Oral trusts

Oral Trusts Can Rescue Poor Planning

It doesn’t take much to create a trust. Most people go to a lawyer, and after a couple of meetings and a signing ceremony, they take home a big binder full of paper. While much of that effort is advisable, it’s not legally required. You don’t even need paper. That’s right, in Arizona, an oral trust can be valid.

A.R.S. § 14-10407 says:  “[A] trust need not be evidenced by a trust instrument, but the creation of an oral trust shall be established only by clear and convincing evidence and the terms of the oral trust shall be established by a preponderance of the evidence.”

The Relationship of ‘Trust’

A “trust” isn’t an entity but a relationship between the creator, the trustee, and the beneficiary. Oral trusts are similar to oral contracts, which also are valid. Whether a trust or a contract, lack of a writing makes its existence hard to prove – both validity and terms that govern. Oral trusts, just like oral contracts, are always a bad idea; no estate planning attorney would advise anyone to have one.

Oral trusts usually arise when something goes wrong. Often people set out to benefit a loved one but don’t realize that the arrangement needed is a trust or how to go about creating one.

An Oral Trust Case Study

Consider this scenario: Teri receives a scary diagnosis. She has an only child, Judy, who has a disability.  Teri knows leaving Judy assets will endanger her benefits. So she names her sister, Tracy, as beneficiary on her IRA and tells Tracy: “I am naming you as the beneficiary on my IRA, but I want you to use the money only for Judy. Be sure to protect her benefits.”

Teri dies, and Tracy starts looking into IRAs. She realizes anything she takes out of IRA will be taxable income to her, and, that she only has 10 years to empty the account. She also learned that if Judy had been the beneficiary, she could stretch the distributions (thanks to the SECURE Act), and thus probably pay no tax. But Judy was in no position to handle the funds herself. And what would happen if Tracy died? Who would take care of Judy then?

Naming Tracy beneficiary was not the best way to accomplish Teri’s goal. There are the above complications. And also, because the directive to Tracy was not in writing, Tracy probably could have kept the money for herself. Then there is the issue of convincing the IRA custodian to title the inherited account to the trust. Convincing Vanguard or Fidelity? Good luck.

Recognizing the Oral Trust

But because Tracy is an honest person, she sought legal advice and learned that Teri’s wishes could be recognized as an oral special needs trust. She petitioned the court and told the judge what occurred.  The judge approved the existence of the trust along with terms that would protect Judy’s benefits, and ordered the custodian to revise the beneficiary. Plus, the new trust provided for a successor in the event Tracy became unable to serve.

Still, Teri could have avoided these complications by creating the trust during her lifetime. It would have been straightforward and  captured Teri’s precise wishes, and likely would have been less expensive.

Oral Trusts Have Limitations

Note that oral trusts don’t always work. They can’t be used for real estate because to transfer real property, a writing is required. And if you already have a written trust, you can’t change or revoke it with an oral trust. A.R.S. § 14-10407 also says: “If a trust is created by written instrument, it may be amended or revoked only by written instrument . . . ”

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