In its simplest definition, a "trust" is a legal device allowing title to, and possession of, property to be held, used and/or managed by one person, the trustee, for the benefit of one or more other persons, the beneficiaries.
The trust is one of the most flexible legal mechanisms available, and is useful for almost any purpose which is not illegal or against public policy.
A trust can conduct a business; hold title to and invest in real estate, cash, stocks, bonds, negotiable instruments and all sorts of personal property; take care of minors or the elderly; pay medical, educational or other expenses; provide financial support in retirement, marriage or divorce; assist in the execution of a premarital agreement; and serve as a major avenue of avoidance for the muddle of probate and the burden of inheritance taxes.
Trusts are rooted in antiquity. Evidence of the earliest known trust was discovered in an Egyptian tomb, part of a document containing a personal last will and testament written in the year 1805 BC. There were trusts in both Roman and Greek law. The Romans called it fiducia, from which our word fiduciary is derived.
Roman law officially recognized the trust concept during the reign of the Roman Emperor, Augustus Caesar, nearly two thousand years ago. This imperial acceptance of the trust resulted from the perfidious actions of a deceitful friend who was asked by a wealthy Roman father to act as the trustee of his property in the event of his death. The father's wife was not a Roman citizen and because of this impediment, neither she nor their children could inherited his property under Roman law. The concerned father proposed to will his property to his friend, in return for the friend's promise to use it only for the benefit of the children. After the father's death, the friend inherited the property but soon betrayed the trust, using the property for his own benefit instead.
This wrong came to the attention of the Emperor who ordered the "trustee" brought before the Roman courts. The judges found the "friend" guilty of a breach of trust, for which he was punished. The ruling was the first recorded judicial approval of the trust in Roman law, and afterwards the device became so popular among Romans, a special court was created to deal exclusively with trust matters.
Ancient Germanic and French law had a trust concept, and from the time of Mohammed the concept of the trust was a fundamental principle of Islamic law. In the Middle Ages, when the quasi-religious Order of Knights Templar acted as Paris-based international financiers, the trust was a common method used for royal and ecclesiastical investors, who wished to shield their financial activity from the public and each other.
The trust was probably the world's first tax shelter. In 16th-century England it took on tax shelter aspects that allowed citizens to avoid feudal taxes on property inheritances and transfers.
Over centuries the concept of the trust was greatly refined by use and development, especially in British common law nations and the United States. American court decisions have also played a large role in refining the law of domestic trusts, with significant legal and tax consequences.
The person who creates a trust (variously called the "donor," "grantor" or "settlor") conveys legal title to a body of his or her real or personal property or money (the "corpus") to a third party, (the "trustee"), perhaps a trusted friend, professional financial manager or a bank with a trust department, to be managed or invested by the trustee for the benefit of a named person or other "beneficiary."
Under the law, legal title and ownership of the trust corpus passes from the grantor to the trust. Control of these assets is vested in the trustee, so long as the trust exists. The trust beneficiary receives only an equitable title to the income or assets of the trust, as described under the terms of the trust declaration. Powers and duties of a trustee can be broad or narrow according to the trust declaration, but should carefully reflect the grantor's intentions as to how the trust is to be used. The grantor may also be the trustee, or one of the trustees, but such arrangements imposes a strict duty against self-dealing, lest the validity of the trust itself be called into question.
In order to create a trust, the grantor must sign a written "declaration" or "indenture" which gives specific details of the trust operation and its income distribution, both during the grantor's life and afterward. Numerous court and IRS decisions interpreting such trust documents have given every clause special meaning, therefore the writing of the trust indenture requires expert advice, assistance and coordination with all other legal arrangements the grantor may have made concerning his or her estate.
What assets should go into a trust? Well, if you have gone to the trouble of creating the trust, an argument can be made that all your assets should be transferred to the trust; all real and personal property, including jointly held property, should also be transferred. Depending on tax consequences, which should be carefully considered, all certificates of stock, securities and other evidences of ownership should be re-issued in the trust name. Cash bank account titles should be changed from your name to that of the trust. The trust can be made beneficiary of your life insurance and in some cases, your pension plans. In some states law requires a separate real estate trust, but that is only a matter of paper work. Business interests, including corporation ownership and partnership interests can also be placed in the trust, but because of management flexibility, consideration should be given to the creation of a separate trust for business interests.
For those who value privacy, the trust affords a shield from "prying eyes" and those who might otherwise contest a will during probate. The creation of the trust can be done in such a way that its existence is a matter of public record, but the names of the grantor and the beneficiaries are kept private - and trust assets need not be disclosed.
There are numerous specific types of trusts, each type characterized by different variables included in the trust terms, each with its own degree of potential asset protection, each with its own advantages, problems and tax consequences. At various stages of a person's economic life, one or more of these legal devices may be appropriate, and as circumstances change, new ones may well be needed.
We will examine each of these trust types from the prospective of effective asset management.
Perhaps the greatest usage of trusts occurs in estate planning as an effective way of passing title to property, while avoiding both lengthy and complicated probate court procedures as well as inheritance taxes. Probate fees (exclusive of taxes) in many countries average from one to 15 percent of the gross value of the entire estate, a large sum in many cases.
A trust, especially if operative for several years, is also less likely to be challenged legally compared to a will, which may be more easily contested during probate. And the existence of a trust is an obvious defense to the charge of mental incompetency often used to attack the validity of a will, especially one written late in life.
If one is from a civil law country with forced heirship requirements, a trust can keep assets out of the local probate system, since the trust and its assets are governed by the laws of the country in which the trust is located.
A living trust is what the term indicates; a trust created while the grantor is living (also known to lawyers as an "inter vivos trust"), which provides for the disposition of the trust assets at the grantor's death. The major benefit is that trust assets avoid probate completely, although they are subject to federal and state estate taxes.
A living trust, in contrast to a testamentary trust (created after the grantor's death under the terms of his or her will), is created by the grantor to take effect and operate immediately, while he or she is still alive. As we shall see, the living trust avoids many of the probate problems of a testamentary trust.
A revocable living trust is an entity to which a grantor voluntarily transfers title to his or her assets, but with a string attached. Assets can include property if all kinds - real, personal or mixed; money, insurance policies, a home, an auto, a boat, shares of stock, or ownership of a corporation ("a business trust"). Usually there is one trustee, but more can be named to manage the affairs of the transferred property, title to which is held in the name of the trust.
When a trust is "revocable," the grantor retains power during his or her lifetime to vary the trust terms, withdraw assets, or even end the trust entirely by formal revocation. To be blunt, such a trust offers little in the way of solid asset protection, especially if the grantor is also the beneficiary during life, a cozy arrangement sure to be challenged by creditors, probably successfully. Upon the death of the grantor, a revocable living trust immediately becomes irrevocable, then the grantor's creditors are out of luck. Under its terms the trust is thereafter administered by the trustees for the benefit of the named residual beneficiaries.
There are real benefits to a revocable living trust, the most obvious being the grantor's ability to manage the trust assets during his or her lifetime - and the option to end the trust whenever changed circumstances may dictate. There is no legal prohibition against the grantor serving as trustee - and being a beneficiary also - so long as there are one or more other beneficiaries at the time of the grantor's death. But as a general rule, this incestuous game of same grantor/trustee/beneficiary would open the entire arrangement to creditor assault.
Other than his or her ability to arrange for the desired provision for family or others, the grantor usually receives no real immediate additional financial benefits from such a trust - though there can be many indirect advantages, such as shifting expenses for medical, educational and other family costs to an entity which is legally insulated against most outside attacks, or at least more difficult and costly for creditors to pursue.
But for a spouse or heirs as beneficiaries, there are many benefits to the living trust, in addition to acquiring immediate income from trust assets. These advantages include: avoiding judicial probate with the attendant expense and time delays (trust property is not included in the grantor's personal estate); allowing the uninterrupted operation of a family business placed in trust; avoiding public scrutiny of personal financial matters; causing no temporary stop in income for beneficiaries during probate after death; allowing the grantor an initial choice of the most advantageous law to govern the trust - it can be created in any jurisdiction - and some jurisdictions are far more flexible than others when it comes to trust law.
The most common form of trust is a testamentary trust, the terms of which the grantor includes in his or her last will to take effect after death. This method allows provision for loved ones, especially when the grantor has concerns about a minor child beneficiary's ability to manage his or her own affairs. Such concerns have given rise to the testamentary creation of the so-called "spendthrift trust," the assets of which are immune from attacks by the offspring-beneficiary's creditors.
While popular, testamentary trusts have distinct disadvantages often unexplained by legal advisors; estate and income taxes usually must be paid at the death of the grantor, although successive estate tax levies often can be avoided as trust property passes to beneficiaries and their heirs in later years. Testamentary trusts do not avoid initial probate and sometimes are subjected to continuous court supervision, which often entails great legal expense. Because they are subject to probate, the activity of the testamentary trust and its trustee is a matter of public record and scrutiny for all to see.
In addition to trusts created by wills, trusts can be created formally by contract between two or more parties ("express trusts"), or, when title to real or personal property is involved, by a deed of trust. An "implied trust" may result even in the absence of a formal trust, when a court finds its creation from factual circumstances, as when one spouse consistently places property in the name of the other.
An offshore trust can also be used for international investment activity; your foreign trustee handles the investments and paper work while you make long-distance investment suggestions. In this way, you can take advantage of the world's best investment opportunities, without worrying about borders or conflicting laws. A foreign trust with a lawyer or trust company as trustee in the offshore country is an excellent way to achieve international diversification or your investments.
Additionally, the trust can provide privacy, confidentiality, and reduced domestic reporting requirements in your home country (since the trust, not you, is the legal owner of the assets); avoidance of domestic taxes and probate in case of death; increased flexibility in conducting affairs in case of disability, in transferring assets, international investing, or avoiding domestic currency controls. Of course, an offshore trust can also substitute for, or supplement, costly professional liability insurance or even a prenuptial agreement, offering strong protection of your assets for your heirs and their inheritance.
The grantor or settlor creates the trust, transferring title to his assets to the trust to be administered according to the trust declaration by the trustees for the named beneficiaries. Often one names three trustees (the grantor usually may not be one), two located in the home country, and one independent managing trustee in the foreign country. The trust declaration can allow the grantor to replace the foreign trustee at any time with another nominee, and may also require the grantor's prior approval of investments or distributions. Beneficiaries can vary according to the settlor's estate planning objectives, and the grantor may be a beneficiary, but usually not the primary one. Trust law often allows a non-national grantor to receive income and benefits from the trust, while maintaining effective control over the investment and distribution of the trust principal.
Many jurisdictions also permit appointment of a local "trust protector" who, as the title indicates, oversees the operation of the trust to insure its objectives are met and the law is followed. A protector does not manage the trust, but can veto actions in some cases.
With a trust, in most of these countries, nothing is required to be registered with the government. The trust agreement and the parties involved are not required to be disclosed, and the information filed is not available as part of a public record. In these privacy-conscious countries, the trustee is allowed to reveal information about the trust only in very limited circumstances, and then usually only by local court order.