.

In an inter vivos trust, the settlor places his or her property into trust, and into the trustee’s control during his or her lifetime, so capacity and the intent to create a trust are especially important for an inter vivos trust.

For their part, the trustees need to know to whom they owe a fiduciary duty. In order for beneficiaries to be ascertainable, either they need to be named in the trust or there needs to be another indisputable way to ascertain who they are intended to be (e.g., in the cases of unborn children or future spouses).

The Process of Setting up a Living Trust

Estate planning practitioners generally have internal office processes they follow in assisting clients create a complete estate plan, including inter vivos trusts.

The first step should always be to explain to potential clients the purposes, pros and cons, and details of a trust. It is also important for a practitioner to explain to potential clients that a living trust is not the best option for everyone. The size of the estate, the family structure, and the types of assets in the estate can impact whether or not an inter vivos trust is the right choice. Practitioners often include other future-planning documents along with the inter vivos trust, as mentioned above. The first meeting is an opportunity for an attorney to explain these documents and ensure that clients understand the ways inter vivos trusts, wills, powers of attorney, and other planning documents function because these documents create fiduciary relationships and involve an exchange of powers that cannot always be reversed easily. This is also the time to ask clients about business and family circumstances, along with goals for establishing a plan for the future.

The next step is to create an inter vivos trust that accounts for the clients’ goals. This includes drafting trust provisions that allow for trustee oversight, if required, limiting powers such as investment authority, or ensuring that beneficiaries are able to utilize the trust assets in the way that the settlors intended. Once the clients are satisfied with the estate plan, the inter vivos trust needs to be notarized or witnessed, depending on state law.

The most important step is funding the trust. It is an estate planning attorney’s imperative to communicate to clients the importance of funding the inter vivos trust during the life of the settlors. A well-funded inter vivos trust does not typically require court oversight; however, a trust that has not been fully funded may require court petitions in order to transfer property into the trust after the death of the settlor, defeating the purposes of avoiding probate.

Funding the trust is the step that requires the most attention during the life of a settlor. Clients should, immediately after forming the trust, change the “owner” of the bank accounts so that the trust owns the bank accounts and the trustees have management authority over the accounts. Similarly, a deed can be used to transfer the ownership of real property, including the residence, rental properties, and land into the trust, with the trustees serving as managers.

One of the misconceptions about inter vivos trusts and trust funding is that if settlors leave their real property in joint tenancy, it will still be protected and avoid probate. However, after the death of the last joint tenant, the property will still go into probate, so it is essential to understand the importance of keeping significant assets in the trust, not outside it. If it seems that it will be difficult or against the clients’ desires to fund the trust immediately, a durable power of attorney can give another person the ability to fund the trust at a later time, if the settlor becomes disabled or otherwise incapacitated.

Things Inter Vivos Trusts Will Not Do

Estate planning practitioners must use caution and advise their clients on the possibilities as well as the limitations of inter vivos trusts. Although inter vivos trusts are a great tool for avoiding probate, there are certain things they cannot accomplish:

  1. Inter vivos trusts do not help avoid taxes rightly owed. For estates with significant assets, there can be some tax benefits to an inter vivos trust, but income taxes generated by the trust property still must be paid, and trusts still have to file taxes. (This article does not cover the tax consequences of making an inter vivos trust or any other trust, but tax consequences should be researched and considered before creating a trust of any kind.)
  2. Inter vivos trusts do not make wills unnecessary. Owing to the way inter vivos trusts are funded, a will is still needed to pass title for assets that were not transferred into the trust during the settlor’s life, as well as assets for which title is difficult to pass, including household items.
  3. Inter vivos trusts do not “hide” assets from creditors. While an irrevocable trust may help shield assets from creditors in certain circumstances, an inter vivos trust does not. Assets in a living trust are controlled by the trustee and can be granted to and removed from the trust, so they are equally assessable to creditors.
  4. Inter vivos trusts are not immune to challenge. Inter vivos trusts are not as easy to challenge as an estate without a trust, but there are certain grounds on which living trusts can still be challenged, such as lack of capacity, undue influence, duress, and unascertainable beneficiaries.

Final Advice

In recent years, online services have begun offering inexpensive wills, trusts, and other future-planning documents. Both lawyers and non-lawyers alike should be wary of any person or service that fails to take an individual’s or family’s circumstances into account to customize a living trust to the specifications of the individual or family. Inter vivos trusts are not and should not be one-size-fits-all solutions. Although there is some standard information that needs to be included in every living trust, there is a lot of information that should be customized and drafted according to the client’s specifications.

Lawyers should also carefully explain the contents, consequences, and maintenance of a living trust to their clients to ensure that the clients understand their responsibility as settlors and potentially as trustees. Clients also should understand that by naming successor trustees, they are binding someone as a fiduciary to themselves after they pass away, so these trustees also must be aware of their responsibilities.

Aastha Madaan

Aastha Madaan is the principal of Madaan Law, P.C., in Irvine, California. She practices in the areas of franchise law and estate planning, with a focus on business succession planning for family-owned businesses.