A few days ago, I was explaining the concept of “funding” to clients who were new to the world of estate planning, and I was struck by the fact that what I’d always thought were commonly understood concepts were actually the cause of significant gaps in the clients’ understanding of what trusts do and how they operate. The two main areas of confusion appear to be in: 1) figuring out exactly how trusts differ from wills; and 2) the mechanics of how accounts are transferred into trusts, which make the trust the “new owner” of those accounts. This article hopes to shed light on these two seemingly simple (or so I thought!) concepts: trusts and trust funding.
We’ve heard people use the word trusts in different settings and under different circumstances. Many mistakenly believe that all trusts offer asset protection. However, not all trusts are made equal – trusts can either be living (i.e. inter-vivos trusts set up during the lifetime of the Settlor or Grantor) or testamentary (i.e. those that become effective upon the death of an individual). All testamentary trusts are irrevocable, but living trusts can be revocable or irrevocable.
Living trusts are typically stand-alone entities that become effective immediately upon the signing of the trust agreement. Those that are revocable are called Revocable Living Trusts, RLTs, or Will substitutes. These RLTs allow a Grantor (also called a Settlor or Trustor) to set up the trust and retain full control of the trust assets as a Trustee, while enjoying the full benefits of the trust assets as a beneficiary. There are several benefits for setting up an RLT, but more notably, RLTs are meant to avoid probate upon death and the associated hassle-ridden probate process in some states.
In contrast, Irrevocable Living Trusts cannot be changed once established. The Grantor transfers assets into trust by assignment, sale, gift, or loan, and then completely gives up control over the assets. The two main benefits of irrevocable trusts are: 1) assets are removed from the Grantor’s estate upon his or her death, thereby avoiding estate taxes; and 2) assets are protected from both the Grantor’s creditors as well as the creditors and predators of the beneficiaries. Properly designed trusts may even escape Medicaid recovery and preserve assets for the Grantor’s ultimate beneficiaries should the Grantor be receiving public benefits. Regardless of which irrevocable trust is used, these trusts are typically sophisticated planning techniques established as part of an individual or married couple’s advanced planning. They should always accompany a robust foundational plan complete with a Will and/or an RLT, a General Durable Power of Attorney, and Advanced Healthcare Directive. For more information on the benefits of an RLT, check out our earlier posts on this subject.
When it comes to “funding” trusts though, it is important to note that this term of art refers the act of transferring accounts into the trust or retitling assets into the name of the trusts and has nothing to do with refinancing or getting loans to trusts. The following comparison may help provide a better understanding of how RLTs actually “receive” assets.
If you think of your trust as a cookie jar, then our firm would work with you to take your cookie jar from concept to design to setup. Once you sign the trust agreement, your cookie jar is now ready to be filled with assets or “cookies.” And because your trust is like your alter-ego, it can do almost anything you can do. This means that if you have five bank accounts, each at a different bank, and you want to continue to bank at these five banks, then you can open five trust accounts at these banks. Our office would then provide you with the necessary documentation you need to present to your bank representative, who will then open a new trust account and give you a new account number. Depending on the type of trust you are setting up (revocable or irrevocable), the account will either be associated with your social security number or have its own separate tax identification number (or EIN#) for income tax reporting moving forward. This process of funding may involve several back-and-forth communications with institutions and can sometimes be challenging, especially if the bank representative is unfamiliar with trusts. This is when your choice of law firm becomes critical, so the firm can coordinate with you and the institutions to see this process through to the end. Our hope is that as trusts become more and more mainstream, funding becomes less daunting on Grantors, who can then leave their organized estates to their loved ones in a smooth manner, completely free of the probate process.
This article would not be considered complete if we did not address funding in connection with real property, businesses, and accounts with beneficiary designations. Here is a quick synopsis of how these assets are funded:
- REAL PROPERTY: Real property must undergo a title change (i.e. the deed needs to reflect the new owner as the trust) in order for this to properly avoid probate. This deed must be recorded at the county clerk’s office just like any other deed. So long as the property is being transferred into an RLT, and the Grantor continues to reside in the property, a lender holding mortgage to the property cannot trigger the due on sale clause as the Grantor is protected by statute.
- BUSINESSES: Depending on how a business is structured (LLC, S Corp., C Corp.), a Grantor-owner’s interest could be assigned to the RLT.
- ACCOUNTS: Accounts passing by beneficiary designations, typically retirement accounts, life insurance policies. and/or brokerage and investment accounts with beneficiaries, must be amended to ensure the RLT (or its subtrusts for the various beneficiaries) is the primary beneficiary of these accounts.
While funding is relatively straightforward and may be handled by the Grantor on his or her own, it is always best to do so under the guidance and counsel of the drafting attorney (or even let the drafting attorney’s office handle the funding process for an extra fee) to ensure the transition is completely correctly and efficiently.
 Benefits of Revocable Living Trusts: https://estateelderplanning.com/2020/09/01/why-revocable-living-trusts-should-not-be-getting-such-a-bad-rap-in-new-jersey/ and Revocable Living Trusts Misunderstood: https://estateelderplanning.com/2018/02/26/legal-tip-of-the-week-22518/
 Our focus in this article is to address funding challenges with Revocable Living Trusts and only briefly discusses Irrevocable Living Trusts in passing.