Establishing a Funding Plan
Establishing a Funding Plan
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Establishing a Funding Plan

The funding of a living trust should not be taken lightly, for it is an essential component of an effective estate plan. The development and execution of a well thought-out funding plan can mean the difference between realizing your objectives or being frustrated by the process.

When you decide to incorporate a revocable living trust into your estate plan, be fully aware of your reasons for doing so. Are you trying to avoid probate? Are you concerned about incapacity? Are you trying to protect vulnerable beneficiaries? Are you concerned about a will contest, or privacy, or both? Having your objectives clearly in mind will take most of the uncertainty out of formulating your funding plan. 

Next, you should have a good idea as to what properties will be transferred to your trust and when. In certain cases, the transfer of specific types of property can present some problems. For example, the transfer of stock in a closely-help corporation may not be permitted by the by-laws of the company or an existing shareholder agreement. In that case, you may want to discuss a solution to this problem with your existing shareholders before you attempt to make the transfer. It's possible, too, that you will want to have your home transferred to your trust. However, if you have an existing mortgage on your home, you should check first with the bank or mortgage company to make sure that the mortgage won't be called if the transfer is made. It's unlikely that it would be if you are the sole trustee, but it's better to be safe than sorry. 

Finally, the two documents that require special attention when developing a funding plan are the trust instrument and a durable power of attorney. Those two documents are so interrelated with respect to the development of an effective funding plan that they must be considered simultaneously. 

A.  The Trust Instrument

The trust instrument (whether a trust agreement or a declaration of trust) must reflect your intentions regarding all aspects of your estate plan, including your intentions regarding the funding of your trust.

First, the trust instrument should give you (as the initial trustee) and all successor trustees the broadest investment powers permitted under applicable state law. If you’re going to transfer some or all of your property to a living trust, you want to be sure that you retain as much power to control your property as you did before the transfer. 

Second, the trust instrument should provide for any special types of property that you may own; i.e., limited partnership interests, closely-held stock, royalties and patents, and the like. Although the trust instrument can be changed as the need arises, it is generally advisable to anticipate certain types of property being added to the trust so that appropriate provisions can be included beforehand. At the same time, the trust instrument should give the trustee (whether you or a successor) the power to hold and manage any special types of properties that may be transferred to the trust. 

Third, your choice of one or more successor trustees may be influenced by the type of property to be held in trust. If one of your properties requires a certain level of expertise, then you may want to name a successor trustee who has that expertise. At the very least, you should do as much as possible to insure that your successor trustee can handle this property in an appropriate manner. 

Fourth, if you intend to transfer certain valuable, but otherwise unproductive, property to the trust (such as a sentimental painting that is not expected to appreciate in value), then you want to be sure that the trust instrument allows the trustee to retain that property in trust. Most state laws prohibit a trustee from holding unproductive property in trust unless the trust instrument provides otherwise. 

It is important to keep in mind that trust instruments are highly personal documents. You should not rely on an off-the-shelf document that does not reflect your personal needs. Take the time to insure that the trust instrument you create has all the required provisions necessary to allow you and your successor trustees to manage and invest your property the way you intend. 

B.  The Durable Power of Attorney

Many people give their spouses or other family members the power to act on their behalf. The document creating this power is called a 'power of attorney,' with the person giving the power referred to as the 'principal' and the person to whom the power is given referred to as the 'agent' or the 'attorney-in-fact.' 

A power of attorney can convey very limited or very broad powers. For example, a power of attorney that authorizes an attorney-in-fact to transact all your personal and financial affairs is a very broad power of attorney; whereas, a power of attorney that only authorizes the sale of a specific parcel of real estate is a very specific power of attorney. 

A "regular" power of attorney can be terminated at any time by the principal, and it will be terminated automatically upon the incompetency or death of the principal. The fact that it is terminated automatically upon the incompetency of the principal is often a problem, because that's when it's generally needed the most.

 

Consider this all too frequent scenario -

A father in his 70s creates a revocable living trust and a pour-over will as part of his estate plan. He also gives a power of attorney to his son and daughter. Since the father lost his wife a few years ago, he set up the living trust so that his son and daughter could take over his finances if he couldn't do it on his own. Upon his death, the father wanted his property to go to his son and daughter, equally, and the trust would avoid having to go through probate.

A few years later, the father has a stroke and was confined to a nursing home. The son and daughter were aware of the living trust and became the successor trustees in accordance with the declaration of trust, but none of their father's property had ever been put into the trust. In fact, all of the father's property was in his own name, including all of his checking and savings accounts, stocks, bonds - even his home. The only way the son and daughter could pay his bills was under the power of attorney that the father had given them. But, when they went to the bank to take money out of their father's accounts, the bank said no. Since the father was incompetent, the power of attorney was null and void under state law.

The only recourse left to the son and daughter was to apply to the local probate court for the appointment of a conservator. Under local law, an independent attorney had to be appointed by the probate court to represent the father, medical reports had to be prepared, and a hearing had to be held at the probate court. In the end, the son was appointed as conservator for his father and the bills were paid. Unfortunately, however, the conservatorship required on-going accountings to the probate court until the father died, then a probate of the father's estate. Finally, the estate was settled, the remaining assets were distributed to the father's living trust in accordance with the provisions of his pour-over will, and then redistributed to the son and daughter in accordance with the terms of the living trust. The process took two years after the father's death and resulted in legal and probate expenses totaling nearly $20,000.

This result - while not a disaster - could have been avoided entirely if the father had taken the time to fund his revocable living trust before he became incapacitated. Because he didn't, the time and expense he incurred in creating the living trust was for naught. Furthermore, the power of attorney he created also proved ineffective because it became null and void once he became incompetent. 

Today, the results might be a little different. Most - if not all - states have now approved a so-called "durable" power of attorney. A durable power of attorney does not terminate upon the incompetency of the principal. Instead, it survives incompetency and continues in full force and effect until the principal dies or the probate court formally declares the principal incompetent and appoints a guardian or conservator. In most cases, however, a probate court will be hesitant to appoint a guardian or conservator if there is a durable power of attorney in place and there are no pressing problems associated with the care and well-being of the principal. If a disgruntled family member is upset because he or she doesn't like what the attorney-in-fact is doing, then that family member may petition the court for a guardian or conservator. Even if the disgruntled family member is able to muster a good case, there will be a window of opportunity to transfer property to the living trust under the durable power of attorney before a guardian or conservator, if any, is appointed.

Hopefully, you can see the benefit of a durable power of attorney in terms of funding a revocable living trust. If the father had a durable power of attorney in the preceding scenario, his son and daughter would have been able to pay his bills directly from his checking account. Then the son and daughter would have been able to transfer all of his property to his revocable living trust, where the son and daughter would have been able to manage the trust property as his successor trustees. Upon the father's death, the trust would have terminated and all trust property would have been distributed to the son and daughter after all final expenses had been paid. There would have been no conservatorship proceedings and no probate proceedings. Moreover, there would not have been nearly $20,000 of expenses. While the ideal scenario is to have your revocable living trust fully funded while you’re able to do it on your own, the durable power of attorney gives your loved ones the ability to fund it for you if you can't. For this reason alone, it is extremely important that you have a durable power of attorney prepared at the same time that you prepare your living trust and your pour-over will. In fact, you should also have a living will and a health care proxy prepared at the same time. A health care proxy is a durable power of attorney for health care decisions.

When you have your durable power of attorney prepared, make sure that it contains a provision authorizing your attorney(s)-in-fact to transfer property to your living trust. Without specific language to that effect, there may be a question as to whether you intended your attorney(s)-in-fact to have that power. The following is a specimen provision authorizing transfers to a trust, but each state has its own rules regarding these powers. Therefore, you should consult your own estate-planning attorney for the right language to use in your state.

"Transfer Assets To Revocable Trust. To transfer, assign, and convey any property or interest in property that I own to any revocable trust established by me, under the terms of which I have expressly reserved the power, exercisable alone or with others, to amend or revoke in whole or in part."

You should also consider giving your attorney(s)-in-fact the power to designate your revocable living trust as the beneficiary of all death benefits payable under your life insurance policies, company-sponsored retirement plans, IRAs, annuities, and the like. This decision should not be made lightly because there are serious income tax considerations involved. However, it is far better to address those issues during the planning stages than it is to address them after the fact.

C.  General Considerations in Funding a Trust

Historically, there has been a question as to whether a formal transfer of property to a revocable living trust is even necessary. The leading authorities seem to distinguish between a trust where the grantor is the sole trustee and a trust where a third party is trustee. If the grantor is the sole trustee, then the consensus of authority indicates that a mere declaration that certain property is to be held in trust is sufficient to constitute a trust of that property. If a third party is trustee, then a valid trust is not created unless there is a valid transfer of property to the third-party trustee.

It appears, then, that a formal transfer of property to a trust is probably not required when a grantor declares himself or herself to be the sole trustee. In that case, all that is necessary to put property into the trust is to simply declare it to be in trust and to attach a list of the trust property to the end of the declaration of trust. Only when a third party is the trustee do you have to actually retitle the property in the trustee's name. This seems to be the general rule followed by the courts in most states. However, New York has passed legislation that specifically requires a formal transfer of property in all cases, even when the grantor is the sole trustee. §7.1-18 of the New York State Consolidated Laws provides as follows:

A lifetime trust shall be valid as to any assets therein to the extent the assets have been transferred to the trust. For purposes of this section, (a) transfer is not accomplished by recital of assignment, holding or receipt in the trust instrument, and (b) in the case of a trust of which the creator is the sole trustee, transfer shall mean in the case of assets capable of registration such as real estate, stocks, bonds, bank and brokerage accounts and the like, the recording of the deed or the completion of the registration of the asset in the name of the trust or trustee, and in the case of other assets a written assignment describing the asset with particularity.

In New York, then, you must formally transfer property to your living trust. It is not sufficient to merely declare the property to be in trust. This also seems to be the direction that many other states are taking even though they may not have passed legislation to that effect. As a practical consideration, then, you should plan on making formal transfers of each and every property that you intend to put into your trust. This should be the case whether you are serving as the sole trustee or someone else is serving in that capacity. A formal transfer of each property leaves little doubt that the property is held in trust. As a backup plan, you should also prepare a list of all the properties transferred to your trust and attach it to your trust instrument for all the world to see if the need arises. In the event a discrepancy arises as to whether a particular property is owned by the trust, the simple declaration attached to the trust instrument may suffice if the formal transfer is incomplete or otherwise ineffective.

 

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