What is a Trust?
A large number of the folks we advise first walk in the door wanting to talk about “having a trust,” “making a trust,” “using a trust,” or having an “in-trust account.” In our experience, very few people arrive with much of an idea of what a trust actually is or the basics of how a trust operates. Fortunately, we enjoy explaining such things.
One way we have found effective in helping people who don’t spend their evenings and weekends writing articles like this to understand the basic idea of a trust is the following.
An Example
Imagine I am sitting in a bustling food court, holding a large envelope with my name written in big, bold lettering on the outside. The envelope is filled with cash. As someone tries to take some money from the envelope, I protect it. But then, I appear to notice a person at a nearby table, enjoying their lunch, and I hand them some money. It seems to you that I have decided to share some cash with them.
To you, the envelope and money appear to be mine. My name is on the envelope. I protect the money from people who try to take it. I give it to others who I appear to want to give it to.
What you cannot see is that on the side of the envelope facing me is a set of instructions from my brother. They say:
“Martin, I am giving you this money because I am dying, and I want you to hold onto it, take care of it, invest it, and use it to take care of my developmentally disabled son, Frank, including paying for his food. He likes to walk around the mall in the afternoons during the week and eat lunch at the food court. I want you to ensure this money always pays for his lunch at the food court.”
Frank is the person sitting to my left, eating lunch. I am reimbursing him for his lunch expenses because it is my responsibility. I am a trustee of that money. I am a fiduciary. This means that if I fail to meet my responsibility to protect the money, manage the money prudently for Frank’s benefit, or act in a manner inconsistent with the terms of the trust, it will be a breach of my duties, and I may be held personally liable for any losses to the trust or to Frank. It is also important to understand that a trustee's role is not just about managing funds but also about upholding legal responsibilities for the beneficiary's benefit.
As the trustee, what I have is the legal title to the envelope and the money it contains. I have the legal right to put my name in big, bold letters on the envelope. I am legally entitled to hold and control it, subject to my fiduciary responsibilities. If it were in a bank account instead of an envelope, my name would be listed on the bank account as the trustee of the trust my brother created. If it were share certificates representing stock in a company or title to a home or car, my name would be listed as the legal owner, again, as the trustee of the trust.
My brother entrusted me with the legal interest and responsibility of managing the assets for the benefit of Frank, the beneficiary. What I do not have is the beneficial interest. I do not have the right to the value of the money in the envelope, and I cannot do whatever I want with it. What I can do with the money is restricted by the terms of the trust (the writing on the back of the envelope) and any relevant trust law (legislation and common law).
When you own your car or house outright, you hold both legal and beneficial interests. You can sell the asset, keep the money for yourself, and do what you want with it (e.g., spend it, give it away, gamble it, etc.). Unlike full ownership, in which beneficial and legal interests are united, when a trust is created, the legal title and the beneficial interest have been separated.
A trustee holds legal title only. Unlike someone who holds both the legal title to an asset and the beneficial interest in that asset, a trustee’s legal title is ‘coated’ in obligations to the beneficiary or beneficiaries of the trust (e.g. Frank).
This separation of legal title and beneficial interest allows one to make arrangements like the one described above in the envelope story. Instead of an envelope full of cash, the legal title to assets like real estate and company shares may be transferred to a trustee to be held by a trustee and administered and applied for the benefit of, for example, a person with a long-term disability, a person who is not good with managing money, or a surviving second spouse and children from a previous relationship.
One can even set up a trust for oneself. For example, there is an amusingly-named kind of trust called an alter ego trust. It is so named because one person acts in three different capacities. You can be:
- the person who gives assets to the trustee to hold (known as the “settlor”);
- the trustee; and
- the only beneficiary of a trust you set up for yourself.
This means that instead of my brother giving me money to hold in trust for Frank, my brother could give himself the money to hold in trust for himself.
We will discuss alter ego trusts further in another article and leave further discussion of specific kinds of trusts and their potential uses to the side for now, as these topics will be best addressed in their own individual articles. However, it is our hope that this article helps provide a basic understanding of the core concepts relevant to understanding what a trust is.
In any discussion of trusts, even a very surface-level one such as this article, it is important to note that there can be non-obvious and potentially very unpleasant traps for the unwary lurking in the twin depths of trust law and taxation of trusts. These must all be carefully considered and addressed if one wishes to safely use the powerful tool of trust law.
Qualified Professionals
In all estate planning, but especially when using trusts, it is critical to obtain the assistance of properly qualified tax and legal professionals. Once a trust has been established, it is also a good idea to check in with them regularly. Regular professional advice can help ensure you remain well advised, that your plan is up to date as the legal landscape changes over time, and that the trust is being administered properly.
By working with qualified professionals to proactively attend to the kinds of considerations addressed in this article, individuals can build a robust foundation for a well-executed estate plan that aligns with their overall goals and reduces the risk of leaving an unintentional legacy of expense, conflict, or outright harm. This can be a challenging process. It requires carefully considering the details of one’s assets, wishes, and goals. It also requires keen attention to one’s family structure and dynamics as well as the relevant legal and tax considerations.
Careful planning like this is always a worthwhile exercise. An ill-conceived estate plan (or, worse, the lack of a plan entirely) can have two primary undesirable outcomes:
- significant expense, delay, confusion, and prolonged legal conflict for surviving family and beneficiaries; and
- a few estate litigators get to purchase bigger boats and go on nicer holidays at the expense of your estate and family members.
Contact Us
If you have any questions about estate planning involving trusts or any other estate planning or administration matters, we can be reached here.