Stabilization of purchasing power and proper administration of assets at the time of death are some of the most common concerns among individuals with substantial assets.
While our previous article analyzed Panamanian Private Interest Foundations, this article will focus on Trusts and, specifically, on the reasons why said instrument has acquired more and more importance over the years, becoming an alternative to Wills and will analyze how certain types of Trusts may ensure real and effective protection of assets.
A Trust may be created for different purposes, including:
- Assets protection: Trusts may be created to protect assets from creditors or for the financial benefit of the person creating the Trust, a surviving spouse, and/or minor or disabled children;
- Pension plans: pensions plans are typically set up as a Trust;
- Wills and estate planning: Trusts frequently appear in Wills;
- Privacy protection: Trusts may be created purely for privacy. The terms of a Will are public in certain jurisdictions, while the terms of a Trust are not;
- Co-ownership: ownership of property by more than one person is facilitated by a Trust;
- Legal retainer: Trusts are often used by Attorneys to hold money on behalf of their clients.
However, the most common purpose when creating a Trust is the administration of decedents’ estates and, in this article, we will focus on such Trusts (i.e., Trusts that are used as an alternative, or in conjunction with, Wills).
A Trust is a fiduciary arrangement in which one or more persons hold the Trustor’s assets, subject to certain restrictions, to administer and protect them for the benefit of others. Trustors may determine the distribution of their property during their lives or after their deaths through the use of a Trust.
Trusts exist mainly in common law jurisdictions (except for the Republic of Panama which, despite being a civil law jurisdiction, adopted the first Trust law in the 1940’s and new provisions on Trusts were then enacted by Law no. 1 of January 5th, 1984), but similar instruments existed since Roman times. A Trust indenture may be drafted in many ways and can specify exactly how the assets should be managed, and how, when, and to whom they shall be distributed.
The person who creates the Trust is named Settlor (or Grantor or Trustor), and transfers title to some or all of his/her assets to a Trustee, who then administers the Trust and holds the property for the benefit of others. The person who benefits from the Trust is named Beneficiary.
A Trust can be:
- Revocable: also known as a living Trust (or “inter vivos Trust”), is a Trust which allows the Settlor to retain control of the assets during his/her lifetime. It is flexible and can be modified or terminated/dissolved at any time (as long as the Settlor is not incapacitated) should his/her circumstances or intentions change, which makes the revocable Trust ineffective against third parties’ claims. The revocable living Trust is the most commonly used type of Trust as it will allow the assets of a decedent to pass outside of probate (the court-supervised administration of a decedent’s estate created by state law to transfer assets from the decedent’s name to his or her heirs. A personal representative must be appointed to handle the estate administration).
- Irrevocable: is as Trust which cannot be altered by the Settlor after it has been established. Therefore, the Settlor will lose control over the assets (which cannot be attacked anymore by his/her creditors) and cannot change any terms or decide to dissolve the Trust.
Thus, while the revocable Trust may be modified or revoked at the discretion of the Settlor, the irrevocable one cannot be modified or revoked (not even by order of a judge), which further ensures the protection of Trust assets against third-party creditors. Nevertheless, there are cases where (although the Trust is irrevocable) the Settlor may have the power to replace/change the Beneficiaries, without compromising the benefits related to the Trust.
However, the most relevant difference between revocable and irrevocable Trusts relies on their tax treatment. In case of irrevocable Trusts, since the assets have been transferred to the Trust and the Settlor has lost control over them, the assets are not subject to estate taxes; moreover, the Settlor is relieved of the tax liability on the income generated by the Trust assets. Instead, a revocable Trust may help avoid probate (by effecting the transfer of assets during the Settlor’s lifetime to the Trustee) but it is still subject to estate taxes (it is treated like any other asset the Settlor owns). An irrevocable Trust is generally preferred over a revocable one if the Settlor’s primary aim is to reduce the amount subject to estate taxes by effectively removing the Trust assets from his/her estate.
During the Settlor’s lifetime, the Trustee must administer the Trust property with the skill and prudence that any reasonable and careful person would use in conducting his/her own financial affairs. His/her actions must conform to the directions in the Trust agreement.
The Trustee is the legal owner of the Trust’s property, but has a fiduciary duty to beneficiaries: he/she must be loyal to them, administering the Trust solely for their benefit and to the exclusion of any consideration of personal benefit, profit and/or advantage. In case of revocable Trust, and if the Settlor is unable, the Trustee may also have the power to make decisions about the management of the assets or any investments to be made on behalf of the Settlor.
When establishing a Trust, the individual’s assets, such as bank accounts, real estate and investments, must be formally transferred to the Trust. This process is called “funding “ the trust and requires changing the ownership of the assets to the Trust. Assets which are not properly transferred to the Trust may be subject to probate and attached by third party creditors.
In the event assets are distributed because of the Settlor’s bankruptcy or because the condition established in the Trust indenture (in order to proceed with the distribution) is fulfilled, the Trustee has to: collect and evaluate the assets in Trust, identify the beneficiaries and creditors, pay the various taxes and expenses and distribute such assets. Also, he/she has to pay the Trust fees and any other fee that might be required for professional services rendered by attorneys or accountants.
According to the Florida law, creditors have two years from the date of death of the debtor to file their claims.
This means that the Trustee cannot proceed with distribution of Settlor’s assets until all creditors have been satisfied. Naturally, two years is a long period that is why some people choose to create their Trust in their Will so to take advantage of the Will regulations, which contemplate a three-month creditor claim period.
To conclude, it is clear that the main advantage of an irrevocable Trust is the total protection that it assures to the Settlor’s assets (with this regard, in our next article we will study more in detail how personal assets may be protected with Cook Islands Trusts). On the contrary, the main purpose of a revocable Trust is to avoid probate, so making simpler the transfer of assets to beneficiaries.
Whatever the choice is, it is always advisable to consult with an expert in the field in order to determine if the assets are appropriate for Trust ownership and to have all the necessary elements to make the right decision for each specific case.
This article contains general information and does not replace in any way the help of a lawyer. We suggest you seek professional help for further information and assistance. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you free written information about our qualifications and experience.