SHOULD YOU HAVE A LIVING TRUST INSTEAD OF A WILL?
SHOULD YOU HAVE A LIVING TRUST INSTEAD OF A WILL?
Only a few years ago, people set up living trusts almost exclusively to save on taxes. Today, they are used to avoid Probate and for other important purposes as well. Many articles have been written to explain living trusts. All of those I have seen are too technical, contain wrong information, or come to conclusions I disagree with. This article explains the living trust as I see it. It is not meant to be a comprehensive discussion of the subject, but it should help you to understand a typical living trust and its plan.
What is a living trust?
There are different kinds of trusts. A trust included in a will (which is to take effect only after a person dies) is called a "testamentary" trust. A trust set up during a person's life is called an "inter vivos" trust or "living" trust. This is not the same as a living will, which directs removal of life support in the face of certain death. A trust that can be changed after it is signed is called "revocable." A trust that cannot be changed is called "irrevocable." Irrevocable trusts are most often used in estate tax planning or where the grantor wants to lock in certain terms of the trust. Most people want to keep their trusts flexible and set up revocable trusts.
This article will deal with the revocable living trust. I will first describe the most common plan and then explain the advantages and disadvantages of that plan.
The most important document in the plan is the living trust itself. The trust document names the trust, names the trustee (usually the grantor) and one or more successor trustees, gives the trustee powers, and directs the administration of the trust for as long as it exists. Most of those provisions are fairly standard from one trust to another, except for names. The trust may specify the property to be transferred to the trust, but most trusts can and do accept any property transferred to them.
The trust then says how the trust is to be run during the grantor's lifetime. The grantor is usually paid from the trust whatever he or she wants, asks, or needs. The trust usually provides for support of the grantor's spouse and children, if any. The grantor can specify exactly what he or she wants done with the trust assets and income.
Finally, the trust specifies what to do with the property left in the trust after the grantor dies. At that point, the trust operates much like a will and serves a similar function. However, distribution can be made directly from the trust without the necessity of Probate and its additional requirements and expense.
The second document in the plan is called a "pour-over" will. Why do you need a will if you have a trust? The trust can only affect property that is specifically transferred to it. The will acts on any property that is not transferred to the trust. The will provides for collection of that property, payment of Probate expenses, and transfer of whatever is left to the trust. In effect, whatever is left in the Probate estate "pours over" into the trust and is then administered according to the terms of the trust. The will can also name guardians for minor children and can address other matters that do not relate only to "assets."
Once the pour-over will and the trust are executed, the job is not completed. It is vital to transfer assets to the trust! Real estate must be deeded from the grantor(s) to the trustee(s). Stock, bank accounts, and other assets which are registered in individual or joint names must be transferred to and re-registered in the name of the trust. Insurance policies and other assets payable on death should be changed so that the trust is beneficiary (and perhaps the owner). Personal property should be transferred to the trust. The goal of the plan is to funnel all of the assets into the trust either by transferring them directly to the trust, having them paid directly to the trust upon death, or passing them through the Probate estate via the will to the trust. Once everything is in the "pot," the trust can do its work.
There is one major exception to the preceding paragraph. IRA's, 401(k) plans, and other tax-deferred assets should usually name the spouse first as primary beneficiary. When those assets are distributed, they are usually deemed to be 100% "income." That can result in a big income tax bite to the recipient! However, a spouse can often roll over the distribution, and income tax will then be deferred or at least spread out. This analysis is usually correct, but not always. These types of assets should always be separately discussed and analyzed in detail.
There are additional pieces of the overall plan. They include living wills and powers of attorney for property and health care. These should be considered and used in virtually all cases. There are also more sophisticated tax planning vehicles for particular types of assets and gifts. A more detailed discussion of those documents is beyond the scope of this article.
WARNING: Not all trusts actually accomplish their purposes. Sloppy or incomplete drafting can sabotage any plan. I can relate specific instances I have seen where questions were not asked, errors or omissions were made, and the results were not what the grantor intended. Virtually every trust I draft has many of the same provisions ("boilerplate"), but no two trusts are identical. Each situation must be separately analyzed and customized.
Example--No Living Trust
In order to better understand the benefits of the living trust, let's look at what can happen without one. Assume a rather typical set of facts. John and Mary have been married for many years and are in their early 70's. They have a house filled with furniture and other possessions they have accumulated over those years. They have a small vacation home in Wisconsin. They also own stocks, bank accounts, IRA accounts, and paid-up life insurance policies, and they receive monthly Social Security and pension benefits. We will assume that their estate does not exceed the Federal Estate Tax Exemption ($1,500,000.00 during 2004). If it does, John and Mary should consider doing more sophisticated estate planning to decrease or eliminate Federal Estate Taxes (which start at 37% of the taxable estate above the exemption and escalate from there). Estate tax planning can be very complex and is also beyond the scope of this article.
John has gradually developed Alzheimer's disease and can no longer recognize Mary or make responsible decisions regarding his personal care or management of his assets. Under Illinois law, John is a "disabled person." Mary has reluctantly decided to place John in a nursing home. The home requires John to have a legally appointed guardian to make decisions for him and to act on his behalf. Mary petitions the Court and is appointed guardian of John's person and estate. Guided by her attorney, Mary now opens separate bank accounts for herself as guardian of John's estate, deposits John's monthly benefits into those accounts, pays John's bills, and otherwise administers the estate. One of those bills is from a surety (insurance) company to guarantee that Mary will not improperly spend the estate's money, even though Mary would never dream of doing that. The premium will vary from $100.00 to several hundred dollars each year the estate is open, depending on the value of the remaining estate. If action must be taken with regard to the Wisconsin house, it may be necessary to open up an estate in Wisconsin to act with regard to the house. So long as the only transactions involve paying expenses, no further actions should be necessary there at this time.
The stress on Mary of being physically separated from John, of her concern for him, and of all of these new duties weighs heavily on Mary, and she suffers a stroke. The stroke leaves her bedridden and unable to speak. Mary's and John's oldest son, Bill, now petitions the Court to be appointed as guardian for Mary's estate and person and successor guardian to Mary for John's estate and person. Second and third sets of bank accounts are now opened, and John assumes the duties of guardian. A surety bond premium must now also be paid yearly for Mary's estate, even though Bill is scrupulously honest and would never do anything improper with his parents' money.
Bill now decides to sell his parents' home. He must ask the Court for permission to list the home and permission to accept the contract once one is presented. After the proceeds of sale are received, an additional bond premium must be paid because of the additional money now in Bill's hands.
Bill must allocate between the two estates all expenses and some of the income received. After one year, Bill must present to the Court a full accounting in each estate. That accounting must itemize each receipt and each expense and must reflect the amounts still held in each estate. This yearly accounting must continue in each estate for so long as John or Mary is alive.
Let us assume John dies first. His will leaves everything to Mary. Bill has to open a decedent's estate for John. After he is appointed executor, Bill presents his final account in John's disabled estate and distributes the net assets to himself as executor of John's decedent's estate. Still another set of bank accounts must be set up to receive the distribution, this time for Bill as executor of John's estate. Under Illinois law, the estate must remain open for a minimum of six months from the date of Bill's appointment to allow creditors to present claims and to allow heirs or other parties to challenge the will or bring other contested proceedings. After the six months, Bill presents a final account for John's estate and distributes the remaining money to himself as guardian for Mary's estate.
Upon Mary's death, her will (now several years old) is also admitted to Probate. That estate must be administered similarly to John's with one exception. When John died, title to the vacation home in Wisconsin passed automatically to Mary as surviving joint tenant. Now, it is in Mary's estate. John must open an additional Probate estate in Wisconsin (called "ancillary" because it is an offshoot of the Illinois proceedings) to clear title to the vacation home and to distribute it according to Mary's will. After he is appointed executor, Bill presents his final account in Mary's disabled estate and distributes its assets to himself as executor of Mary's decedent's estate. One final set of bank accounts must be set up to receive the distribution, this time for Bill as executor of Mary's estate. After the six months, Bill distributes what is left equally to himself and his brothers and sisters according to Mary's will. At last, the transfer from parents to children is complete.
The great cost in money and time of going through these multiple proceedings should be obvious. There were in all five different estates (including Wisconsin), one with two different representatives. In fact, guardianship proceedings are usually far more costly in money and in stress than decedents' estates, which typically run their course within one year and then are over. John, Mary, Bill, and all of Bill's brothers and sisters would have agreed with virtually everything that was done. Still, a Court had to approve all of the actions taken in the disabled estates and had to play a part in the administration of the decedent's estates. Mary and Bill would be lucky if they found an attorney who billed them only for the time spent on each estate and not with regard to the value of the estate. The attorneys' fees each year for handling the disabled estates totaled at least $3,000.00. The fees for handling John's and Mary's Illinois estates as decedents were less, approximately $2,500.00 each, since all of the assets except the Wisconsin home had previously been converted to cash. The Wisconsin proceedings would add several hundred dollars more.
Example--With a Living Trust
Now, let's change the facts. John and Mary executed a living trust, transferred all of their assets to the trust, and made the trust the beneficiary of each insurance policy and contingent beneficiary of each IRA and other tax-deferred account. John and Mary named themselves co-trustees, with either allowed to act as sole trustee if the other would not or could not serve. Bill was to be the trustee when neither John nor Mary could act. The trustee was directed to take care of John's and Mary's expenses so long as either was alive and to distribute the net estate equally to their children after all final bills were paid.
Under the same facts, when John was put in the nursing home, Mary might still have had to be appointed his guardian. However, she would be named guardian of his person only, and with proper powers of attorney, even that would not be necessary. No guardian of his estate would be necessary, because of the trust. The procedure to have Mary appointed as guardian of the person would require one or two Court appearances and would cost at most only several hundred dollars. Once Mary was appointed, no further proceedings would be necessary other than to have Bill appointed as successor guardian for John later on. No surety bond would be required, since no assets would be subject to the supervision of the Court. All of John's and Mary's assets were owned by the trust, not by either John or Mary individually.
When John's doctor certified to Mary that John could no longer make responsible decisions about himself, Mary became the sole trustee of the trust without any Court action being required. When Mary suffered her stroke, Bill became the successor sole trustee in similar fashion. Bill already "owned" all of the trust assets as trustee. All institutions holding trust assets (banks, brokerage firms, corporations issuing stock, etc.) were notified of the change in trustees and changed their records accordingly. Bill took care of both funerals and related expenses, paid all of the final medical bills, and filed appropriate income tax returns. Bill distributed the Wisconsin house without any Probate proceedings (although perhaps some Wisconsin tax). Bill distributed most of the estate to himself and his siblings within a month or two after Mary died and held back only enough to cover expected additional expenses.
What legal services were required? Assistance in appointment of two personal guardians (if no Powers of Attorney were in effect), representation for the sale of the Illinois house (required in any case), and transfer of the Wisconsin house. No additional petitions, accountings, or other legal proceedings were necessary. In all, the trust saved thousands of dollars in legal fees and costs associated with Probate proceedings for two disabled estates and three decedents' estates. The trust also saved time by completing the administration and distribution of the total "net" estate several months earlier.
Advantages of the Living Trust
Disadvantages of the Living Trust
Neither Advantages Nor Disadvantages But Important
Cary A. Lind, P.C.