Keys to Creating an Effective Trust

You expect the trust you create to provide for your beneficiaries’ health, education, maintenance, and support. But how would the trustee handle a discretionary payout? It’s important to design an instrument that will anticipate multiple scenarios and provide tax-saving advantages.

Trusts can be effective estate planning tools for mitigating taxes and helping to ensure your beneficiaries are cared for according to your wishes. Often a grantor’s exact wishes are carried out to the letter. But, the complex language of trusts is not always black and white. Distribution standards can be challenged in court when disputes arise between the trustee and the beneficiaries over disbursement of funds.

The language of a trust agreement must be carefully crafted to balance your wishes with the powers of the trustee and the needs of beneficiaries. Tax consequences must also be considered. Qualified attorneys specializing in trusts and estates will carefully weigh all the issues when drafting a trust document and will take time to understand your particular situation.

Too much discretion may come at a cost

A qualified attorney can determine the proper language to best meet your needs. If provisions in the trust are too broad, beneficiaries may be treated by the IRS as the owners of the trust property and taxed accordingly. Alternatively, standards left to interpretation by the courts may mean your beneficiaries are not cared for according to your wishes.

Some of the most tragic disputes arise when the trustee and beneficiaries are at odds over a distribution from the trust’s principal assets (known as invasions of principal). Understanding some key trust terms may help you steer clear of such disputes.

What does the trust language mean?

A trust’s distribution standards must be clearly measurable. Some commonly accepted standards include support, maintenance, education, and health. Other standards may include comfort, best interest, and emergency. Here is a brief explanation of how some of these standards may be interpreted:

Support and maintenance
These terms include normal living expenses, such as housing, clothing, food, and medical care, according to the beneficiaries’ customary standards of living.

Best interests
Under this less restrictive standard the trustee may make distributions allowing beneficiaries to enjoy  higher standards of living, covering such niceties as extensive travel, a luxury automobile, or expensive jewelry.

Education
This typically includes college education but may not include graduate level or professional education. If you wish to provide for a grandchild’s pursuit of a medical degree, communicate those desires when the trust is drafted. Considerations for travel expenses to and from school and a reasonable allowance for related expenses also should be clarified.

Health
This includes all routine medical care, medication, surgery, and hospitalization, as well as nursing care and mental health expenses. This term is less restrictive than “medical care,” which may not cover expenses for treatment of ailments such as addictions or psychological problems.

Emergency
To minimize confusion, specify the types of emergencies for which distributions are authorized. A court and the IRS may see things differently.

Picking the right trust for your family

Many factors determine the level of access beneficiaries will have to trust assets. Ultimately, choosing the provisions for distributions is a balancing act between tax consequences and the wishes of the grantor. Seek the counsel of a qualified estate planning attorney to be sure you are creating the right trust to suit the needs of your family.

This article is for information purposes only and is not intended as an offer, recommendation, or solicitation for the sale of any financial profit or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs.