By Randall Kleinman, JD, CPCU, CLU
(Agents' Legal Issues provides a brief general overview of a complex area of law, and neither the author nor Rough Notes intends it to be taken as legal advice for any specific legal problem. For a specific problem, consult legal counsel that understands the law of insurance agencies, and provide all the details.)Trusts are everywhere these days. There are so many different popular uses of trusts that you'd think insurance professionals would understand them quite well. Instead, the opposite is usually the case. Most insurance people, in spite of their personal and professional needs to work with and to understand trusts, really don't know what the key types of trusts are all about. This article will focus on a number of types of trusts that are very popular these days. Even if an agent doesn't feel qualified as an "expert" in the area of trusts, (s)he ought to acquire this general information on the subject. The kinds of things we'll discuss come up so often in the business world that you simply need to be aware of them in order not to make big mistakes in doing your job as an insurance agent--not to mention your need to understand how these types of trusts impact your personal life.
First, we'll look at what a trust is, legally. Then, we'll look at several common types of trusts: insurance trusts, living trusts, trusts connected with wills, and others. We'll even take a brief look at some types of property-casualty trusts, including MEWAs, which are a type of property-casualty trust that has gotten much attention from regulators in recent years.
Keep in mind that trusts come in two forms: revocable and irrevocable. Both types have their purposes in the modern world. Both have their drawbacks as well. For example, the IRS is often looking to see whether a trust that is said to be irrevocable really takes the assets permanently out of the hands of the person who entrusts them. If the IRS feels that the person still controls the assets, the IRS may continue to consider the assets (and their resulting income and appreciation) as part of the person's assets instead of as part of the trust's assets.
You might think that trusts have to be put in writing, but that is not necessarily the case. You might be considered a trustee under the terms of an unwritten trust if you hold money or assets for someone else. It might be an oral trust; but in other cases it might be what lawyers call a "constructive" trust, which means that a court has constructed the terms of a trust where no formal agreement existed, but where justice demands that one person be seen as having a responsibility to hold assets for another person.
Because trusts are a well-established legal concept, there are not only a lot of types of trusts that lawyers in the field know about, with lots and lots of legal details and minutiae; but there are tax implications which also are quite complex. As a result, it is not possible to cover the whole field of trusts in only one article. We'll just skim the surface here so that you get a brief idea of what key areas of the field are about.
Trusting your assets
People have been creating trusts for hundreds of years. While some types of trusts are fairly new, the basic legal concept, which virtually all trusts follow, is extremely old. At its most basic, a trust is a legal device that allows one person to put assets into the care of another person for the benefit of a third person. The person who transfers the assets is called the "grantor"; the person who will care for the assets is the "trustee"; and the person for whose benefit the trust is set up is the "beneficiary." In some trusts, the same person might have two or even all three of these roles.
In the eyes of the law, a trust is considered a legal "person," in the same way that a corporation has its own legal status. Among other things, this means that a trust has to file tax returns (they have their own tax rate schedule). It can also be sued as a person. It may need to be specifically listed, therefore, as an insured or additional insured on an insurance policy.
Many people have tried to play games with trusts in order to avoid creditors, income taxes, alimony, etc. While most of these games do not work at all, there are in fact a number of clever things that one can accomplish with certain kinds of trusts--enough things, that trusts are quite popular. However, since the public misunderstands them completely, it is also a popular field for con-artists and incompetents to inhabit. One should not try to create, administer, or even deal with a trust on any matter of consequence without consulting a knowledgeable, reputable attorney as to the consequences.
Life insurance trusts
Estate planning attorneys and experienced life insurance agents dealing with the affluent market work with trusts on a daily basis. If set up properly, an "insurance trust" that holds life insurance can take the value of the insurance out of a person's estate at death, thereby potentially saving the estate hundreds of thousands of dollars of taxes. Any property/casualty agent that dabbles in life insurance should be very wary of selling a policy of any size to a client without suggesting that the client talk to an estate planning attorney about whether an insurance trust is the appropriate method to hold the policy for the particular client. In most cases, it is certainly malpractice to sell an insurance policy directly to a client without suggesting that a trust be set up to purchase or hold the policy, if that would save the client lots of estate taxes.
In addition, the mechanics of putting the policy itself into the trust, and the handling of premium payments and dealings with the insurer, have to be treated carefully, since it is generally the trust that owns the policy, not the insured. Many life insurers prepare sample forms for insurance trusts that they are happy to distribute to agents; but for professional liability purposes, agents have to be careful not to imply to clients that the agent can do the legal work to prepare the trust, or that the form of the trust is suitable, without its being tailored to the client's specific needs by an attorney.
As you probably can tell, an insurance trust usually will be an irrevocable trust, since it is necessary to take the policy out of the insured's estate. However, some attorneys will suggest to a client that, in particular cases, the trust should be made revocable at the start, and that only upon death should the wording of the trust make it irrevocable.
Living trusts--a live opportunity for con-artists
Living trusts have been pushed very heavily for the last few years. While some of the people pushing them are con-artists who have been pursued by regulators, others are legitimate lawyers and business people who are trying to teach the public about the benefits of living trusts. Unfortunately, you have to be careful in order to tell the difference.
A living trust is a type of revocable trust created by a grantor during his or her lifetime. The grantor continues to control the assets and the income, so there are usually no income tax advantages for the grantor. There are also no estate tax benefits for the grantor in most cases--something that many, many people are confused about. Sometimes, the people who hawk living trusts to the public very cleverly make it sound as if living trusts will cause you to avoid all your estate taxes. It simply isn't true. This columnist has talked to several insurance people who were fooled by that very pitch.
What living trusts can do that is of value is avoid "probate costs." In some states, the costs of probate court are calculated as a small percentage of the size of the assets in the estate. For a million-dollar estate, even a 3% probate cost amounts to $30,000. And since probate is often public knowledge, using a living trust can keep information about an estate more private.
In addition, a trust goes on "living," unlike a person, so that there can be continuity regarding the assets. For example, if a business is held in a living trust and the grantor dies, the trustee (or the successor trustee) will continue to run the business.
But don't get too excited about living trusts. Many states allow estates to cut down the cost of probate by using "independent administration," which takes most of the procedures out of the court. The cost is much less, and the privacy is greater. Since the cost of running a trust can mount up over the years, it well may be more cost-effective in some circumstances just to skip it.
Even the saving of probate costs might be illusory. Many people pay to form living trusts but never take the actual steps necessary to put their assets into the trust once it has been created. As a result, upon their death, the assets are still in the estate and must go through the probate process anyway.
Insurance agents who have been financially successful (considering not only earnings, assets, and savings, but also expected inheritances during life, and life insurance payments expected upon death) should definitely consult with a knowledgeable attorney about whether a living trust is cost-effective. But even people who think they have no interest in a living trust may wish to consult with an estate planning attorney, too, because there are very useful techniques that can be used during one's lifetime to minimize tax consequences upon death.
These are not magical tricks that "fool" the IRS. Rather, they are proven ways of structuring your assets that fall within the laws and IRS guidelines. It's fair to say that people who come to an estate planning attorney (or expert financial planner specializing in estate planning) expecting that nothing can be done are often surprised at the number of techniques that can be employed. Perhaps due partly to the political influence of the life insurance lobby in Washington, many valuable techniques involve the use of life insurance, but not all. On the other hand, people who come in expecting that the attorney or planner will magically do away with all possible tax liability by virtue of some "quick fix" are usually disappointed.
Trusts that are connected with wills
You might be surprised to know that a great many wills, perhaps even the majority of the ones that lawyers prepare, are prepared in conjunction with trusts. Such trusts are usually testamentary trusts, which means that they are activated and funded around the time of the grantor's death. Many grantors prefer to have a third party hold and manage some of the assets which the grantor owned. Since many grantors have children under the age of 30, whom they intend to name as the beneficiaries, they may feel that an experienced trustee with financial experience is advisable for holding and managing the assets. Other grantors use the testamentary trust as a catch-all device to hold any assets which the grantor may have forgotten to bequeath in the will to heirs.
Property-casualty trusts:Should you trust them?
A number of types of trusts are connected with property-casualty insurance.
A MEWA is one type of insurance trust for property/casualty insurance. The initials "MEWA" stand for "multiple-employer welfare arrangement." The terminology refers to technical language from a law called ERISA that was passed in 1974. ERISA is a wide-ranging law that affects virtually every employee benefit where money or assets are held by an employer or by a firm hired by the employer; and since "trusts" are the devices that usually hold money that belongs to another, ERISA is very concerned with trusts.
ERISA was passed because some employers and unions had abused the trust of people whose money they were holding. ERISA, among other things, requires detailed reporting and detailed behavior on the part of most trustees who hold the money of others.
Because ERISA is a federal law, and federal law usually overrides a conflicting state law, a number of people thought that perhaps it was the intent of Congress that ERISA would override state insurance statutes. Therefore, they reasoned, an ERISA trust could be set up which might be subject to federal law but not subject to state insurance laws. This reasoning drove property-casualty insurance regulators crazy for seven or eight years, until court rulings were obtained in a number of states to show that state insurance laws were not rendered completely obsolete by ERISA. As a result, many property-casualty insurance trusts operating under ERISA were required to comply with certain state insurance laws as well. However, litigation on this point and others still goes on in a number of cases.
This doesn't mean that all MEWAs are illegal. It just means that they need to comply with certain rules.
There are other types of property-casualty trusts, too. First, in those states that allow true "group" insurance for auto or other property-casualty lines, an attorney might advise that the group policy be put in a trust. Second, some states allow specific kinds of trusts to be formed to pursue property-casualty business. For example, in Illinois, trusts can be formed to sell insurance to certain non-profit institutions. These "trusts," however, usually look a lot like insurance companies in their operations and in the rules that they are required to follow.
Third, that premium fund trust account you set up is a sort of trust, since you are holding money for insureds; and if you ever have a problem with your trust account, you may find that the law of your state considers you a trustee and applies your state's law of trusts to the problem.
Other important trusts
There are other important types of trusts as well. First, there are "educational" trusts, which can be set up to hold money destined for the eventual educational costs of young children. Putting the money in trust may get the funds out of the hands of future creditors and perhaps avoid the high income taxes which the grantor might otherwise have to pay.
Second, there are trusts set up for health care purposes. In some states, some assets of a person with health problems can be put in trust so that a trustee can make the health care expense decisions, or so that the person might be able to qualify for medicaid or other governmental benefits. It is not easy to set up a trust to hold assets so that a person will qualify for governmental benefits, so anyone seeking to do this should be sure to consult a competent and reputable attorney.
Third, in some states "land trusts" are permitted. They allow the grantor to use a trust to hide to some extent his or her ownership and control of the land. Land trusts may serve other purposes as well, but they don't usually allow a grantor to avoid property taxes.
There are other types of trusts as well, such as trusts set up to purchase stock, trusts set up to get tax benefits in connection with charitable gifts, "rabbi" trusts in connection with payments under non-qualified deferred benefit plans, and a number of other trust forms.
Space does not permit a discussion of these types of trusts, but their mention should you aware that innovative lawyers and financial experts have been able to use the trust concept profitably in quite a variety of situations.
Most affluent people have a need eventually to set up or deal with trusts, and most insurance agents have a need, at least occasionally, to deal with trusts as insureds. Since trusts are a complicated and varied concept, the more you know about them, the more likely you are to be able to deal with them competently and to use them to your benefit. Trust in trusts, but be sure you understand them first!
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The author
Randall Kleinman, JD, CPCU, CLU, a graduate of Stanford Law School, has spent many years focusing on the legal and business needs of insurance agents. He also is a speaker, seminar leader and expert witness, and is the president of Oospensky Communications, Inc., of Wilmette, Illinois, which publishes Insurance Magic, an unconventional newsletter.