A challenge faced by some is the possibility that a beneficiary will challenge the the terms of a trust. A "no-contest" clause is a way to dissuade a beneficiary from contesting the terms of a trust. The clause, in essence, provides that a beneficiary would forfeit what he or she would've received under the trust if he or she challenges it.
Whether a no-contest clause is enforceable and how effective they may be in California will be topics explored in a subsequent post.
To create a trust, certain legal requirements must be met. California Probate Code Section 15200 describes the ways in which a trust may be created:
Subject to other provisions of this chapter, a trust may be created by any of the following methods:
(a) A declaration by the owner of property that the owner holds the property as trustee.
(b) A transfer of property by the owner during the owner’s lifetime to another person as trustee.
(c) A transfer of property by the owner, by will or by other instrument taking effect upon the death of the owner, to another person as trustee.
(d) An exercise of a power of appointment to another person as trustee.
(e) An enforceable promise to create a trust.
Although there are a number of ways in which a trust can be created, there are a few other elements that must be satisfied:
In California, trusts are not permitted to last indefinitely. Under California Probate Code Section 21205, a trust must not last longer than 21 years after an individual alive at the time the trust is created or 90 years, whichever is called for in the trust document. Here's the actual code section:
A nonvested property interest is invalid unless one of the following conditions is satisfied:
(a) When the interest is created, it is certain to vest or terminate no later than 21 years after the death of an individual then alive.
(b) The interest either vests or terminates within 90 years after its creation.
Understanding the elements of a valid trust can feel like an academic exercise, since it is virtually impossible to create an effective estate plan that carries out a client's wishes without necessarily meeting all of the elements. That being said, understanding the elements can help form an understanding of the considerations required in creating effective trusts.
One of the major objectives of using a revocable living trust is to plan for incapacity. For that reason, revocable living trusts typically contain a provision that provides for a successor Trustee who is able to manage the assets of a trust for the benefit of the Trustor (the creator of the trust) while the Trustor is incapacitated.
The standard for when the successor Trustee will assume the role of Trustee usually depends on the medical determination of one or more physicians. Some trusts may also allow the successor Trustee to make this determination based on his or her personal judgments. As a practical matter, however, financial institutions that hold the trust assets may have a difficult time accepting an informal determination by a successor Trustee.
If relying on the certification of one or more physicians, it is important to ensure that an Advance Health Care Directive naming an agent is in place. A physician may decline to render an opinion regarding the current Trustee's capacity without a document allowing disclosure of sensitive medical information.
As our population's lifespan increases, the risk that a portion of it may be spent in an incapacitated state makes it even more important to ensure that proper measures are in place to plan for these situations.
Many revocable living trusts contain a provision known as a "spendthrift provision." This type of provision is generally included to protect the beneficiaries of a trust after the Trustor (the creator of the trust) has passed away and the trust has become irrevocable. The provision typically provides that the beneficiary's interest in the trust cannot be voluntarily or involuntarily transferred, and is not subject to judgments until property has actually been distributed to the beneficiary.
This type of provision is most effective when a third party (i.e., not the beneficiary) is acting as Trustee for the beneficiary and has the discretion, but is not required, to make distributions to the beneficiary. Often clients ask about this when a child or other beneficiary has creditors, but nevertheless want to leave assets to that person.
It's important to remember, however, that a Trustor cannot avail him- or herself of this benefit by placing their own assets into a trust. While a Trustor is also the beneficiary of the trust, the assets remain subject to the Trustor's creditors.