Trusts and Estates
A trust is a legal arrangement where a grantor (also called settlor or trustor) transfers assets to a trustee to manage for the benefit of beneficiaries. The trustee has a fiduciary duty to manage trust assets according to the trust document and applicable law. Trusts are separate legal entities that can own securities, open brokerage accounts, and be clients of an investment adviser.
Investment decisions must align with the trust document's terms and the Uniform Prudent Investor Act (UPIA).
Revocable Trust (Living Trust)
- Grantor can modify, amend, or revoke the trust at any time during their lifetime
- Assets remain in the grantor's taxable estate (no estate tax benefit)
- Grantor typically serves as trustee during their lifetime
- Avoids probate at death; assets pass to beneficiaries without court involvement
- Becomes irrevocable upon the grantor's death
Irrevocable Trust
- Cannot be changed or revoked once established (with limited exceptions)
- Assets are generally removed from the grantor's taxable estate (estate tax benefit)
- Grantor gives up control of the assets
- May provide asset protection from the grantor's creditors
- Trust is a separate taxpayer; files its own tax return (Form 1041)
Testamentary Trust
- Created through the terms of a will - only takes effect upon the grantor's death
- Goes through probate (unlike a living trust)
- Always irrevocable once the grantor dies
Charitable Trusts (Split-Interest Trusts)
| Type | Income Beneficiary | Remainder Beneficiary | Tax Benefit |
|---|---|---|---|
| Charitable Remainder Trust (CRT) | Grantor or named individuals | Charity | Immediate partial income tax deduction |
| Charitable Lead Trust (CLT) | Charity | Grantor's heirs | Reduces gift/estate tax on transfer to heirs |
- CRT: pays income to the grantor/beneficiary for life or a term of years (max 20 years), then remaining assets go to charity
- CLT: pays income to charity for a specified period, then remaining assets pass to the grantor's heirs
- CRT remainder to charity must be at least 10% of initial fair market value
Exam Tip: Gotchas
- CRT and CLT are "mirror images." CRT = income to individual, remainder to charity. CLT = income to charity, remainder to individual/heirs. The exam tests which beneficiary receives income vs. remainder.
Estates as Clients
- An estate is the legal entity that holds a deceased person's assets during the settlement process
- Managed by an executor (named in will) or administrator (appointed by court if no will)
- The executor/administrator has fiduciary duties similar to a trustee
- Estates are temporary - they exist only until assets are distributed to beneficiaries
- Estate is a separate taxpayer (files Form 1041)
- Investment objectives are typically capital preservation and liquidity (short time horizon)
- Adviser must work with the executor/administrator, not the beneficiaries
Exam Tip: Gotchas
- A revocable trust avoids probate but does NOT remove assets from the taxable estate.
- A testamentary trust goes through probate because it is created by the will, which must be probated.
- At the grantor's death, a revocable trust becomes irrevocable.