Money & Power

A Matter of Trust: How a Living Trust Could Help You During Emergencies

Quite common in the U.S. and Europe but less so in the Philippines, a living trust is a practical alternative to a will and life insurance.

In 1978, a young man—let’s call him Marco—fresh out of college, decided to vacation at his family’s 900-hectare farm in the southern Philippines. On his way home one evening, Marco’s car collided with another in a horrific smash-up. Airlifted to Manila and operated on by the city’s top surgeons, Marco survived, although injuries to his skull were so extensive that portions of his brain had to be removed.

Thirty-two years later, Marco is still alive and, except for hypertension, is remarkably healthy. He has already outlived his only brother, his oldest sibling.

But Marco has not emerged from the coma that resulted from his accident decades ago. He still requires round-the-clock care and occasional medical attention. And while his devoted family insists that he is no problem at all, his longevity may pose difficulties later for his four sisters. If more of his siblings die ahead of him, the financial burden, which is shared equally among the sisters, will increase for the survivors.

Marco’s case illustrates the need, first of all, to acknowledge that certain painful realities will outlive you, and then to make financial arrangements to deal with them. Such problematic situations are usually dealt with through wills and life insurance, but there is an alternative method—living trusts.

When a Living Trust is Called For

These are arrangements whereby one person, called a trustor or grantor, conveys property or assets to another person or entity, called a trustee, for long-term management, for the benefit of the trustor and designated beneficiaries, or for beneficiaries alone. They are called living trusts for the simple reason that they are set up during the trustor’s lifetime.

Living trusts are quite common in the United States and Europe, but less so in the Philippines. Nevertheless, they can provide solutions not only to sticky family situations but also to the problems that confront large estates—specifically, heavy tax burdens and the need for privacy.

Marco’s mother, for example, could have placed his expected inheritance in a living trust, with instructions that income from the fund should be used for his living and medical expenses, thus easing the financial burden on his siblings.

Another parent might set up a living trust for an illegitimate minor child, or for children of a second family. While illegitimate or natural children are entitled to the same inheritance as legitimate children under the new Family Code, a parent could resort to such an arrangement to lessen family friction or to make doubly sure that the younger ones receive the same advantages in life as the older siblings.

Another situation would be one in which a parent worries that his or her spouse will run through the estate assets immediately after his or her demise, leaving their children penniless and dependent on the charity of relatives and friends. Another parent may feel that a particular child is so irresponsible that he should not be allowed to receive a large amount of money before a certain age, by which time, it is hoped, the child will have acquired some maturity and a sense of responsibility. For these situations, a living trust that conserves and grows the estate assets while providing an income to the beneficiaries might be a better alternative than bequeathing the estate assets outright through a will.

Real Estate, Taxes, and Living Trusts

Any real or personal property of value can be placed in a living trust. However, the simplest living trust in terms of administration—from the trustor’s point of view, at least—would be a living trust arrangement with a bank that has a trust license issued by the Bangko Sentral ng Pilipinas. Banks, however, are primarily interested in managing liquid assets; most would balk at being asked to manage real estate. Even the rare testamentary trust service offered by a bank would be in the nature of an executorship of a deceased person’s estate, i.e., to dispose of the estate according to the testator’s will.

The tax benefits of a bank-trusteed living trust would partake of whatever is allowed by law. Mario Miranda, BPI Asset Management and Trust Corporation president, says the bank advises its clients to maximize the tax benefits by making the trust an irrevocable one. He says the assets donated to the living trusts become subject to the donor’s tax, which is less than the estate tax. Since the estate has also been reduced by the amount donated to the trust, the estate tax is correspondingly reduced.

According to Miranda, the living trust has a juridical personality. Thus, it can be designated as an irrevocable beneficiary of a life insurance policy. Proceeds of the policy would thus be tax-free. A word of caution, however: The life insurance policy should also have natural persons as irrevocable beneficiaries. Upon death, all the bank accounts of the deceased person are automatically closed, even joint accounts, so that if the insured person dies suddenly, the heirs may find themselves temporarily strapped for cash to settle the estate. On the other hand, the proceeds of a life insurance policy can be released very quickly to the beneficiaries without the need of a court order.

Since assets in an irrevocable trust no longer constitute part of the trustor’s estate, they do not go through probate court, unlike wills. If the trustor has specified that the beneficiaries are to receive regular income from the trust, the income continues even though the estate assets go on hold while the will is probated. The identities of the beneficiaries also remain private.

Privacy, however, does not apply in the case of real estate, which is placed in an irrevocable trust. The donation must be notarized, which has the effect of making it a public document, and the property has to be registered with the Register of Deeds.

Playing Devil’s Advocate

The downside of an irrevocable living trust is that since assets placed in the trust are a donation, you have lost those assets. Forever. In the case of living trusts with banks, you have also lost control over the disposition of the funds; you cannot change the beneficiary, the terms of the agreement, or cancel the trust. And naturally, the trustor cannot include himself as a beneficiary.

Revocable trusts offer fewer tax benefits, but more flexibility. The trustor retains full ownership and control of the trust. He can name himself as one of the beneficiaries, although not the only one. He can change the terms and beneficiaries of the trust, and in the case of bank living trusts, can change the investment direction. However, since the revocable trust remains part of the estate, it is subject to estate tax.

A trustor might consider a revocable trust with himself or herself as one of the beneficiaries, if that person, for instance, is single, is aware that a degenerative disease like Alzheimer’s runs in the family and wants to prepare for the day when he or she will no longer be capable of independent living.

Anyone who would be eligible for a will or a donation can be designated as a beneficiary. “But beneficiaries must actually be existing,” Miranda says. They cannot be some person or persons that the trustor hopes will materialize in the future, like grandchildren who are not yet born.

Setting up a living trust, however, does not eliminate the need for drawing up a will. After all, it would be extremely imprudent to place all your assets in living trusts; you need to retain a certain amount of assets to maintain yourself and your lifestyle. The will should cover the disposition of the assets remaining in the estate.

Do Your Homework Before Jumping In

Setting up an irrevocable living trust is a major step and not one to be taken lightly. It is important to study your options seriously. What are the likely contingencies you have to prepare for? You must weigh the tax advantages of living trusts versus the drawbacks, and your current and future needs versus those of your beneficiaries.

In a bank-trusteed irrevocable trust, the trustor must state clearly the purposes of the trust and be equally clear and specific in the dispositive clause of the agreement, which defines the terms of distribution of the asset and the income or the principal and interest. Since you are authorizing the trustee bank to make investments on your behalf, you have to realistically assess your own risk profile (adventurous investor? moderate? conservative?) versus the long-term needs of your designated beneficiaries. It is also important to remember that trust funds are not insured by the Philippine Deposit Insurance Corporation, so this fact should guide your investment decisions.

Non-bank trustees who are natural persons, executors and guardians should be chosen carefully, not on the basis of how much you like them but on how decent, trustworthy and diligent they are. And healthy—you want them not only to outlive you but also to see your children to adulthood.

And while we’re on the subject of nonbank trustees, executors and guardians, please do them the courtesy of formally informing them and securing their approval. And finally, always consult a lawyer, particularly one who specializes in estate planning, and an accountant. On matters financial, the advice of experts is worth its weight in gold.

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Araceli Z. Lorayes
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