Estate Planning and Asset Protection: The Terminology of Trusts

Most of my clients are aware of the device called a "trust," but the language we use when talking about a trust can get confusing quite quickly. In this article, I'll break down the terminology we use in the business and give a few examples of how trusts work.

What is a trust? It's an arrangement or a relationship between people. We'll see what we call the people involved in the trust scheme below, but for now, here's a simple example. 

Al owns a gold Rolex watch worth some money. Al has a nephew, Bart, who he would like to give the watch on his 21st birthday. Al thinks he might not live to see this day so he contacts his attorney, Chet, and instructs him to hold the watch in trust for Bart, to be given to him on his 21st birthday. Al and Chet have formed a trust for the benefit of Bart. 

The neat thing about this arrangement is that Al and Chet don't actually need to have a document to declare that a trust has been formed, although it would be a good idea just in case Chet passes or becomes incapacitated before Bart's 21st birthday. This is a basic form of estate planning, and we always need to be thinking about the possibilities.

In the example above, each individual is called a specific name which is important for understanding trusts.

Al is the "grantor" or "settlor" of the trust. He made the arrangement to give something to Chet for the benefit of Bart. Although he doesn't have any fiduciary duties to anybody else, the act of giving the watch to Bart might be taxable under the federal or state gift tax depending on how much Al has given away in the past.

Bart is the "beneficiary" of the trust. Bart, too, owes no fiduciary duty to anybody else in this example. All he has to do is wait until his 21st birthday and then take the watch. He might have to pay income tax on the property received at that time depending on how the trust is structured. Al might want to also give Bart the power to remove Chet as the safekeeper of the watch, which trust law allows you the flexibility to do.

Chet is the "trustee" of the trust. Chet is the man in this scenario who has all the duties. He owes a duty both to Al and Bart to make sure that the watch is kept safe, not stolen, etc. He also owes a duty to give the watch to Bart when he turns 21. If Chet decides to sell the watch and pocket the money, or gives the watch to Bart early, or refuses to give it at Bart's 21st, he's liable to Al and Bart for breaching the trust agreement.

The watch is the "corpus" of the trust. "Corpus" means "body" in Latin -- so it's easy to wrap your head around why we call it that. This is important for determining whether a creditor can get at whatever is being held in trust -- like if Bart runs up a gambling debt before age 21 and the casino tries to take the watch.

The thing to remember: A trust is not an entity like an LLC -- it's a relationship or an arrangement. This can get confusing when you see a bank account or a house titled "The Christian Carson Trust," leading to the impression that the trust is like a corporation. The reason why this makes a difference is that a trust cannot be sued -- the trustee gets sued. The trust is a contractual relationship between the trustee and the settlor to do something for the beneficiary. And once the trust no longer has a purpose, it ceases to exist. One could create a charitable trust that essentially lasts forever, but the rule against perpetuities generally are effective at stopping people from creating unending family trusts. That's a topic for another article.

Conclusion

This is just a basic outline of the words we use when talking about trusts. A trust is a very powerful tool not just for estate planning, but also creating arrangements between two people. For example, you could theoretically appoint your property manager as trustee of your properties held in trust for the benefit of you and your family, and that property manager would be able to step into your shoes and act as if he owns the property. It's a very elegant solution to leveraging your time and allowing people to work for you.