what is a trust?
March 21, 2022
|John Brennan, Senior Vice President of Trust and Financial Services at Cape Ann Savings Bank, talks with John Maher about trusts. He explains their basic purpose and talks about how they can shield assets from certain taxes or creditors, help estates avoid probate, protect the finances of people who are mentally incapacitated, and more.
Transcription Disclosure: Below is a transcript of the conversation between John Maher and John T. Brennan. Please note, this is an unedited "word for word" rendition of the actual conversation and is not intended to be grammatically correct.
John Maher: Hi, I'm John Maher. I'm here today with John Brennan, Senior Vice President of Trust and Financial Services at Cape Ann Savings Bank in Gloucester, Massachusetts. Today, our topic is, what is a trust? Welcome, John.
John Brennan: Hi, John.
Definition of a Trust
John Maher: So, John, why don't we start at the beginning and just have you give me a basic definition of a trust?
John Brennan: So in essence, John, a trust is a legal agreement between at least two parties. First off, you're going to have to have somebody who's going to create the trust. This person is typically called a grantor, or sometimes called the settlor. Sometimes, when people want to be clear, they just call them the trust creator.
Then you're going to have to have a person who's going to be the trustee of the trust, who's going to take ownership and control of the assets and direct the beneficial interest of them. Oftentimes, you can have another person, persons, or entities, who are party to the trust and who are going to be the beneficiaries of the trust. So in essence, it's an agreement that contains these people wearing these hats.
A little note on ownership… When somebody is a trustee of a trust, they actually take the legal title to the property. I'm not sure people are always aware of that, but the person who originally owned it gives it over to the trustee. The trustee then actually owns it, takes legal title, and directs the interest. Now, your next question would probably be, "Well, how do they direct the interest? How do they know how to direct the interest?" And the simple answer is, it's in the trust.
The trust directs the trustee or gives the trustee parameters on how to use the trust assets. Another analogy that we sometimes use in the trust world: think of the trust as a bucket and think of the grantor or the settlor or the trust creator as somebody who wrote a set of instructions on the outside of the bucket. And then on the bottom of the bucket, there's a spigot. And the spigot controls the beneficial interest of the trust, and we'll use an analogy of water here. The trustee is the person who controls that spigot, and the beneficiary is the person who receives that water.
Trusts are often parts of estate plans. They can exist. They exist as their own independent economic entity, and many trusts can exist for decades. They're often created as a part of someone's estate plan.
Role of the Trustee and the Trustor
John Maher: Okay. So tell me a little bit more about the difference between the trustee, and the trustor, as you're referring to it, as the grantor. What is the difference between those and what are their roles?
John Brennan: Sure. Well, going back to what I said at the beginning, the person who's the trustor or the grantor or the settlor, these are all synonyms. They are the original owner of the property, most likely, and the creator of the trust. We can't use the term "trust owner" because the settlor is gifting property or directing property into the trust. So that's why you don't say "trust owner," it's just not appropriate.
A trustee is really what it sounds like. It's the person entrusted with trust property, who then has the responsibility, a legal responsibility, to manage the asset and direct it according to the trust terms.
The trustee is an appropriate name for this role because it does require tremendous amounts of trust and confidence. Someone can be the grantor of a trust, that is the creator of a trust, and be their own trustee. You'll often see this in revocable trusts, which we'll talk about later. A person who is a trustee can be an individual or multiple individuals, or in the case of Cape Ann Savings Bank, an entity. All of these, any one of these people, could be the trustee of a trust, because that person is the one who is tasked for managing the property for the benefit of another.
What Type of Property Can You Put in a Trust?
John Maher: And can you just define what a property is in this case? You're saying that the owner, or that the trustor, the grantor, has the property and basically gives it to the trustee to manage that property. What types of property are we talking about here? Can they actually be physical properties? Can it be money? What are the different types of properties?
John Brennan: The types of property that can be transferred over a trust is really, you name it. The most common one is probably the most obvious, which is money. And even maybe more common than straight cash would be investments.
Because as I stated earlier, trusts can exist for years or decades. So they often hold investments with the idea that the trust both gains value through its existence, and also sheds what we call "income." Income is exactly what it sounds like. So you might have something like a bond that gives out a coupon or interest. You might have some stock that pays dividends. You might have a mutual fund that pays dividends. So you have all those Wall Street-type investments that are very commonly in trusts. Another type of property that you see in trusts, that both trusts can own and trusts often receive the benefit of, is life insurance.
If there's a payout, a trust can both own life insurance on an individual and also can receive cash, and potentially convert that cash into the investments we talked about earlier. A trust can also own real estate. It can own a plain old house, and at times a beneficiary might receive their interest to the trust in the ability to live in the house. Out in the Midwest, or out in other parts of the country, farms are very commonly in trusts. Another item that you see in trust quite a bit, not in New England, but in other parts of the country, is gas, mineral, or oil interests.
Another way a trust can hold property is that the trust can actually have an interest in a business. So if a trust owns stock, say, in a closely held company, this means the trustee could potentially sit on the board of a corporation and have a voice in the business in order to direct the business to do what the trustee wants it to do, which is most likely, to aid their beneficiary. So that's another way a trust can assert control over property.
Another thing you see in trusts, and this is, I think, interesting, is intellectual property. Say Elvis Presley, as an example, his likeness has value. And so that is the type of thing that could go into a trust as he still receives compensation for representations of himself and his songs. Another thing, which is analogous to the trust situation, and I think it's apt, is that recently, you've seen some very big musical legends, namely Bob Dylan, David Bowie, Bruce Springsteen, Stevie Nicks, and Neil Young, sell their song catalogs.
And you might ask, "Why did they do that?" Well, they did that because, as you could imagine, it takes a lot of work to reap the benefits of say, "Born in the USA", which could be played countrywide and for all these different purposes. Bruce Springsteen sells it to an entity that can manage that, has the resources to manage that. And probably, his heirs don't have the ability to do that. So here's a case where, potentially, a trust would be a good owner of that. Because it has the administrative, or it has the potential of administrative power to manage that kind of intellectual property.
When we're talking about property that can go into a trust, just think in terms of title. Is there a title to it? Cars have a title, so they can go in a trust. Some other things you see in trusts, guns. There are gun trusts. And also, you can have antiques or collections which are owned by the trust. And the other thing I want to point out, John, while we're here and talking about property, when you add property to the trust, it is known as funding. Because what can happen is just as you, John Maher, could own property on your own, you could also create a revocable trust in your own name and you and your trust could own the property at the same time.
When you put that property in your trust's name, that means the trust is funded. It means the trust is no longer just a piece of paper. It has a controlling interest in the property once you pass away.
Beneficiaries of a Trust
John Maher: Okay. All right. Yeah. That's a good distinction. Let's go take another step back as well and define another thing that you talked about before, which was beneficiaries. Can you talk a little bit about beneficiaries and what they are?
John Brennan: Sure. Beneficiaries, the good thing about trust is some of these terms are obscure. Some of them are exactly what they sound like. A beneficiary is exactly what it sounds like. It's somebody who accrues the benefit of a trust. That benefit can be in the form of income, going back to a trust that might shed interest in dividends. There's always this concept of income. And the reason why is, trusts operate on a principal and income accounting basis. This goes back to a legacy of trusts, because remember when I said trusts own farmland? Think of farmland as the principal and then the crops as the income. So the beneficiary is the person who most often has a right to that income. And then often, beneficiaries receive the ability to ask for trust principal on certain circumstances. So a trust beneficiary just accrues the benefit of the trust, and has rights delineated by the trust to use, enjoy, occupy the benefits of the trust.
How Trusts Help Your Heirs Avoid Probate
John Maher: And then let's talk a little bit about estate planning and how trusts are used in an overall estate plan and what the advantages are.
John Brennan: Trusts do a couple big things. And one of the things I'll be specific about, John, is that trusts do more than one thing at the same time. So if you ever catch me saying, "Hey, I thought you said, 'Trust did that.' And then you said, 'Trust did that.'" Well, that's true because they can do more than one thing at the same time.
Just as I talked about a trust being capable of taking title of an asset, one of the advantages of a trust taking title of an asset, where we have the John Maher revocable trust, and then you put your million dollars of stock in the trust and you title that investment account in the name of the John Maher trust.
The advantage of that is that if you were to suddenly pass away… and this revocable trust has this unique ability for both the individual and the trust to own something at the same time. What that means is the moment you drop off, the trust takes ownership. And that means that the assets that the trust owns do not have to go through probate. Do you want me to explain probate?
John Maher: Yeah. Yeah. Go ahead and explain probate a little bit.
John Brennan: So probate is a process in which say, you, John Maher, own property. And let's say, imagine you're holding a pen. And then if you pass away, boom, the pen drops on the floor. Well, who gets to pick it up? Probate answers that question. How does probate answer that question? Well, what happens is, hopefully, say, your wife or another loved one gets your will.
They take that will to, you guessed it, the probate court. Probate, in Latin, the root of that word is to prove. Because the probate court's function used to be to substantiate somebody's will. A will is a formal, legal document that requires two witnesses and signatures in order to substantiate its authenticity.
So the probate court's job used to be really to make sure they had the right will. And somebody would walk in with another piece of paper that was supposedly somebody's will. So the probate process is that you bring in the will, the court verifies it. And then the court appoints what you know as an executor. The term people use now is a personal representative, but the executor or personal representative, they are empowered by the court, by letters testamentary that they received from the court, to gather up all the assets that were in your name and direct them according to the terms of your will.
What you need to be conscious of in the probate process is that probate can take a while. Once somebody passes away, you have to get a death certificate. And then after you get a death certificate, you have to locate the will. And then the death certificate and the will and probably an attorney, head down to the probate court to get the will verified and to basically get the will proven in order to empower the executor. This can take time. The challenge is, let's say, you have a wildly fluctuating stock market. You really might not have three months in order to get things in order for an executor to get empowered and take control of that property.
And it's challenging. We are professional fiduciaries who guide people through the probate process, and it can be challenging to very smart people because it is arcane. It dates back to laws that have existed for hundreds of years and aren't always up to date. So it can be a challenging process for the layperson. Trusts and the ability for a trust to own property, avoids the entanglements and the challenges of probate.
Additional Advantages of Trusts and Estate Plans
John Maher: And then what are some of the other advantages of trust in terms of estate planning?
John Brennan: Well, the other good thing about trusts is let's say you put your property in a trust and then you are incapable of taking care of yourself. You could have a plan within your trust where there is a co-trustee or a successor trustee who you could appoint or who could be appointed for you, in case of incapacity. That would empower that person to take control of your property.
And if your trust is logical, it will direct the benefits of property to you on your behalf. So trusts act as a plan for incapacity. The other thing that trusts do is that trusts can allow for continued management and often professional management of property. Here are a couple of examples.
Now, when I say continued management, I'm talking about a longer time horizon than, say, a year. Say, somebody who has a child with special needs and that child has no siblings. You often see trusts where property is managed for the benefit of someone with special needs, because they don't have the capacity on their own to do that. You also have trusts which manage property for people who might have no interest in managing money. Finance is not everybody's forte. So that's another reason why assets might be held in trust.
You can also have somebody who might have a substance abuse issue, and they really shouldn't have all that cash because that might lead to them reverting to abusing substances. And of course, you have all sorts of health issues, mental or physical, or you could just have somebody who's too young and immature to take control of their property. So all of these are reasons to keep money in trust until people get to the point where they can do it themselves, or just have that professional manage it. The other thing trusts offer is when somebody has money in trust, they have a certain amount of protection from creditors. They may not be able to alienate their interest in the trust. And at the same time, a creditor may not be able to reach their interest in a trust. Meaning they have some protection from somebody who is seeking to extract money from them. Now, the other thing trusts do is they allow the settlor or the trust creator to impose some values upon the beneficiary of their trust. They could say, "Hey, if my nephew graduates from college, I'll give him $100,000." So as long as you don't have something that subverts the law or public policy, it's all right to put conditions like that in the trust.
Just as we've gone through all these advantages of trusts for estate planning, the other thing that is important is trusts have the ability to reduce estate taxes. Now, this is something that has become less important as the federal estate tax has become much higher. And between married couples, that number can pass... Well, briefly, estate taxes are levied when someone dies and they want the privilege of passing on their money to the next generation. Trusts have the ability to shelter some assets from the estate tax and use what I always call the "decedent's coupon," or their ability to pass on a certain amount of assets, estate tax-free, to their beneficiaries.
So trusts are, as I was saying in the beginning, doing two things at once. They're avoiding probate by taking title to assets, and they're being useful in how they direct their benefits on a go-forward basis. But then on this other level, they are also a vehicle to reduce taxes. And they do both things at once.
Who Needs a Trust?
John Maher: All right. So any final thoughts before we wrap up on trusts. Who should have a trust? Or who should be thinking about getting a trust?
John Brennan: Well, as I explained earlier, there's a lot of reasons people might have a trust. They have a child with special needs; they have young children; they're creating an estate plan. They have a beloved family home they want to protect. They have a child who's a surgeon and is potentially exposed to lawsuits. They want to impose their values on a set of beneficiaries by encouraging them to go to college or to behave in a certain way. And the other reason would be for their own benefit. They want a trust in case they become incapacitated and the trust can then step in and work for their benefit. And then for people here, especially in Massachusetts, where there's a low estate tax, trusts are useful in reducing that estate tax in the passing of money from generation to generation.
To Learn More, Contact Cape Ann Savings Bank
John Maher: All right. Well, that's really great information, John. Thanks again for speaking with me today.
John Brennan: Sure thing, John.
John Maher: And for more information, you can contact Cape Ann Savings Bank Trust and Financial Services at 978-283-7079. Or visit the website at capeannsavings.bank.
Investments purchased through the Cape Ann Savings Trust and Financial Services department are not FDIC insured, not FDIC guaranteed, not bank guaranteed, and may lose principal value.