At the death of the surviving spouse Trustmaker (or at the death of a single Trustmaker), the trust enters its final phase of administration. At the conclusion of this administration, no assets should remain in the name of the Living Trust, Family Trust, QTIP, or in the name of a Trustmaker. So, where does the money go? As usual, the answer to this question is dictated by the terms of the trust. According to blackletter law, a bequest will either be a specific bequest or a residue bequest (sometimes called “residuary bequest”). Within each of these, a bequest can be either “in trust” or “outright.” These scenarios are each addressed in turn.
A specific bequest is a distribution of particular property or a particular amount, for example “Five Thousand Dollars,” or “My Cessna 180, Tail Number N-55555.” These bequests are the first to be made from the trust assets, which is an important consideration, since a substantial specific bequest can significantly deplete the amount of assets available to be distributed among “residue” beneficiaries, as discussed below.
Specific bequests are typically “outright,” which means not in trust, but not always. An outright bequest has no creditor protection or management assistance for the beneficiary. Instead it is distributed to the beneficiary with no strings attached, and usually all at once. For example, a specific bequest of a parcel of real estate would simply be transferred to the beneficiary using a quitclaim deed. For a specific bequest of money (sometimes referred to as a “pecuniary” bequest), the trustee would simply write a check from the trust account to the beneficiary, or transfer the funds to the beneficiary’s personal bank account by wire. However, it is important to note whether a bequest passes free of taxes and expenses of administration—meaning the beneficiary will receive the exact amount or asset—or whether the bequest passes subject to taxes and expenses, in which case those taxes and expenses will be deducted before the bequest is actually distributed to the beneficiary.
A residue bequest is the distribution of a portion of the “leftover” trust assets. Typically, the portion each beneficiary is entitled to is outlined in the trust as a percentage or fraction of the residue. For example, if the entire estate after claims and expenses are paid is worth $4 million, and there is a specific bequest of $1 million to a charity, the residue is $3 million. If there are three children who are receiving equal shares of the residue (one third, each), each child will receive $1 million in value.
So how will they receive those funds? Again, it depends on the terms of the trust. If the trust dictates that the beneficiary receive the assets outright, then the trustee simply transfers the assets to them at the appropriate time. However, if the trust directs that the beneficiary receive their share in trust, then a sub-trust is created for the benefit of that beneficiary, and the trustee transfers the assets to the sub-trust. Due to the complexity of maintaining and segregating trust assets in a sub-trust, except in extenuating circumstances (for example, a special needs trust), it is generally not recommended to create a sub-trust for the purposes of holding less than $1 million.
In Part IV of this series, we will cover what beneficiaries should know about handling their inheritance and what Trustmakers should know about different types of inheritance trusts that can be created.