Trusts are used in estate planning for various purposes, including: to provide tax reduction benefits, to hold property for a person until he or she is mature enough to manage it, to hold property for distribution only for specific purposes, to protect property from the claims of a beneficiary’s creditor, to protect property from the claims of an estranged spouse of a beneficiary, to provide for the management of property with distributions for a beneficiary’s long term support, and for any other reason that the grantor desires. The trust agreement drafter writes the agreement with the grantor’s intentions in mind.
A trust is a form of contract. The person who creates the trust, the grantor (also sometimes referred to as “settlor” and “trustor”), requests another person, the Trustee, to hold property for the benefit of a third person, the beneficiary. A trust is usually set out in a Will or trust agreement and is not restricted to any particular terms or language. In fact, a provision in Mary’s Will which states, “I leave $50,000 to my brother, John, to use to educate my niece, Nancy” creates a trust upon Mary’s death where Mary is the grantor, John is the trustee and Nancy is the beneficiary. If the Will or other document which describes the trust relationship leaves out the Trustee’s powers, as in Mary’s Will, or other convenient provisions, then Texas law as found in the Texas Property Code provides those powers or provisions. For example, if the Will or other document does not provide for an alternate person to serve as Trustee if John cannot, then the Texas Property Code includes provisions for the appointment of a successor trustee. If terms are left out of the trust agreement or if the terms as set out in the trust agreement are ambiguous, then the beneficiaries may apply to a state court to determine what the grantor intended. Although trust agreements can be as simple as one statement, most trust agreements include all of the provisions necessary to manage the trust.
A Trust generally:
• Names the grantor. The grantor is the person who creates the trust. Mary, who included the above provision in her Will leaving $50,000 to her brother, John, to use to educate her niece, Nancy, is the grantor.
• Names the Trustee. The Trustee is the person who will hold the property put into the trust, manage the property and distribute income and principal as set forth in the trust. In the above example, John is the Trustee.
• Identifies the beneficiaries. The beneficiaries are the persons for whose benefit the trust assets are held. The trust can benefit only one person, such as “my niece, Nancy” or can benefit a group of people, such as “all of my children” or “all of my descendants.” < Must be funded. The grantor must contribute some property and at least $1, to the trust in order for the trust to exist.
• Provides for distributions. The trust agreement provides when and for what reason the Trustee will distribute the property to the beneficiaries. For example, the trust can provide that the Trustee will hold the property and reinvest the property and the income from the property, making no distributions until the beneficiary is a certain age, e.g. 25, and then the trust terminates and all of the property is distributed to the beneficiary. More commonly, the trust agreement will provide that some distributions can be made prior to the termination of the trust. For example, the trust can provide that all income earned on the assets in the trust will be distributed to the beneficiary. The trust may provide that the Trustee will distribute the income only if the beneficiary needs it for his education or for his health needs. The trust can provide that income is distributed but that principal is not distributed. The trust can provide that income and principal may be distributed if the beneficiary needs it. The distribution provisions are the ones that outline the beneficiary’s rights in the trust assets. These trust agreement provisions are the most important provisions of the agreement and reflect the desires of the grantor regarding how the trust property shall flow to the beneficiary. Generally, income generated by trust property is ordinary income for federal tax purposes and generally includes interest, dividends, and rents. There are actually some distinctions between trust accounting income and taxable income, but this is a helpful shorthand reference. Principal is the trust property transferred to the trust and all appreciation in that property. Generally, capital gains are considered part of principal.
• Identifies the Trustee’s powers. The trust usually includes a list of the powers that the Trustee has relating to managing the trust. Generally, these powers are in addition to any powers granted to Trustees under state law. For example, the grantor may want to give the Trustee the power to loan money (a trust asset) to the beneficiary.
• Includes a spendthrift clause. Frequently, trusts include a spendthrift clause which provides that the beneficiary cannot pledge the assets of the trust as collateral on a loan nor can he assign his right to receive income from the trust. This provision protects the assets in the trust from the claims of creditors of the beneficiary.