MD Trust Act enhances protections for revocable and irrevocable trusts

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For years, affluent Marylanders routinely crossed the border to Delaware or Virginia when setting up complex trusts, attracted by those states’ stronger liability shields and more permissive trustee rules.

But over the past decade, Maryland has made great strides in improving its trust protections, said Christine Hubbard, esquire, of Christine W. Hubbard LLC in Davidsonville.

That’s thanks to the Maryland Trust Act, which first became law in 2015, said Hubbard, a fellow with the American College of Trust and Estate Counsel, and the Past Chair of the Maryland State Bar Association Estate & Trust Law Section Council.

The law has since been updated each year to provide clear administrative guidelines, broader asset-protection opportunities, and improved protections for trustees and beneficiaries, she said.

For instance, new rules make it easier for trustees to resign. Reasonable trustee compensation is also now clearly defined in the law.

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And as circumstances change, trusts can also now be modified through the courts, or a non-judicial settlement agreement or another process known as decanting, which allows for the creation of a new trust from the old with more favorable or updated terms.

“Our laws have been very beautifully developed over the years to make trust administration so much easier,” Hubbard said.

Revocable vs. irrevocable

A trust is a legal arrangement where one person (grantor) gives legal ownership of property to a second person (trustee) who is responsible for managing the property for the benefit of a third person (beneficiary).

Revocable trusts can be easily changed or modified by the grantor at any time, Hubbard said.

These can be seen as a substitute for a will on death, and if properly funded, can be used to avoid the time-consuming probate process when you pass away.

The idea is to make things easier and simpler on your beneficiaries when you pass away, said Helen Smith, a member attorney with Maryland’s PK Law’s Wealth Preservation Group.

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However, revocable trusts provide little to no asset protection during the grantor’s lifetime, Hubbard said.

Irrevocable trusts, which can be created during life or on the death under a person’s will or revocable trust, are powerful tools to help keep assets in the family bloodlines and protected from creditors, including divorcing spouses, she said.

Dozens of different types of irrevocable trusts can help people achieve their goals for estate planning, handling charitable giving, distributing business assets or taking care of a special needs child.

Maryland’s estate tax exemption is $5 million for individuals and $10 million for married couples, with a tax rate up to 16% kicking in for those with assets above the exemption threshold.

A federal estate tax of up to 40% also kicks in for individuals with more than $15 million and couples with more than $30 million in assets.

Funding trusts

Generally, people don’t want to fund irrevocable trusts (and thus take those assets out of the taxable estate) with assets that have a low cost basis, as there’s no real tax advantage in terms of a step up in basis, Smith said. An example could be a security you buy at a low price (the cost basis) that rises substantially in value over time.

An example of a type of asset that many people put into irrevocable trusts is life insurance policies, she said.

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When the grantor dies, the proceeds from a life insurance policy are paid to an irrevocable life insurance trust, which is typically a surviving spouse or descendant. If properly set up, these proceeds are free from income and estate tax, Hubbard said.

A Spousal Lifetime Access Trust or SLAT is another type of irrevocable trust that is created by one spouse for the benefit of the other. The grantor transfers his or her separate property, not joint property, into the trust, typically using a portion of the grantor’s federal gift tax exemption, she said.

The grantor is not a beneficiary but sometimes benefits indirectly as the beneficiary uses the SLAT assets.

The main benefits are that the trust assets appreciate outside of the couple’s estate for estate tax purposes, the grantor uses separate assets to pay the income taxes on the SLAT’s earnings (akin to a tax-free gift), and the trust assets are protected and distributed according to the grantor’s instructions.

Hubbard said creating such irrevocable trusts is a complex matter and should only be done in consultation with an experienced attorney.

Preparing the way

Each trust, including its terms and conditions, can vary greatly by individual circumstances.

So before even beginning to discuss the possibilities of what type of trust to set up, Smith said she advises clients to get organized, beginning with the low-hanging fruit.

For starters, make sure you know what you have – check all of your retirement accounts and other investing accounts – and set up the beneficiary or transfer-on-death designations you want. It’s common for people’s circumstances to change – like getting a divorce – and forget to update these, Smith said.