Trusts are common estate planning instruments used to manage and distribute property. There are three categories of people involved in a trust’s creation, management, and distribution. A trust is created when the “grantor” (sometimes called a “trustor” or “settlor”) transfers their assets and property into the trust. The grantor chooses a “trustee” who is responsible for managing the assets and property that were transferred. Finally, the grantor also designates one or multiple “beneficiaries” to receive the “benefit” of the trust. The trust is established and maintained for the trust beneficiaries. This article focuses on who qualifies as a trust beneficiary, the types of trust beneficiaries, and their respective rights. For a better understanding of how trusts are formed and some different categories of trusts, click here to see our article on trusts.
Who Qualifies as a Trust Beneficiary?
A grantor has complete control when deciding who to name as a trust beneficiary. A beneficiary can be one individual or a group of individuals. Trust beneficiaries can be minors (some grantors establish educational trusts for their children or grandchildren) or people with disabilities (“special needs” trusts were created to serve people with disabilities). It is important to note that if you name a minor child as a beneficiary, a guardian will need to be appointed to manage the trust assets at least until the child reaches the age of majority. A guardian may also be required to manage trust assets for a disabled individual. “Charitable trusts” also allow charities to be named as trust beneficiaries. While almost anyone can be named as a beneficiary, it is important to be specific when identifying your trust beneficiaries. For example, naming your “friends” as beneficiaries is far too vague to establish to whom you want to leave your property. Be specific, for example, “to my friends, Joe Smith and Jane Smith.”
Types of Trust Beneficiaries
Primary v. Contingent Beneficiaries
Many trusts designate “primary” and “contingent” beneficiaries. Generally, primary trust beneficiaries are first in line to receive property from the trust when the grantor dies. A primary beneficiary is not limited to a single individual; a grantor can designate several beneficiaries as primary beneficiaries.
A contingent beneficiary is designated to receive the trust property only if the primary beneficiary is not available to receive the trust property (i.e. unable to locate), not eligible to receive the trust property (i.e. predeceases the grantor), or declines the inheritance. Contingent trust beneficiaries essentially become second (or third) in line to receive trust property. For example, grantor designates John Doe as primary beneficiary and Jane Williams as contingent beneficiary. If John Doe predeceases (dies before), the terms of the trust, Jane Williams’s interest in the trust property vests, and she is entitled to receive the trust property. However, if John Doe does not predecease the terms of the trust, he is entitled to the trust property. Jane Williams, while not currently entitled to the trust property may retain a future interest in the property, at the occurrence of some event as written in the trust, such as at John Doe’s death. The beneficiary presently entitled to receive trust property is often referred to as the “current” beneficiary. The contingent beneficiary may also be referred to as the “remainder” beneficiary.
Many estate planning attorneys recommend naming one or more contingent trust beneficiaries because there are significant consequences of not doing so. Taking the example above, if the sole beneficiary of your trust was John Doe and he predeceased you, the trust would be without any beneficiaries. If you created a will, the assets in your trust may be distributed through your designated will. However, if you only created a trust, the assets from the trust would be distributed through your general estate and pass through probate. The two major drawbacks to this are: (1) probate can be a lengthy, expensive, and public process; and (2) your state’s intestacy laws would determine who received your assets, not you. This may result in your property being inherited by someone you would not have wanted.
A discretionary beneficiary receives trust distributions only upon the completion of a designated occurrence. This type of beneficiary is not able to receive property from the trust unless certain conditions have been met. Common examples of these conditions include: a child attaining the age of 18 or 21; a person obtaining their college degree; a person obtaining stable employment; or a person becoming drug or alcohol free. The beneficiary will only be entitled to receive trust assets once the named condition is met. If the named condition is never met, the discretionary beneficiary is never entitled to receive the trust property.
Removal of Beneficiary
Generally, because the grantor created the trust, the grantor determines who should or should not be included as a trust beneficiary. Whether a grantor may remove a beneficiary from the trust depends on the type of trust formed. In a revocable trust, a grantor may freely alter the terms of the trust, including the trust beneficiaries, during the grantor’s lifetime. When a grantor dies, a trust automatically becomes irrevocable. Ordinarily, an irrevocable trust is one that cannot be changed or modified after its creation. A grantor may also create an irrevocable trust during their lifetime. In so doing, even if the grantor is still living when the irrevocable trust is created, generally the trust remains irreversible and its terms, including its designated beneficiaries, cannot be altered.
However, there are a few exceptions to this general rule concerning irrevocable trusts. Some state laws allow for judicial intervention, in limited circumstances, to alter the terms of an irrevocable trust, including beneficiaries. Additionally, some trusts may include a power of appointment, which is a legally binding provision in the trust where the grantor confers authority on the trustee to appoint or remove beneficiaries. Generally, a trustee does not have the power to remove or appoint beneficiaries. However, if the trustee is given a power of appointment, the trustee may remove or appoint trust beneficiaries, in accordance with the power of appointment and other trust provisions.
It is important to remember that each trust is unique with its own set of conditions and stipulations. If you have questions concerning the removal of trust beneficiaries, you should contact an estate planning attorney near you as the law in this area varies by state.
Not all trust beneficiaries share the same rights. A beneficiary’s rights are dependent on both the type of trust created and the type of beneficiary listed. Beneficiaries to a revocable trust have limited rights (if any) because a grantor can freely change revocable trust beneficiaries; revocable trust beneficiaries are not guaranteed to receive income or property from the trust. Contrastingly, a beneficiary to an irrevocable trust, generally, has more rights. The scope of rights given to an irrevocable trust beneficiary depends on the type of beneficiary. Further, as with all issues concerning trust law, a beneficiary’s rights also depend on state law. Common rights given to irrevocable trust beneficiaries include:
- Copy of Trust: generally, both current and contingent/remainder trust beneficiaries have a right to examine the trust and any of its amendments. The beneficiary should request, in writing, from the trustee, a copy of the trust. If a trustee fails or refuses to provide the beneficiary with a copy of the trust, the beneficiary may petition the court to compel the trustee to provide a copy.
- Payment: current beneficiaries are entitled to distributions of trust property as outlined in the trust.
- Information: current and contingent/remainder beneficiaries have the right to know enough information concerning the trust and its administration such that the beneficiaries know how to enforce their rights.
- Accounting: trustees are generally required to provide a yearly accounting of trust assets to current beneficiaries. An accounting provides a report regarding all the trust’s income, expenses, and distributions. Contingent/remainder beneficiaries may also be entitled to an accounting depending on the terms of the trust and state law.
- Remove trustee: both current and contingent/remainder beneficiaries may petition the court for removal of the trustee. Because a trustee has a fiduciary duty to act in the best interest of the beneficiary, if a beneficiary does not believe a trustee is acting in their best interest, the beneficiary may petition the court for the trustee’s removal.
- Terminate trust: some circumstances may allow the beneficiaries (if all agree) to petition the court to terminate the trust. This right varies depending on state law. Generally, termination may be allowed when the purpose of the trust has been fulfilled or would be impossible.
Beneficiaries also have the right to challenge the trust, either in its entirety or a portion thereof. A trust challenge objects to the validity of the trust. Two common methods of trust challenges are through allegations of (1) a lack of testamentary capacity, and (2) undue influence.
A grantor must have the requisite mental capacity to create a trust. If the grantor did not have the mental capacity to understand that they were transferring their property and to whom, the trust may be invalid. A challenge of undue influence alleges that the grantor was wrongfully influenced and taken advantage of by another person when creating the trust. This alleges that the trust is not the result of the grantor’s wishes, but the wishes of the person asserting influence over the grantor. Fraud claims often accompany undue influence claims.
Be aware that many grantors will include no-contest clauses in trusts. A no-contest clause states that if a beneficiary unsuccessfully challenges a trust, that beneficiary’s right to the trust property is automatically severed.
The tax consequences for trust beneficiaries depend on the type of trust and the status of the beneficiary. In revocable trusts, the grantor retains access to and control over the trust property. The grantor is still entitled to receive trust income and principal. For these reasons, the property in a revocable trust is generally treated as the grantor’s property for both income and estate tax purposes. Because a beneficiary of a revocable trust does not receive distributions from the trust until the grantor’s death, revocable trust beneficiaries generally do not owe income tax related to the trust.
Conversely, in irrevocable trusts, beneficiaries receive distributions from the trust. These distributions are generally trust income which has been generated by the trust’s assets. Beneficiaries are usually taxed on the amount of income distributions received. The amount taxed to the current beneficiary depends on their personal tax rate. Note that if a beneficiary requests a disbursement from the principal balance of the trust, that beneficiary will not usually be required to pay income tax.
Please understand that there are tax consequences in estate planning. You should always consult an accountant or estate planning/tax attorney to better understand the tax implications and liabilities of your trust.
Consulting an Estate Planning Attorney
As discussed throughout this article, trust law varies as it is state-specific. Further, each trust is created via the specific intent of its grantor. Therefore, trust terms can vary dramatically. If you are a grantor wanting to establish a trust or you are the beneficiary of a trust, it is vitally important that you consult a local estate planning attorney to help address your questions or concerns.
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- Discretionary Beneficiary, Investopedia, https://www.investopedia.com/terms/d/discretionary-beneficiary.asp#:~:text=Discretionary%20beneficiaries%20are%20individuals%20or,milestones%20in%20age%20or%20education.
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