Key Takeaways
- Properly setting up a trust is essential for ensuring that the wishes of the grantor can be effectively carried out after their death.
- Trust funding mistakes include underfunding the trust, failing to properly transfer the titles of assets, and unintentionally excluding some assets.
- Other common mistakes when initially funding a trust include choosing an unqualified trustee, setting unclear parameters and expectations, and failing to update the trust regularly.
- Consider the importance of seeking professional support for funding the trust and addressing any potential disputes that can arise.
Introduction
A trust is a legal arrangement established by the trust creator to transfer assets into the ownership of the trust, managed by a trustee, in order to protect them for the beneficiaries. A trust can be a valuable estate planning tool, but it is crucial that the arrangement is set up properly in order to maximize the true benefits and avoid any conflicts between beneficiaries and other interested parties.
When you first set up a trust, it’s essential that you take the necessary steps to clarify what assets should be titled under the trust and ensure that they are transferred properly under the ownership of the trust to avoid confusion or issues in administration. This guide covers the most common trust funding mistakes to avoid, what steps you can incorporate into your estate planning to prevent them, and the value of a trust administration attorney in the process.
Importance of Proper Trust Setup
Proper trust setup is essential for protecting the assets in a grantor’s estate and ensuring they are distributed to the identified beneficiaries according to the wishes of the grantor. A trust is created by a grantor to hold and protect assets for beneficiaries until the trust can be distributed.
If a trust is not properly set up or properly funded, it could lead to issues for the trustee and beneficiaries when it comes time to distribute trust assets. For example, ambiguous language or unclear terms can prevent the trustee from understanding the grantor’s wishes and distributing assets to the appropriate identified beneficiaries. Meanwhile, it’s also important to consistently fund the trust with investments and financial accounts to ensure that there is sufficient capital for beneficiaries upon distribution.
From clearly outlining the terms of the trust to choosing the right trustee, there are several steps you should take to properly set up the trust, including carefully considering asset protection provisions and tax implications.
After setting up the trust, it’s important to review it regularly so that you can account for any changes and make any updates to ensure that the instructions still effectively represent your wishes. Regularly reviewing a trust allows for any necessary updates so that it remains accurate and structured according to your needs and goals.
Consequences of Trust Funding Mistakes
If trustors are not careful when setting up and funding a trust, they can undermine the potential benefits of this valuable estate planning tool. Failing to fund the trust both initially and consistently can lead to potential consequences for a trust and its beneficiaries down the road by preventing them from realizing the trust’s full potential.
The following are some of the most common consequences of trust funding mistakes:
- Improperly funding a trust may require some assets to still have to pass through probate, eliminating one of the primary advantages of a trust
- Underfunding a trust may prevent select assets from being safeguarded for the beneficiaries they are intended for and provide less financial security
- Not consistently funding the trust with investments, real estate, and other proceeds may undermine the importance of a trust by failing to leave sufficient capital for beneficiaries
- Inconsistent funding of a trust may lead to confusion or complications during its administration
- Failure to be conscious in setting up a trust may lead to higher estate tax obligations
- Failing to provide a comprehensive inventory of the assets to be funded into the trust may result in assets being inadvertently left off the trustee’s radar and not properly marshalled for the benefit of the beneficiaries
To prevent these potential consequences, it’s vital that you are proactive in developing a comprehensive trust instrument while also remaining aware of the most common mistakes that lead to the above concerns.
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Trust Funding Mistakes to Avoid
Clearly and responsibly establishing and funding a trust is crucial for ensuring it fulfills its purpose and preventing the arrangement from being rendered ineffective. The following are the most essential trust funding mistakes to avoid so that you can maximize the benefits of the trust.
1. Failing to Properly Fund the Trust
Properly funding a trust requires transferring the ownership of assets into the trust so that assets are adequately protected and accessible to the successor trustee. A common oversight is failing to formally transfer ownership of the assets into the trust, which requires that assets be titled specifically in the name of the trust, typically by the execution of some document separate and apart from the trust document. Assets commonly transferred into a trust include real estate property, bank accounts, investments, and personal property.
Assets can be transferred directly into the trust via their title, designated as “payable on death” to the trustee as the beneficiary upon the grantor’s death, or included in a pour-over will to be transferred to the trust upon the grantor’s death. Working closely with an estate planning attorney can help you ensure that any assets added to the trust are correctly titled in the name of the trust.
If assets are not properly funded into the trust, they may be considered part of the grantor’s taxable estate instead. As part of the estate, they may still be subject to the probate process, which would leave them to be distributed by an executor according to the laws of intestate succession, unless there was a separate will that describes how these specific assets should be handled.
When assets are distributed through probate without a will, they are distributed to legal heirs according to the line of succession outlined by state law, which could potentially conflict with the original wishes of the trust grantor. The risk of intestate succession makes it crucial to verify that a trust is funded and all assets are accounted for.
There are other processes for re-capturing assets into the trust if they are not titled properly, but they ultimately result in avoidable expense and delay, as those other processes often require court intervention. That said, that option may still be preferable to having the asset pass through the estate through the formal probate process.
2. Selecting the Wrong Trustee
It is, unfortunately, common that trust creators unsuspectingly select an inexperienced trustee, which can lead to mismanagement or conflicts during the trust administration process. A well-intentioned grantor may choose a trusted family member to serve as the trustee when they may not actually be well-equipped for the role.
The trustee maintains significant control over the trust while managing, investing, and distributing assets to beneficiaries. Choosing an inexperienced or unqualified trustee can have unfortunate consequences, such as potential financial losses for the trust and the risk of failing to maintain legal compliance with factors such as creditor deadlines or tax obligations. A poorly equipped trustee may also be more susceptible to engaging in conduct that could be considered a breach of their fiduciary duties, such as self-dealing or failing to treat beneficiaries impartially.
A grantor should ensure that they choose a professional trustee who possesses strong organizational skills, financial acumen, and can maintain impartiality. It’s also a good idea to name a successor trustee who can step into the role and fulfill the necessary duties if the initial trustee becomes incapacitated. The beneficiaries must then hold the trustee accountable to uphold their fiduciary duty to preserve the best interests of the trust, its grantor, and its beneficiaries.
3. Setting Unclear Goals and Parameters
When establishing a trust, the grantor must set clear expectations for how the trust should be managed in order to ensure that it is properly administered upon their death. Failing to be clear about trust funds and how they should be distributed could stifle the trust administration process by creating a lack of clarity on how the trustee should move forward, while also unlocking the potential for family conflicts.
Some considerations include:
- Whether the trustee should prioritize investing trust funds or preserving the present trust value
- A timeline for when assets should be distributed to beneficiaries
- Beneficiary designations identifying who is entitled to receive assets, and what share each beneficiary is entitled to
- Whether there are any restrictions the grantor has for extravagant or significant purchases
Failing to set these parameters could lead to confusion and ambiguity regarding appropriate trust management, disputes amongst beneficiaries, and delay the administration of the trust. It’s advisable to review the trust document with an experienced estate planning attorney or consult a trust administration attorney who can help identify any potential holes in the trust instrument and discuss any clarification that may be necessary.
4. Neglecting Regular Reviews and Updates
Once a trust has been created, it’s important that you keep in mind the importance of updating it regularly so that it remains effective in its purpose. Regular review of the trust and necessary updates are essential for ensuring that the trust’s instructions continue to reflect the most recent wishes of the grantor, given their family dynamics.
A major life event, such as the birth of a child, a marriage, a divorce, or a family death, can potentially change a grantor’s wishes for how their assets are handled following their death, requiring an adjustment of their estate plan. Most experts recommend reviewing your estate plan every three to five years after it has been created, regardless of what changes have been made.
5. Ignoring Tax Implications
Setting up a trust has important tax implications for a grantor to consider, and failing to consider them can lead to a loss of value in trust funds if not carefully managed. Failing to understand the full scope of tax implications or liabilities may also result in a larger unforeseen income or estate tax burden on the beneficiaries’ share of trust funds.
The tax implications of a trust often depend specifically on the type of trust:
- Revocable living trust – This type of trust is still considered part of the grantor’s taxable estate while they are still alive, potentially increasing estate taxes.
- Irrevocable trust – With this type of trust, the grantor relinquishes their ability to control assets, but they are considered separate from the taxable estate, which may offer tax benefits.
Any revocable living trust becomes an irrevocable trust after the grantor dies, which means a change in the tax implications. There are several other types of trusts to consider that may each have their own unique tax structures, so it’s important to consult an estate planning advisor and tax professional who can offer more guidance on which types of trusts would be the most fitting for your case and how to maximize their benefits.
It’s also important to stay aware of changing tax laws, such as the federal estate tax exemption, so that you can make any applicable changes to the trust if it is beneficial following any legal changes.
6. Skipping Asset Protection Provisions
Asset protection provisions can offer important safeguards against beneficiaries making financially harmful decisions. These provisions act as a checks and balances system to prevent the mismanagement or irresponsible usage of trust assets over time. However, when creating a basic trust, a grantor may fail to properly account for such provisions, potentially putting trust assets in jeopardy.
A revocable living trust does not provide asset protection, as the property is still considered part of the taxable estate during the grantor’s lifetime, so it’s important to weigh your options for protecting these assets. Such provisions are also beneficial in cases where there is a risk that the beneficiary may act recklessly or irresponsibly if given access to trust funds. For example, spendthrift provisions can protect a beneficiary’s assets within a trust and restrict their access to prevent them from spending irresponsibly or being seized by creditors.
It’s critical that the grantor is sure to appoint an unbiased and impartial third-party trustee who will protect assets with impartiality and fulfill the wishes of the grantor. Other strategies may include using a tax entity like a Family Limited Partnership (FLP) or LLC to shield assets from creditors or irresponsible personal financial choices.
7. Forgoing Professional Guidance
Overlooking the value and importance of professional guidance during the creation of a living trust is a far too common mistake. Professional guidance is a crucial element in ensuring a trust instrument is clear, well-formulated, and rigid enough to avoid the common pitfalls that can arise during trust formation.
Professionals can offer their assistance throughout several steps in the process, from the creation of the trust to the distribution of assets. During the creation of the trust, professional advisors like an estate planning attorney or financial advisor can help you consider all the important legal implications, as well as ensure your estate plan is customized to your specific needs while maximizing the potential benefits of the arrangement.
Meanwhile, during the distribution process, professional guidance can be beneficial in helping facilitate the proper distribution of assets for beneficiaries in line with the legal duties of the trustee. It’s advisable that a trustee engage the support of a trust administration attorney to ensure that they are adequately fulfilling their responsibilities and upholding the integrity of the grantor’s wishes.
Safeguarding Trusts in Administration and Conflict With RMO
Trust administration can be complex, and mistakes, whether in funding, management, or communication, often lead to disputes that put the trust’s purpose at risk. When issues arise, beneficiaries and fiduciaries alike need experienced counsel to protect their interests and ensure the trust is carried out as intended.
At RMO Lawyers, we focus exclusively on trust and estate disputes. Our attorneys understand the challenges fiduciaries face and the conflicts beneficiaries often encounter. Whether it’s addressing mismanagement, enforcing fiduciary duties, or defending against claims, we provide clear guidance and strong advocacy to resolve problems efficiently and effectively.
If you are navigating trust administration issues or facing trust litigation, our team is here to help protect the trust and the people it was meant to serve.
Schedule a free consultation with RMO Lawyers today to discuss how we can help you resolve trust disputes and safeguard your rights.
Glossary
Grantor – A person who creates a trust to describe how their assets should be distributed to identified beneficiaries.
Trust – A trust is a legal agreement that grants a third party, or fiduciary, the authority to hold and manage assets for the beneficiaries of an estate.
Trust Instrument – A written declaration or agreement designed to allocate a settlor’s property to beneficiaries, including the trust and regulating how the trust should be executed.
Irrevocable Trust – A type of trust that cannot be modified or revoked by the grantor after it has been established, providing benefits such as asset protection and tax advantages.
Revocable Trust – A trust that can be modified, amended, or revoked by the grantor at any time during their lifetime. It typically becomes irrevocable upon the grantor’s death.
Trust Beneficiaries – An individual or entity identified in a trust as being entitled to receive benefits from the estate.
Intestate Succession – The legal process for facilitating the distribution of estate assets based on state intestacy law regarding inheritance priority when someone passes away without leaving a will.