If you’ve ever thought about a living trust, it’s probably because you hate the idea of going through probate. Living trusts have been heavily marketed on that basis over the past several years and, yes, living trusts certainly do avoid probate. But, there’s a whole lot more to living trusts than just that. In fact, avoiding probate is not even one of the top three reasons for a living trust. In my opinion, it’s #4. To set the record straight, here are the top 6 reasons why you should have a living trust.
This is seldom mentioned as a reason for a living trust, but it’s probably one of the most important reasons. When most of us think about estate planning, we think about giving our property to our husband or wife, our children, and other loved ones after we die. However, sometimes our intended beneficiaries just aren’t able to handle an inheritance.
Minor children are the usual suspects here. Many states don’t even allow minor children to own property because they’re just too young. Instead, the state appoints a guardian to hold the property until they reach majority age (usually age 18). Even then, parents cringe at the thought of an 18-year old getting any amount of money in a lump-sum. The first thing they might do is quit school, buy an expensive car, and head to Cancun.
But, minor children aren’t the only ones who might squander an inheritance. Most experts agree that no one under the age of 25 should be given an inheritance outright because they generally are not mature enough to handle large sums of money. Of course, there are many people over the age of 25 that shouldn’t have money either. Some are spendthrifts at heart, others are in not-so-good marriages, still others are going through bankruptcy. Then there are those who are just too frail and incapacitated to manage property on their own. Giving any amount of money or property to any of these people is never a good idea.
That’s when a trust becomes a vital part of your estate planning; i.e., a trust allows you to give your hard-earned money and property to those you care about while protecting it for them at the same time.
Let’s take a look at a typical example and see how it works. Let’s say that you have a 20-year old son who is a junior in college. If you and your wife both die, you'd probably want your son to get all your property, including the equity in your home, your life insurance, retirement plans, etc. If you reduce all your property to cash, it could easily amount to a good sum of money. For illustration purposes, let's assume it's $500,000. Having the executor of your estate write a check to your 20-year old son for $500,000 is probably not a good idea. Instead, it would be far better to create a trust for the benefit of your son with someone you trust - say a friend, family relative, attorney, or your local bank - serving as trustee. The trustee would then hold the money and invest it for your son’s benefit until he reached a more mature age, say age 25. In the meantime, the trustee would use the money to pay for your son’s schooling, his general living expenses, and any other expenses you might specify in the trust instrument - including a down payment on a home or a new business. Then, when your son reaches the age specified in your trust instrument, the trust would end and all property held by the trustee would be turned over to your son. And, because your son will probably be finished with his schooling at that time and already embarking on a career of his own, he'll probably be mature enough to make good decisions regarding his inheritance.
Revocable living trusts have been used to protect property in this manner for hundreds of years, and it is probably one of the most important reasons for a revocable living trust today. So, if you have any beneficiaries who are not quite able to handle large sums of money on their own, then a revocable living trust is a necessary component of your overall estate planning.
Many people say that a revocable living trust doesn’t save estate taxes. Technically, they’re right. There are no provisions in the federal tax laws that exempt revocable living trusts from estate taxes. However, living trusts are often used by individuals and families to take advantage of certain deductions and credits that are allowed under the tax laws.
That sounds like double talk, but let me explain. For individuals dying in 2009, up to $3,500,000 was exempt from federal estate taxes. That exempt amount was made possible by virtue of a so-called “unified credit.” In addition to the unified credit, all property that passed to a surviving spouse was exempt from federal estate taxes by virtue of a so-called marital deduction. The “marital deduction” was unlimited, so you could transfer any amount of money or property to your spouse without paying any estate taxes on it.
For 2010, we had an anomaly in the tax laws, in that Congress allowed the estate tax to expire without coming to an agreement on what the tax rate and the various exemptions and deductions ought to be. Without any further action on the part of Congress, the estate tax automatically returned in 2011, with an increased tax rate and a unified credit amount equivalent to $1,000,000 instead of the 2009 amount of $3,500,000.
Then, for 2011, Congress restored the estate tax, with the exemption amount set at $5,000,000 and the tax rate reduced to 35%. In addition, Congress authorized a so-called portability provision relating to the exemption amount. Prior to 2010, if the first spouse to die failed to use all of his or her exemption amount, the unused portion was lost forever. For 2011 and beyond, that unused portion is not lost; instead, it is carried over to the surviving spouse to use in addition to the surviving spouse's own exemption amount. That portability provision almost single-handedly eliminated the need to use a revocable living trust to reduce or eliminate the estate tax upon the death of the surviving spouse.
However, unless Congress acts before December 31, 2012, the portability provision will be lost; the exemption amount will be reduced to $1,000,000 and the tax rate will return to 55%. In that case, the revocable living trust will once again emerge as an invaluable technique to reduce or eliminate the federal estate tax upon the death of a surviving spouse.
So, here's how this simple technique actually works. Assuming that the exemption amount is $1,000,000 and the tax rate is 55%, then here’s what typically would happen when a husband and wife have simple wills and a combined estate that exceeds $1,000,000.
Let’s assume, for sake of illustration, that you (the "husband") and your wife each have estates worth $750,000. Let’s also assume that you die first and that all your property is left to your wife. Your estate will not pay any estate taxes because of the unlimited marital deduction. Upon your wife’s subsequent death, her estate would then be worth $1,500,000 [her $750,000 plus your $750,000]). Upon her subsequent death, her estate would pay a federal estate tax of roughly $175,000. That's because her unified credit would shelter only $1,000,000 from the federal estate tax. The remainder of her property ($500,000) would be taxed at graduated rates reaching 55%.
You could eliminate this $175,000 estate tax very easily with a revocable living trust. Let’s assume, for example, that you don't give all your property to your wife upon your death. Instead, you give her only $250,000 (just enough to keep her under the $1,000,000 exemption amount), with the remainder of your property ($500,000) passing to your revocable living trust. The trust would provide that your wife would be the primary beneficiary during her lifetime so that she could have access to the money if she needed it, with the remainder at her death passing to your children. In that case, no federal estate taxes will be paid upon your death because the property given to your revocable living trust ($500,000) is exempt from federal estate taxes under your unified credit.
By doing that, your wife’s estate will be worth $1,000,000, since she received only $250,000 from you upon your death. Then, upon her subsequent death, her estate will pay no federal estate taxes because the entire $1,000,000 will be exempt from estate taxes by virtue of her unified credit. The $500,000 still in your revocable living trust will not be taxed in your wife’s estate because she doesn’t own it, even though she is the preferred beneficiary and could receive distributions if needed. After all is said and done, your children will receive $500,000 from your living trust and $1,000,000 from your wife's estate, for a total of $1,500,000, with no estate taxes having been paid - a savings of $175,000.
This very simple but highly effective technique - made possible by the use of a revocable living trust - would eliminate roughly $175,000 in federal estate taxes in the above example. However, as stated above, this technique assumes that the so-called portability provision under the estate tax laws is not in effect beyond 2012 and that the exemption amount is reduced to $1,000,000 and the tax rate is 55%. However, we don't know at this time what Congress will do for 2013 or beyond. For this reason, it is very important that you consult with an experienced attorney or tax consultant if your estate may be subject to federal estate taxes.
One of the major concerns that many of us have today is not about dying - it’s about living too long! We see it all around us - we worry about our parents living in their own home. We worry about their bills being paid and whether someone will walk off with their money. In many cases, we are powerless to help them because all of their property is in their own name. Unfortunately, without doing some prior planning, the only option we have is to file an application with the probate court to have a guardian appointed for them. That’s a gut wrenching experience because all their personal and financial affairs will have to be paraded before total strangers, and they will be forced to suffer the indignity and humiliation of being declared incompetent.
It doesn’t have to be that way. Many people try to avoid that result by putting certain properties (particularly checking and savings accounts) in joint name with a son or daughter. That enables the son or daughter to pay their bills, but it doesn’t provide a lot of help with other financial matters. It also creates more problems when the parent dies because those accounts pass automatically to the son or daughter and leaves the other children out in the cold.
A better solution is a durable power of attorney. A durable power of attorney allows you to designate the people you want to help you with your financial affairs. However, as good as a durable power of attorney is - and I’m a firm believer that everyone over the age of 50 ought to have one - it does have some shortcomings. First, your attorney-in-fact may find some financial institutions difficult to work with. Second, it may not give your attorney-in-fact all the powers needed to manage your affairs. For instance, if you were making gifts to family members on a regular basis, your attorney-in-fact would not be able to continue making those gifts unless that was specifically stated in the document.
A much better solution is a revocable living trust. A revocable living trust allows your successor trustee to take over whenever you resign or become incapacitated. There is generally no interruption in the management of your property, and there is no court supervision. Revocable living trusts also enjoy a greater level of acceptance throughout the legal and financial community, and almost all states provide a broad range of statutory powers regarding the management of trust property. While it is true that a living trust isn’t effective unless your property is in the trust, a durable power of attorney will enable your attorney-in-fact to transfer property into your trust if you can’t do it on your own.
It is true that property in your revocable living trust will not go through probate when you die. That’s because the trust instrument spells out who get’s the property. It’s a lot like life insurance, annuities, 401(k) plans, IRAs, and company retirement plans - those properties do not go through probate because they each have a designated beneficiary. Jointly-owned property, with rights of survivorship, doesn’t go through probate, either. It passes automatically to the surviving joint owner.
That does not mean, however, that your successor trustee is free to distribute the trust property immediately. It’s not as simple as that. Just because your property is in trust doesn’t mean that your outstanding debts don’t have to be paid. Likewise, the federal government still wants to collect its estate taxes; your state government still wants to collect its inheritance taxes; and the probate court still wants some fees even though most of your property may avoid probate. There probably will be trustee’s fees and attorney’s fees as well. In view of all these expenses, the successor trustee may be able to make some advanced distributions from the trust, but enough money has to be retained in the trust to pay all the debts and expenses.
Still, a reasonably efficient successor trustee will be able to determine fairly quickly just how much the potential debts and expenses will be, and he or she will then be able to make advanced distributions accordingly. In the final analysis, most revocable living trusts are able to distribute property more quickly and with much less cost than is possible through probate.
Does that mean that everyone should avoid probate? I don’t think so. Some people suggest a threshold limit of $100,000, exclusive of real estate, in order to justify the expense of a revocable living trust. I think the cutoff should be much lower than that. Most states have a simplified probate for estates valued at less than $20,000. If you’re in that situtation, then a simplified probate is probably right for you. However, if your probate estate is valued at more than $20,000, then you really need to look closely at a revocable living trust, especially if any of the other reasons for a revocable living trust apply to you. After all, it doesn’t take much to make up for the few dollars it takes to establish a revocable living trust.
It is true that a will is far more likely to be contested than a revocable living trust. That’s because a will goes into effect only when a person dies, whereas a revocable living trust goes into effect as soon as the trust instrument is signed and generally lasts for some time after the owner’s death. If you’re going to contest a will, all you have to do is prove that the testator was either incompetent or under undue influence at the precise moment the will was signed. To contest a revocable living trust, you have to prove that the grantor was incompetent or under undue influence not only when the trust instrument was signed, but also when each property was transferred to the trust, when each investment decision was made, and when each and every distribution was made to the owner or anyone else. That is virtually impossible to do.
Moreover, it costs nothing to contest a will. All a disgruntled family member has to do is object when the will is presented for probate, then hire an attorney on a contingency fee basis, and wait for the final outcome. A disgruntled family member has nothing to lose. On the other hand, contesting a revocable living trust generally involves a substantial commitment of time and money. Whereas a will contest is heard in probate court, a revocable living trust contest is heard in civil court where there are substantial filing fees and formal procedures that have to be followed.
Still, some people argue that will contests are seldom successful, so why bother with a revocable living trust? The answer is threefold: First, a will contest puts a screeching halt to the settlement of an estate. Most will contests take a minimum of two or more years to complete and, during that period, no distributions will be made to anyone. Second, defending a will contest involves lots of attorney time that results in large attorneys’ fees. Even unsuccessful will contests end up costing $50,000 or more in attorney’s fees. And, those fees come out of the estate, which means that much less for the beneficiaries. Third, many will contests are settled before they ever get to court. In that case, the estate will be further diminished by the amount of the settlement that is eventually reached. In the final analysis, will contests are time consuming and expensive. The best way to avoid them is through a revocable living trust.
Most of us naturally dislike the concept of probate because it is a public process. Theoretically, anyone can go into probate court when a person dies and look at the estate file. You can read the will, you can find out who the relatives and beneficiaries are, you can look at the claims of creditors and the list of assets, and you can find the phone numbers and addresses of estate beneficiaries. Unscrupulous sales people often go through estate files to locate grieving heirs to prey on. Disgruntled heirs, even friends and neighbors, often like to poke their noses into an estate file to see what’s there. And, with the advent of the internet, they don't even have to get themselves down to the probate court to take a look. All they have to do is fire up their computer in the comfort of their own homes. To see this for yourself, take a look at all the Wills of the Rich and Famous people that we have posted on our site. These wills are available simply because they are considered public documents once they're admitted to probate. But, that's not all. Now, probate courts are posting all the events associated with the settlement of an estate on the internet for anyone to see in real time. For example, to see what's being filed in George Steinbrenner's estate in Tampa, Florida, just click here. This link will take you to the website for the clerk of the circuit court of Hillborough County. Just click on the link for probate dockets, and then enter "Steinbrenner" on the appropriate place on the line. That will take you to a listing of all events taking place in his estate.
Revocable living trusts can prevent all of that. Revocable living trusts are private; they don’t get filed with the probate court, and no one gets to look at them unless the grantor or the trustee allows it. Some people put a high value on privacy - some people don’t. In my experience, most individuals know whether they will have a problem with a family member or some other person regarding their estate. In those cases, privacy becomes a very important concern and one that should properly be addressed with a revocable living trust. It's no accident that almost all of the Famous People whose wills are displayed on our website have utilized a living trust to keep their affairs private.
These, then, are the top 6 reasons why you should have a revocable living trust. If one or more of these reasons apply to you, then you should consult a professional to see whether a revocable living trust makes sense in your overall estate planning.
[Editor's Note: This article has been updated as of October 15, 2012 to reflect the tax laws as they existed on that date.]
About Michael Pancheri, Trust & Estate Attorney, Canton, Connecticut