Are Monthly Bills Paid From a Residuary Trust or a Living Trust?

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Monthly bill payment is a standard function of the trustee of a trust account. Bills can be paid from either a living or a residuary trust. The decision of whether to pay those bills from the living trust or the residuary trust is governed by the trust document, by state statute, by IRS regulations or opinion letters and, in some cases, by the needs of the beneficiaries.

History

The original use for living trusts, according to "A Quick History of Revocable Living Trusts" by attorney Jefferey G. Marsocci, was to prevent the King of England from making accusations against noblemen for the purpose of confiscating the nobleman’s property. Marsocci goes on to explain that noblemen were often falsely accused of crimes so the Crown could confiscate their property. To avoid this, the noblemen of the 1400s and beyond put their assets into a revocable living trust so if they lost their freedom, or even their lives, the King couldn’t legally get to their property.

Types

Two basic trust types are a living trust and a residuary trust. A living trust is a trust that has been created by an individual (the trustor) during his lifetime. Although a living trust can be irrevocable, the majority of living trusts are revocable. That is, the trust can be changed or even revoked altogether by the trustor while he has the physical and mental capacity to make legal decisions. A residuary trust (also called a remainder trust, an exemption trust or a bypass trust) is created upon the death of the trustor by the terms that were written in the living trust document. A typical scenario calls for the living trust to be split into two surviving trusts: a marital trust (for the benefit of the surviving spouse) and a residuary trust (for the benefit of the the surviving spouse and other beneficiaries called remaindermen).

Identification

The marital trust, also commonly called the "A" trust, is designed to avoid estate taxes at the time of the first spouse's death, and to take care of the financial needs of the surviving spouse. A marital trust can be identified by language in the trust document giving the surviving spouse a general power of appointment. This means that she has the power to give the property to anyone she chooses, up to and including herself. The residuary trust, also commonly called the "B" trust, is designed to avoid estate taxes at the time of the first spouse's death, to benefit the surviving spouse (should the marital trust not be sufficient) and to provide for the ultimate distribution of the estate's assets to the named remainder beneficiaries (typically children or grandchildren). A residuary trust can be identified by language in the trust document creating such a trust and assigning to it the remainder of the decedent spouse's estate.

Considerations

If monthly bills to be paid are for the benefit of the surviving spouse, the trustee should always look first to the marital trust. Unless the language of the trust document states otherwise, the spouse's bills are to be paid from the "A" trust until it is exhausted. Generally, only then will the surviving spouse be entitled to have bills paid from the "B" trust. If the monthly bills are for the benefit of the remainder beneficiaries, the trustee must consider a number of things. Does the trust document allow monthly expenses to be paid on behalf of the remaindermen while the surviving spouse is still alive? Are there any tax consequences to paying funds from the "B" trust to, or for the benefit of, the remaindermen? If the trust document is silent on the topic, are there any state statues or IRS rulings that govern residuary trust distributions?

Warning

Since marital/residuary trusts are established to avoid or minimize estate taxes, consideration should always be given to the tax consequences of making any distributions from a residuary trust. If you as the trustee are not a tax expert, consult an estate planning tax accountant or attorney for advice.

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