The Ins and Outs of Subtrusts

At death, a person’s revocable living trust becomes irrevocable. It may leave inheritances outright (free and clear of trust) or it may transfer inheritances into one or more sub-trusts for continued management. Subtrusts are contained, as implied, within the same master trust instrument (document) as the original revocable living trust. A subtrust, therefore, shares administrative provisions within the original master trust.

Subtrusts receive assets after the settlor’s death through the trust administration of the now irrevocable living trust. Unless the subtrust is funded by assets belonging to a surviving co-settlor of the living trust (e.g., the surviving spouse), the subtrust is typically irrevocable. It cannot be revoked or amended unless someone is given such powers in the trust.

Different subtrusts exist for different purposes, such as asset protection, asset management, the receipt of government benefits, the management of inheritances, and imposition of restrictions on a beneficiary’s use of assets.

For example, asset protection trusts (including special needs trusts) provide the trustee with full discretion over when, whether (if) and how to make any distributions either directly to or for the benefit of the beneficiary (e.g. making purchases and paying expenses), and will benefit from a “spendthrift clause” that protects assets while still held in the trust from many ordinary creditor claims (e.g., credit card debts). The same also applies, to one degree or another, with the “A-B” Trust, the children’s trust, and the discretionary spendthrift trust. Basic concepts still apply to all subtrusts.

First, will the subtrust even be established? This may depend on satisfying conditions, such as, did the intended beneficiary survived the settlor, was the subtrust beneficiary still married to the settlor (if relevant), did the beneficiary disclaim (refuse) their inheritance, and do assets exist to fund the subtrust. Let us assume they are satisfied.

Second, once funded, how and when are distributions made? Does the subtrust require mandatory distributions of income and principal, or just income alone? Does the subtrust provide for discretionary distributions by the trustee? What are the purposes and standards that control distributions? Can distributions be made indirectly for the beneficiary’s benefit?

Third, when does the subtrust end? Does the trust terminate when the beneficiary reaches a certain age, when the beneficiary dies, or even sooner if the beneficiary violates an obligation? In California an irrevocable trust cannot last more than 90 years. For example, in a children’s trust the trust may terminate when the youngest child attains a certain age, say twenty-five, at which time the trust is divided equally amongst all then living children. Also, for example, benefits may terminate if the beneficiary starts abusing substances.

Fourth, what happens when the subtrust ends? Who receives the remaining assets? For example, with a Bypass Trust, the death of the surviving spouse (beneficiary) typically means that the predeceased spouse’s own children inherit. It may also transfer into yet a further subtrust.

Fifth, are there any special provisions? For example, is there a right of first refusal to allow the deceased settlor’s children to purchase a piece of real estate? Is a trust director appointed to control how the trustee manages assets or makes distributions?

Sixth, sometimes it is better to use a standalone trust, i.e., one established under its own separate instrument. For example, special needs trusts may be standalone because such trusts may receive gifts from various persons and not just assets held in one persons living trust and also because special needs trusts are better drafted with provisions properly suited to a special needs trust.

A beneficiary of a subtrust has rights to information regarding the administration of the trusts and its assets and liabilities. Thus, not only the trustee but also the beneficiary may need to consult an attorney to discuss the subtrust administration.

The foregoing discussion is not legal advice. Consult a qualified attorney for guidance. Dennis A. Fordham, attorney, is a State Bar-Certified Specialist in estate planning, probate and trust law. His office is at 870 S. Main St., Lakeport, Calif. He can be reached at Dennis@DennisFordhamLaw.com and 707-263-3235.