A trust is a creature of English common law, originally devised to avoid the reversion of lands to the crown and the strictures of primogeniture. Legal scholars have struggled to give a definition. There is a famous definition from a law book that describes a trust negatively by listing all the things it is not. A trust is not a bailment, a trust is not an executorship, a trust is not an agency….
A trust is a relationship with respect to property. The grantor (or settlor) creates the trust either by declaring himself trustee or making a transfer to a trustee. Legal title to the property is held by the trustee, but the property is held by the trustee for the benefit of the beneficiaries on the terms specified by the grantor. At common law, there had to be some property, no matter how small, in order to create the trust. That is why many trust documents recite that $1 is being transferred to the trustee. At common law, “a mere peppercorn will do.” The statutory law of most states (including Pennsylvania), now permits the creation of “empty” trusts – vehicles awaiting funding on some future date.
There are more types of trusts than you can shake a stick at. Some of the categories are (1) revocable vs. irrevocable, (2) inter-vivos vs. testamentary, and (3) grantor vs. simple or complex.
A revocable trust can be revoked, amended, changed in any way. An irrevocable trust can’t. I once was supervising a client’s execution of an irrevocable trust. I explained, “This trust is irrevocable – you can’t amend it and you can’t revoke it.” The client looked at me searchingly and said, “Then how do you change it?” That is precisely the point – it can’t be changed. However, a good estate planner knows how to include flexibility in even an irrevocable trust.
An inter-vivos trust is one that is created during life. A testamentary trust is created in a will and does not come into existence until after the death of the person who wrote the will. A testamentary trust is always irrevocable – by definition the creator of the trust is deceased and can exercise no power over the trust. An inter-vivos trust may be revocable or irrevocable. A good example of an irrevocable inter-vivos trust is an Irrevocable Life Insurance Trust. By contrast, many people use a revocable inter-vivos trust to manage their affairs. This is sometimes called a Living Trust. Assets titled to a revocable inter-vivos trust avoid probate.
Trusts are treated variously for income tax purposes. A revocable trust, for example, is ignored for income tax purposes. All of its income and deductions simply pass through to the grantor. In income tax nomenclature, this is a “grantor” trust. Some trusts are treated as separate entities for income tax purposes. There can be trusts that distribute all their income; they are called “simple” trusts. On the other hand, the trustee may choose to accumulate income or to distribute principal; in such cases, the trusts are “complex.” These trusts require careful accounting, and the Internal Revenue Code provides complicated rules for the allocation of income and deductions between the trust and the beneficiaries.
For centuries, only an individual could be a trustee. In the 19th century in the United States, state legislatures began authorizing banks and trust companies to act as trustees. To this day, banks and trust companies are the only corporate entities who are permitted to be trustees. However, there remain many firms of private individual trustees, especially in Boston and Philadelphia, many of them lawyers who manage billions – in large part what you and I would call “old money.”
Trusts fulfil a myriad of purposes and intentions. Some are to protect minors, providing for management and distribution of the funds during a child’s tender years. Some are for the benefit of incapacitated persons who cannot handle their own financial affairs. Some are used as vehicles to provide investment management advice. Some are used for tax planning strategies; an important part of estate planning is to minimize the impact of estate and gift taxes.
The dispositive provisions of a trust are those that dictate when and to whom the trustee is to distribute the property. These provisions are tailored to each case, depending on the intentions of the person creating the trust and the needs of the beneficiaries. The trustee is bound to carry out the terms of the trust. The trustee has a duty to manage the trust for the benefit of the beneficiaries. This fiduciary duty is the highest duty known to the law and requires impartiality, loyalty, prudence, and fairness. A trustee is personally liable for any breach of the duty.