If you search the internet to attempt to understand a Trust, you may walk away more confused than when you began. In this article, you will learn exactly what a Trust is and how it works.
A trust is simply an agreement between an owner of property (grantor) who transfers the property to a third party (the trustee) for the benefit on another (the beneficiary). It is a contract. It does not need to be long.
A few years ago, the author was involved in a litigation based on the followings sentence, “I give all my money to my brother to take care of my children.” The court held that this sentence created a trust.
The court found that all the elements of a trust existed. There was a transfer of property, i.e. money, from the grantor to his brother. There was a written instrument, albeit, it was only one page. It had a trustee to handle the money, and it had beneficiaries along with instructions that could be reasonably understood. Thus, a trust had been created.
The implications of a contract where one person (the grantor) gives property to another (the trustee) for the benefit of a third (the beneficiary) creates several logical and and thereby legal issues. Let’s look at an example to illustrate the point. Let us assume I transfer $100,000 to my brother for the benefit of minor children. My brother and I sit down and draft the following terms: I hereby irrevocably give $100,000 to my brother for the food, shelter, medical needs and education of my children until the youngest reaches age 21 and thereafter distribute in equal shares to my children.
The above is a valid trust. Here are some questions regarding who owns $100,000.
Is the $100,000 my brother’s money? Well he may have legal access to the money and thus legally is the title owner. However, he can not legally use the money for himself. He must use it for the benefit of my children. Thus, if he cannot use the money then it is not his as ownership is commonly understood.
Is the $100,000 my children’s money? The answer is kind of. My children cannot have a party with the money or force the trustee to purchase a car for them. Video games are certainly out of the question (much to their chagrin). Thus, unless my instructions either expressly or can reasonably be interpreted to allow for an expenditure, it cannot be made.
Is the $100,000 my (the grantor’s) money? No, unless I expressly reserve the right to change the trust or access the funds. Most trusts, including trusts commonly referred to as Living Trusts, are revocable and therefore considered the donor’s money. The rational being that even if I name my kids as beneficiary, I can change the trust to name myself as sole beneficiary. However, in the example above, the transfer states it is irrevocable so it is no longer my money.
So if the one sentence trust is not my money, it is not my brother’s money, and it is not my children’s money, then whose money is it? The $100,000 sits in limbo. It is not my children’s money until it is spent for them. This results in some very important tax and creditor implications.
My future creditors cannot access the money as I have made a completed gift. The funds transferred to an irrevocable trust where I am not the beneficiary are valid.
Furthermore, I can add provisions to protect my children. The logic as as follows - I, as a grantor, can restrict how and to whom my money will be paid from the trust. I have every right to put money aside and say this will only be used for education. I also have the right to require that the money not be used for my children’s creditors. If someone wants to loan my children money, they should not look to me or my assets to make good on that loan. These restrictions, called spendthrift provisions, have a long history of being enforceable in Illinois. In fact, you can find them in the Illinois Code of Civil Procedure, see 735 ILCS 5/2-1403. This is one of the commonly overlooked benefits of creating a trust.
Now that you understand what a trust is, you can begin to envision how its provisions can be helpful. The ability to place an assets in limbo, beyond the reach of creditors, and to control payouts while providing flexibility is the hallmark of good planning. This is why the selection of an estate planning attorney becomes so important. It is someone who can bring clarity of thought to the trust instrument in addition to technical expertise. Thus, protecting assets from poor choices while preserving a legacy is the benefit of using trusts properly.