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REVOCABLE LIVING
TRUSTS
Advantages and Disadvantages
A
trust is a legal entity that can own property, much like a corporation
is a legal entity that can own property. The trustee named in the trust
document manages the trust assets, and can sell trust assets, invest the
assets, collect income, and pay bills. The beneficiaries of the trust
receive income and principal of the trust at the times set forth in the
trust document, according to the instructions given to the trustee in
the trust document. The "settlor" or "trustor" is the person who creates
the trust. In estate planning, two types of trusts are generally used,
namely "living trusts" (sometimes called "inter vivos" trusts) and
"testamentary trusts." Usually trusts for estate planning are
"revocable," but some trusts, such as those designed to own life
insurance, may be "irrevocable."
LIVING TRUSTS AND TESTAMENTARY
TRUSTS
A trust which is established while the settlor is living is commonly
known as a "living trust." A trust which is set up under the
terms of a will, after the settlor's death, is called a "testamentary
trust." In a living trust, the settlor usually acts as trustee as
long as he or she is living and competent. In a living trust, the settlor
changes the legal title of his or her assets to the trust during his or
her lifetime so that the trust, not the settlor, becomes the legal owner
of the settlor's assets. With a testamentary trust, assets are not
transferred into the trust until the probate court directs distribution
from the deceased settlor's probate estate to the trustee of the
testamentary trust, which usually occurs toward the end of the probate
proceedings.
ESTATE, GIFT AND GST TAXES
The current estate tax exclusion is $2 million,
and future increases are scheduled -
See Table. The generation
skipping transfer (GST) tax exemption is now equal to the estate tax
exclusion. The lifetime gift tax exclusion is $1,000,000. In 2010,
the estate tax is scheduled to be repealed for one year (and partially
replaced with a capital gains tax). Unless the law is changed, the estate
tax comes back in 2011 with a $1 million exclusion. It is almost certain
that Congress will act in the next few years to either repeal the estate
tax permanently, or make the larger exemption permanent, but at this time
there's no way of knowing which way our lawmakers will go.
ADVANTAGES OF TRUSTS IN GENERAL
Either a living or a testamentary trust can provide estate tax and
generation skipping transfer tax benefits. For married couples with net
assets worth more than the individual estate tax exclusion, separate
trusts can be created on the death of one spouse to preserve the estate
tax exclusion available to the estate of the first spouse. Similarly,
separate trusts can be created after one spouse's death to preserve each
spouse's exclusion from GST taxes on transfers to grandchildren or others
in the grandchildren's generation.
Both living trusts and testamentary
trusts allow the settlor to keep "strings" attached to his or
her property after death by distributing assets to beneficiaries over a
period of time, or limiting distributions to beneficiaries only for
certain purposes. For example, many parents do not wish to leave assets
outright to their children, but prefer to have a trustee hold the assets
and distribute them to the children only as needed until they attain one
or more designated ages.
WILLS AND LIVING TRUSTS
A living trust is often called a "will substitute" because,
like a will, it says what is to happen to property when the settlor dies.
However, unlike a will (which only has legal effect after a person dies),
the living trust also says that during the settlor's lifetime, the trust
property is to be used for the benefit of the settlor. A will controls all
of a person's property which is owned by a person in his or her own name
at the time of his or her death other than joint tenancy property (which
automatically goes to the surviving joint tenant), or property which
passes by beneficiary designation (such as life insurance or pension plan
proceeds.) The living trust controls only property transferred to it. A
settlor of a living trust should try to transfer all of his or her
property into the trust while he or she is living. However, if some assets
remain out of the trust, then after the settlor's death those assets may
be probated and the settlor's will should direct that they will be added
to the trust; alternatively, it may be possible to have the court issue an
order confirming that the property is in the trust, without a full probate
proceeding.
A living trust is not treated as a
separate taxpayer for income tax purposes during the lifetime of the
settlor, as all income from trust assets is reported under the settlor's
Social Security number on the settlor's own individual income tax returns.
ADVANTAGES OF LIVING TRUSTS
There are several benefits to a living trust over and above those
which can be provided by a testamentary trust. Some of these advantages
are summarized below.
1. Probate Avoidance.
An important goal of many people who establish a living trust is the
avoidance of probate. Probate is a process for establishing the validity
of a will, paying the decedent's death taxes and creditors, and
transferring the legal title of a decedent's assets to the decedent's
beneficiaries. The judge of the probate court decides if the decedent's
will is valid (i.e., that the will is not a forgery, the decedent
wasn't crazy when he signed it, he wasn't forced to sign the will against
his wishes, and there is no later will.) The judge appoints an executor
(who is usually named in the will) to locate the decedent's assets and pay
the bills and taxes. When these things have been done, the judge signs a
court order to transfer legal title to the decedent's beneficiaries. If
assets are placed in a living trust during the settlor's lifetime, then
upon the death of the settlor, the trust continues in existence as the
owner of the trust assets. The successor trustee named in the trust
document simply takes over management of the trust, and is responsible for
paying the decedent's death taxes and creditors. Accordingly, no court
proceeding is needed to transfer title on death, since assets continue to
be held by the trust.
Some of the reasons people may wish to
avoid probate are:
A. Expense. The executor and the
executor's lawyer are entitled to be paid for their work. California law
sets the maximum fees payable to executors and lawyers for
"ordinary services" based on the gross value of the probate
estate assets. In California, there is a statutory maximum fee for
ordinary services rendered by the lawyer and executor equal to 4% of the
first $100,000, 3% of the next $100,000, 2% of the next $800,000, and 1%
of the next $9,000,000. The executor and lawyer are entitled to these
fees, but family members who serve as executors often do not charge for
their work, and lawyers sometimes will agree to work on an hourly rate
basis (but may not charge more than the maximum fee.) In addition,
executors and attorneys are entitled to extraordinary fees for special
services such as handling lawsuits, selling real property and tax work.
Usually, fees are payable when the probate is over. There are also court
filing fees, which are based on the size of the estate, and fees for
appraisers.
In a living trust, there are no
administrative fees while the settlor is living and serving as the
trustee. After the settlor's death, the trustee and the trustee's lawyer
are entitled to "reasonable" fees for their work. Unlike a
probate, these fees are usually payable on a monthly basis. Generally,
these fees will be approximately the same as the fees in a probate,
especially if the probate lawyer agrees to charge on an hourly rate
basis. Still, there is usually somewhat less legal work in administering
a living trust, so costs of administration are usually slightly lower.
B. Time. It takes at least one
month after the decedent dies to have the executor appointed in a
probate. Usually, administration of a living trust can begin immediately
after the decedent dies.
Probate proceedings ordinarily take six
months to two years. The time period is determined by many factors,
including the type of assets being probated, creditor's claims, sales or
other dispositions of assets, and other problems concerning the assets,
the beneficiaries, or other family matters.
If the estate is large enough to
require the filing of a federal estate tax return (i.e., in
excess of the estate tax exclusion), the amount of time needed to
administer a living trust may be about the same as the time needed to
administer a probate.
C. Privacy. All documents filed
with the probate court are public records, available for public
inspection. Among these records are the provisions of the will, a
listing of the probate assets and their value, and the names and
addresses of the beneficiaries. Furthermore, notices regarding the
probate court proceedings must be sent to any person whose name appears
in the will or any codicil, as well as to all relatives within a certain
degree, whether or not these persons are named as beneficiaries in the
will.
Some people place their assets in a
living trust during their lifetimes so that these matters won't be open
to public inspection upon their death. However, California law requires
certain notices to be sent to all heirs and beneficiaries at the death
of the settlor of a living trust.
2. Provides for Incapacity and May
Avoid Conservatorship.
A living trust can eliminate the need for the appointment of a conservator
of the estate upon incapacity. A conservator may be needed to handle the
assets and financial affairs of a person who loses the capability of
handling his own affairs, unless provisions are made prior to incapacity.
Conservatorship proceedings are court proceedings in many ways similar to
probate proceedings. They involve expense, time, notice to a large
category of relatives, and continuous reporting to the court over the
lifetime of the conservatee. However, if a settlor who has placed his or
her assets into a living trust prior to incapacity later becomes
incapacitated, the trust document generally provides for a successor
trustee to step in. The settlor, in the trust document, can define when
his or her incapacity will be deemed to occur. Many settlors provide that
upon the certification of one or more physicians, the successor trustee
will be authorized to take over the management of the trust from an
incapacitated trustee. Except for the change in the trustee, the trust
continues to own and manage the trust property and to apply the assets of
the trust for the benefit of the incapacitated settlor during the period
of incapacity.
3. Out-of-State Real Property.
Avoiding probate by using a living trust is especially beneficial to
persons who own real property in multiple states. Unless the title to the
out-of-state property is held in joint tenancy or in a living trust, a
separate probate, known as an "ancillary probate," must be
conducted in each state where the decedent owned property. This is in
addition to the probate being conducted in the decedent's state of
residence.
4. Maintaining Separate Nature of
Separate Property.
People who enter into a marriage owning separate property or who acquire
separate property after marriage which they wish to maintain as their
separate property may benefit from the use of a living trust. If separate
property assets are placed in a living trust, and the administration of
those assets in the trust as a separate entity is properly maintained by
the trustee during the marriage, the problems arising from the commingling
of separate and community property assets are greatly minimized. Having
separate property separately maintained in a living trust also minimizes
problems related to the distribution of these assets which may otherwise
arise on the settlor's death. Property acquired by one spouse by gift or
inheritance is that spouse's separate property.
DISADVANTAGES OF A LIVING TRUST
While the list above describes several of the advantages of
establishing a living trust, there are certain disadvantages as well.
1. Initial Cost.
For some people, the advantages of the living trust are outweighed by the
initial cost of establishing the trust. First, the legal fees for
preparing a living trust (with a pour-over will) are generally more than
the fees for preparing a will. Second, there will be fees involved in
transferring title to assets into the name of the trust.
2. Costs and Record-Keeping Required
After Death of First Spouse for Tax-Saving Trusts.
As mentioned above, both living and testamentary trusts of married couples
can contain provisions to eliminate death taxes upon the death of the
first spouse and minimize them on the death of the second spouse. However,
a disadvantage of these trusts is that the surviving spouse must be
prepared to do the accounting and record-keeping which is necessary to
keep the trust assets separated to obtain the benefit of the death tax
savings. The surviving spouse must have the help of attorneys and
accountants familiar with these matters. Failure to carefully follow
through on these procedures can result in the loss of the deceased spouse's
tax exemptions and exclusions, thereby causing higher taxes on the
surviving spouse's death.
3. Certain Advantages of Probate.
There may be advantages to having title to assets transferred upon death
through probate, rather than through a living trust, as follows:
A. Creditor Protection One such
advantage is that probate proceedings provide a slight additional amount
of protection from creditors. Creditors must file a claim in the probate
proceedings within four months after the executor is appointed, or they
are forever barred from making any claims against the decedent's
beneficiaries. In a living trust, creditors can make claims up to one
year after the date of death, although a Trustee has the option to
publish and send notice to creditors, in which case creditors must file
their claims within 30 days from receipt of a mailed notice or four
months from publication of notice.
B. Court Supervision In some
situations, the judicial and public scrutiny provided by probate
proceedings may be desirable. There have been cases where unscrupulous
successor trustees prevented beneficiaries of living trusts from
claiming their rights, since the beneficiaries never received notice of
their rights and there was no public record which they could check to
find out what the decedent's assets consisted of, or what their rights
were.
C. Income Tax Savings. Prior to the
enactment of the 1997 Tax Act, there were income tax advantages of going
through a probate; however, under the new law an executor can make an
election to treat a revocable trust the same as an estate.
4. Bank Loans.
Some banks and mortgage companies are reluctant to lend money secured by
property in a living trust. Thus, if you want to borrow money secured by
trust property (such as by giving a deed of trust or mortgage), it may be
necessary for you to sign and record a deed to transfer the property out
of your trust while the bank records their deed of trust, after which you
can sign and record another deed to put the property back into trust.
After a settlor's death, it is not possible to do this (since the trust
becomes irrevocable when the settlor dies) and thus it is necessary at
that time to find a bank or mortgage company willing to lend on trust
property.
PREFERRED COURSE OF ACTION
A prospective settlor must review the circumstances of his or her
assets and family, and weigh the benefits and costs of a living trust as
applied to those particular circumstances, to determine the most
appropriate course of action in his or her own situation. To avoid the
payment of unnecessary death taxes or transfer taxes, however, married
persons with combined assets valued at approximately $1.5 million or more
should seek advice regarding the establishment of tax minimizing trusts,
either living or testamentary. |
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