How Does a Trust Work After a Death?

Updated

The stress of dealing with the death of a loved one can be traumatic for many people. Not only are you experiencing grief and sadness over the loss, but you may also be overwhelmed by all the other financial tasks involved post-loss. One of these financial tasks can be settling a trust after death. 

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Typically, people establish a trust when they want to transfer property to a beneficiary, but they are not confident that the person is able to manage the property. Trusts can be created for beneficiaries such as a minor, a person with a disability, or otherwise just not someone you trust to manage the property.  In these cases, you appoint someone else who you do trust—known as a “trustee”—to manage the property for the beneficiary.

You also can create a trust to safeguard assets from creditors and to reduce income tax and estate tax liabilities. 

People can encounter trusts when handling an estate for a deceased loved one. However, for those unfamiliar with the intricacies of a trust, they may have many questions. How are trusts settled? What happens when a beneficiary or a trustee passes away? 

Who is Responsible for Settling a Trust After a Death?

Whenever people talk about trusts, they may say “settling the trust.” This term is  given to the process of dealing with trusts after the death of a loved one. To determine who is responsible for settling a trust, it is necessary  to thoroughly review and understand each of the provisions of the trust agreement set up by its “grantor.”

A trust agreement is a written document that enables a “grantor,” or the person who established the trust, to pass on the grantor’s assets to beneficiaries who are unable to manage these assets on their own, as mentioned earlier.

Death of a beneficiary

If a beneficiary dies, the person responsible for settling the trust is the trustee designated under the trust agreement. However, trustees can call upon other professionals to help perform the necessary work to settle the trust.

Some trustees may want to hire the following: 

  • Attorney: This attorney does not need to be the original drafter of the trust agreement that helped create the trust, but the attorney should have knowledge of and experience in trust law.
  • Accountant: An accountant can help prepare relevant tax returns and handle property valuation issues.
  • Financial Analyst: Can help sell any stocks in the trust.
  • Real estate broker: Can help sell any land or property.

It is important to remember that even if the trustee hires experts, the trustee is legally responsible for properly settling the trust. The trustee still may have liability if the trust is not properly settled.

Death of a trustee

In the case of the death of a trustee, the person responsible for settling the trust depends on the terms of the governing trust agreement. For example, if there are already one or more co-trustees appointed under the trust agreement, these co-trustees will be responsible to settle the trust. 

The same applies for a successor trustee (on the death of a trustee) appointed under the trust agreement for the trust. This successor trustee will be responsible for settling the trust.

A properly drafted trust agreement should always designate co-trustees or a successor trustee in the event of the death of a trustee. Otherwise, you may have to go to court to have a judge appoint a trustee.

What Documents or Information Do You Need to Settle a Trust?

The central document that you need to properly settle a trust is the written trust agreement that governs the trust.

While people often refer to a “standard trust” or “trust boilerplate,” trust agreements will come in all shapes and sizes. 

On the whole, if you do not understand any of the provisions of the trust agreement, you should have a trust attorney review them and explain them to you.

Here are some of the relevant issues that a trust agreement should include:

  • Who are the beneficiaries of the trust after death?
  • Do the beneficiaries receive their interests outright or “in trust”?
  • If the benefits transfer in trust, what are the provisions of these trusts?
  • Who are the trustees of the trust after death?
  • What special provisions can affect settling the trust?

Sometimes the trust agreement will make it necessary for you to complete additional research and obtain information to properly settle the trust.

For example, if it is unclear from the trust agreement or other knowledge as to whether a designated beneficiary is still alive, you will need to research and determine this information. If you are responsible for sorting out how to settle the trust, you will need to contact these potential beneficiaries to alert them of their interests.

In addition, should the trust agreement delegate an issue to you as a trustee according to your “discretion” after death, you may have to research and obtain information on the issue before settling the trust.

An example of this would be if the trust agreement provides, “On the beneficiary’s death, all of the trust estate to a charitable organization whose primary purpose is to prevent and cure cancer through research and education, as determined in the sole discretion of the trustee,” You would be responsible for carrying this out.

Inventory of assets in a trust

You also will need to determine the assets and the liabilities of the trust before settling.  

Trustees typically have to “inventory,” or determine the assets of the trust. If the trust has already been in existence, you should review a current financial statement or tax return for the trust as a first step in completing this inventory.

As part of this inventory, you need to determine if the trust has any notices or consents that require delivery. You do not want the trust to miss any deadlines by failing to timely deliver a notice or consent. For example, if you have to give notice to terminate a lease or other contract by a certain date, you do not want to miss this deadline.   

It is also important that you determine the liabilities of the trust before distributing assets to any beneficiary. Creditors may have a claim to distributed assets before distribution to a beneficiary. You may be held personally liable if you improperly distribute assets to a beneficiary when a creditor has a preferred claim to the asset.

Litigation paperwork and taxes

If the trust is in any litigation, you should review the litigation with the attorney handling it before settling the trust.     

Based on tax considerations, you also may need to research and obtain valuation information on the assets of the trust before settling the trust. You can find this out by having an accountant determine the values of trust assets. If you will need to pay tax liabilities concerning the trust, it may be necessary to hold back certain trust assets, and not distribute them to beneficiaries, to account for these tax liabilities.

How to Settle a Revocable Trust

There are two distinct types of trusts, known as revocable trusts and irrevocable trusts. A revocable trust is a trust that you can revoke or otherwise amend 

In settling a revocable trust, once you review the trust agreement and obtain all necessary information, your next step is to distribute trust assets, after reviewing any liabilities as previously mentioned, subject to liabilities, as described above) to beneficiaries.

The process of distributing trust assets to beneficiaries can range from simple to complex. Complexity can result from the nature of the trust assets. It may be easier for you to distribute cash than interests in a closely held business or intangible property such as stocks and bonds.

Specific beneficiary provisions under the trust agreement can also make settling the trust more difficult.

Choosing whether you should distribute trust property in its present form to beneficiaries or first sell and convert trust property to cash and then distribute it to beneficiaries depends on a few things. As a trustee, you may want to conduct a detailed analysis based on the desires of the beneficiaries, liability issues, and tax considerations.

In settling the trust, as part of distributing trust assets to beneficiaries, you should receive the following:

  1. a receipt which acknowledges transfer of the specific trust distribution.
  2. a release, waiving trustee liability.

The receipt and release, which are often combined in a single document and executed by each beneficiary, provide important protections from liability for you in settling a trust.

In addition to distributing trust assets, you also need to pay trust liabilities in connection with settling the trust. This can include both “pre-death” outstanding liabilities of the trust, as well as “post-death” expenses incurred in connection with the trust. These expenses include paying the attorney and other experts described above and costs necessary to maintain trust assets.

Once you distribute all trust assets and pay all trust liabilities, you can “terminate” the trust.         

How to Settle an Irrevocable Trust 

Settling an irrevocable trust is generally similar to settling a revocable trust. The same basic activities generally tend to occur. You can distribute the assets, pay the liabilities, and terminate the trust. Irrevocable does not mean it will last forever, as you also can terminate an irrevocable trust after death.

One added issue in settling an irrevocable trust concerns taxes. While a revocable trust generally files its taxes under the Social Security Number of the person who created the trust, an irrevocable trust has a trust FEIN.

As a result, in settling an irrevocable trust, it is important to file a final tax return. This lets the Internal Revenue Service and the applicable state tax authorities know that the trust FEIN is no longer in use, as the irrevocable trust is being terminated.  

Frequently Asked Questions: Settling a Trust

How a trust works after death is a complicated issue and leads to many questions.While the above information can help you with this issue, here are a few frequently asked questions you may want to keep in mind when settling a trust:

How long do you have to close a trust after death?

There is no precise time by which you have to close a trust after death.

Closing a trust can depend on the circumstances. While you must meet certain income tax and possible estate tax deadlines (in connection with income tax returns and estate tax returns), the time to close a trust after death can vary from a month to many years after death.

The key issue in determining how long it will take to close a trust is how much work is necessary to distribute trust assets and pay trust liabilities. Generally the more assets there are, the more liabilities there are, and the more transactions that  need to take place involving these assets and liabilities, it will take more work to close a trust after death.

How long does it take to get inheritance money from a trust?

Just as there is no precise time to close a trust after death, the amount of time it takes to get inheritance money from a trust can vary from case to case.

Every family is different in regards to when they want to start dealing with the financial implications of death. Some families (as is their right) will want to focus on a long period of bereavement, rather than financial issues, which will delay the receipt of inheritances.

The more complex the situation (i.e., more trust assets, more trust liabilities, and more trust transactions to complete), the longer it will take to obtain inheritance money.

Do you have to pay taxes on money inherited from a trust?

Money inherited from a trust generally is not taxable for Federal income tax purposes. Currently, only six states—Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania—impose an inheritance tax.  

However, the money inherited from a trust could be subject to estate taxation. There is currently an exemption of $11,700,000 from Federal estate taxation.  Some states follow this exemption, and some states set a lower exempt amount for estate taxation (for example, $4,000,000 in Illinois).

Figuring Out How A Trust Works After a Death

Settling a trust is like cleaning up after a meal you prepare at home. It is the last step, but a necessary step, in the trust process.  

It is important that you properly settle a trust. Poor decisions in connection with settling a trust can lead to unhappy beneficiaries and unanticipated liabilities.

Properly settling a trust may not enable you to avoid the emotional pain that comes when a loved one dies. However, it can help make a difficult time in your life at least somewhat easier, by minimizing your financial stress.

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