What Is a Trust Exactly?

Here is an interesting dialogue on an attorney listserv about one attorney asking other attorneys how trusts work. Even for attorneys, it can be a complicated concept to wrap your head around. I asked the answering attorney, whose answer was quite good, if I could post his response here to the question.

Thanks to Mike Koenecke, Attorney and Counselor, from Richardson, Texas.  Mike also has a neat website about macros and such for WordPerfect users. Mike can be reached at mike[insert "at" symbol here]koenecke.us.

Here is the question paraphrased:

I am trying to understand how trusts work.   Let's say someone wants to set up a trust- They take the money and assign a trustee, either an individual or a corporation who puts that money in an account, and then it is distributed to beneficiaries from that account. 

But how does this work when it comes to real property? Don't some people put their whole estate in trust? Obviously they don't liquidate all of their assets, so how does it work?  Why would they want to have it all in trust, and not just have a will and let it go to probate?

And here is Mike's unedited answer:

One thing that is hard to understand about trusts is that, like estates, they are not legal entities. They are *relationships*. Property held in the Doe Family Trust is actually held by John Doe, Trustee of the Doe Family Trust, since he holds in in a fiduciary relationship to the beneficiaries of the trust. Just as John Doe, Executor of the Estate of Jane Doe actually holds property of the estate.

They may be *taxable* entities (i.e., filing their own Forms 1041), but they're not *legal* entities, even though they are commonly treated as such by financial institutions.

Trusts are favored in many jurisdictions for estate planning purposes for a few reasons. One of them is avoidance of probate: not just cost, but administration time and expense. Instead of having to transfer an asset via court order, the holder of the asset is merely notified of the successor trustee. Another reason is privacy: one generally has to file a Will to probate it, leaving one's dispositive scheme a matter of public record. Also, one has to file an Inventory and Appraisement, advising the world in general of the contents of the estate. Not the case with a trust. A third reason is supposedly ease of amendment and administration, where one may make changes to one's estate plan more easily than adding a codicil to a will, but I've never found that a very persuasive argument, since it is foolish to advise clients that they can amend their own estate planning documents willy-nilly.

Those are the positive aspects of trusts, and in states with antediluvian probate laws (like California, for example - or so I've heard) that place onerous burdens on an executor to administer an estate, the idea of avoiding the process is very attractive. In states with more progressive probate laws, allowing for flexibility and ease of administration, not so much. In actual practice, I have found that the administration costs are not all that different between wills and trusts, and wills in fact have certain advantages, because they allow one to present letters testamentary to fiduciaries, which makes transfers relatively easy.

Of course, there are many other uses for trusts, as in ILITs, CRATs, CRUTs, GRATs, special needs trusts, asset protection trusts (generally placed in a foreign jurisdiction), and so on.

Some people do put their whole estates in trust, but that does not involve liquidating assets, only a transfer. It could be as simple as John Doe transferring Blackacre to "John Doe, Trustee of the Doe Family Trust."  His brokerage account is held similarly, and (if it's a revocable trust) in John Doe's Social Security number.

Just a few thoughts.

It's a good answer.  He is right about California's probate code and trusts are preferred for that reason in California.

Thanks Mike.