A living trust is an estate planning device whereby a person, known as the “settlor,” transfers his or her assets to the custody of a trustee. In most living trusts, the settlor and trustee are the same person. When the settlor dies, the trust instrument appoints a successor trustee, who then manages or distributes the trust assets as the settlor directed.
If you decide to create a living trust, it is essential that you and your successor trustee observe all appropriate formalities. That is, when dealing with trust assets, you must not refer to yourself as the owner, but rather the trust. Let’s say John Doe creates a living trust. He wishes to fund the trust with his home. In order for the house to be considered a trust asset, Doe must file a deed transferring the property from himself to “John Doe, Trustee of the John Doe Revocable Living Trust.” Failure to take this step means a court may decide the asset was never part of the trust.
Avoid Co-Mingling Trust Assets
Another mistake to avoid is co-mingling trust and non-trust assets. Not only may co-mingling confuse your estate planning, it can have serious legal consequences for your successor trustees and the beneficiaries of your trust. Here is a recent example from a California appeals court decision, which is provided here for informational purposes only.
Hiroko Friedman created a living trust in 1999. She funded the trust with her real and personal property. Upon Friedman’s death in 2008, her trust named her daughter, Claire Bradenburg, as beneficiary and successor trustee. The trust directed Bradenburg to pay herself the income from the trust assets. Additionally, she could use the principal of the trust to provide for her health, education and maintenance. A special trustee, William A. Kuhns, had to approve any further payments from the trust principal for Bradenburg’s “comfort, welfare and happiness.”
In late 2010, Bradenburg accidentally struck Micah Schwerin with her car. Schwerin later sued and obtained a personal injury judgment against Bradenburg for approximately $865,000. Bradenburg herself passed away in 2011.
Upon Bradenburg’s death, the trust directed Kuhns, as the successor trustee to Bradenburg, to distribute any remaining assets to Friedman’s nephew and niece. However, in 2012, Schwerin sued Kuhns and the beneficiaries, arguing she was entitled to collect her $865,000 judgment against Bradenburg from the trust assets. Kuhns argued the trust had a “spendthrift clause,” which prohibited the use of trust assets to pay off a beneficiary’s debts. A trial court agreed with Kuhns and dismissed Schwerin’s lawsuit
The California Court of Appeals reversed the trial court. The appeals panel said there was some evidence to suggest Bradenburg improperly co-mingled trust and personal assets. Put another way, she “held herself out as the owner of Trust assets” and Kuhns failed to oversee her in his capacity as the special trustee. The evidence suggested Bradenburg failed to observe trust formalities, and in effect held the trust out as “the alter ego of herself.” In such circumstances, Schwerin may be able to establish a claim against the trust assets.
Exercising Proper Supervision of a Trust
If you decide to include a trust as part of your estate plan, carefully consider the successor trustees and their responsibilities. In the case of the Friedman trust, the special trustee’s apparent failure to fulfill his duties may result in the use of trust assets to pay off a beneficiary’s creditors. If you want to avoid a similar situation, it is important you work with an experienced California estate planning attorney who can help you identify the best fiduciaries to oversee your assets after you’re gone. Contact the Law Office of Scott C. Soady in San Diego today if you have any questions.