ADVANTAGES OF A LIVING TRUST

What is a living trust?
A living trust is a form of contract.  It is created by drafting documents while you are alive to hold legal title of your property for the benefit of yourself or another person.  The trust document will dictate how your property will be managed while you are alive and provide instructions on how to distribute your assets upon your death.  You can be the trustee of your own living trust as well as the beneficiary, keeping full control over all property held in your trust.  It is entirely amendable and revocable during your lifetime.  Upon your death, instead of a Will, your estate will be distributed in accordance with the trust terms.

What are the benefits of having a living trust?

• The biggest advantage of a living trust in California is that property left through the trust does not have to go through the time-consuming and expensive costs of probate.  California has a probate exemption for estates valued $100,000 or less so if you have assets worth more than that, the cost of setting up a living trust is much lower than the cost of probate.

• Administering a living trust takes less time than going through probate

• In situations where the trustor becomes incapacitated, a living trust can also avoid a conservatorship proceeding, which can be expensive and time-consuming.

• For high net worth estates, trusts can be drafted to reduce or avoid federal estate taxes (which can be as high as 45%).

• It avoids intestate succession without becoming public.  A living trust is a private document and unlike a will, does not become a matter of public record because it does not have to be filed in probate court.  You can name beneficiaries and provide gifts while still attaining privacy.

• A living trust is flexible and can be revoked or amended during the trustor’s lifetime so you can change it as necessary.

What is a conservatorship?

Conservatorships are basically adult guardianship proceedings and the legal fees can be substantial.   When an individual is incapacitated and can no longer manage his or her own personal affairs, a conservator is appointed by a court to manage the conservatee’s financial affairs, and also make decisions concerning the conservatee’s living arrangements. If the trustor is incapacitated, a properly drafted trust can avoid a court ordered conservatorship by providing powers to a successor trustee who will manage the trust for the benefit of the trustor.

What is intestate succession?

The laws of intestate succession determine who will inherit the  estate when a decedent  did not leave a will.   The order of distribution is set by California law.  If you die without naming beneficiaries to your estate, the State determines who will receive your assets.

What is probate and why do I want to avoid it?

Probate is the legal process of administering the estate of a deceased person by resolving all claims and distributing the deceased person’s property.   A court  of proper jurisdiction oversees the process of distributing the deceased’s assets to the proper beneficiaries.  This may be in accordance with a valid will or through the laws of intestate  succession if there was no will.  Depending on the size and complexity of the estate, probate can take 6 months to a few years to close, tying up assets the whole time.

The cost of probate includes:

• a fee for the court petition (currently $350 in Los Angeles County)
• publication fees for legal notice ($500 and up)
• fees for a probate referee to appraise all of the assets (currently .1% of appraised asset values)
• bond costs
• fees paid to an attorney and/or personal representative (yes, there could be double the fees).

These last fees are set by statutory law and can be very expensive for large estates.  The fee is calculated as a percentage of total assets without taking into account any encumbrances on such assets.  For example, if one of the estate’s assets is a home worth $500,000 with a mortgage balance of $150,000, the fee is calculated as a percentage of the entire $500,000.

The fees are 4% of the first $100,000 of the estate, 3% for the next $100,000, 2% of the next $800,000, 1% of the next $9,000,000 and 1/2% of the next $15,000,000.

Estate Value      Statutory Fee
$100,000              $4,000
$200,000              $7,000
$300,000             $9,000
$400,000             $11,000
$500,000             $13,000
$1,000,000          $23,000
$2,000,000         $33,000

The average probate drags on for a year or longer before the inheritors receive anything. By that time, a significant percentage of the property has been depleted by legal and court fees during the probate process.  Since trust administration does not require court involvement, distribution of assets is much quicker and the statutory fees are avoided.

How does a living trust avoid probate?

Property you transfer into a living trust before your death doesn’t go through probate. During your lifetime, you will be the trustee.  Your trust will outline the terms of distribution of your assets after your death, and your successor trustee (the person you appoint to handle the trust after your death) simply transfers ownership to the beneficiaries you named in the trust. For simple trusts, the administration process takes only a few weeks. When all of the property has been transferred to the beneficiaries, the living trust ceases to exist.

Does a living trust provide creditor protection?

Holding assets in a revocable trust doesn’t shelter them from creditors because you still have control over the assets.  A creditor who wins a lawsuit against you can go after the trust property just as if you still owned it in your own name.

Can a living trust reduce estate taxes?

A simple probate-avoidance living trust does not reduce estate taxes. However, this issue is not relevant to most estates because California does not have an inheritance tax and the federal estate tax exemption per person is $3.5 million.

For clients who may exceed the exemption amount, there are other trust options that can greatly reduce the federal estate tax bill.

How do I set up a living trust?

A trust document is drafted to name the trustor(s), trustee(s), successor trustee(s), beneficiaries and outline the trustee’s powers and distribution plan for all trust assets. The trustor is the creator of the trust and the trustee is the manager of the trust.  You usually serve initially as trustee and nominate a third party (relative, friend, bank, or trust company) as successor trustee to take over management of the trust after the death, resignation, or incapacity of the original trustee(s).

Your distribution plan for the living trust’s assets can be the same as those in your will. This might include specific gifts, gifts to charities, creation of minor trusts, etc.

Depending on the size of your estate, your trust might also include provisions that will reduce or eliminate federal estate taxes.

After the trust is signed, you (as trustor) transfer your assets to the trust (known as “funding” the trust).  This can require some crucial paperwork such as preparing a new deed to show that you now own the house as trustee of your living trust.

What is a pour-over will?

A pour over will is usually drafted in conjunction with your living trust and serves as a back-up device for property that you have mistakenly left out of your trust. For example, if you acquire property shortly before you die, you may not think to transfer ownership of it to your trust — which means that it won’t pass under the terms of the trust document. The pour over will transfers these assets into the trust so that they may be distributed according to the terms of the trust.

If you don’t have a will, any property that isn’t transferred by your living trust or other probate-avoidance device (such as joint tenancy) will go to your closest relatives in an order determined by state law. These intestate laws may not distribute property in the way you would have chosen.

Maximum rates for federal estate taxes are 45% this year and scheduled to hit 55% in 2011.  What could this cost you?

An Estate Planning Case Study

Bill, 61 and Mary, 55 have been married 30 years and have two children, Casey 23 and Tom 25.  Bill and Mary have always been a practical couple who saved most of their income.  Bill worked as a senior manager for a hotel and Mary is a nurse.  When Bill recently passed away in 2009, their net worth was $2,287,000.  $1.5 million was in the form of an insurance policy paid out to Mary upon Bill’s death.  While Bill was careful enough to purchase an insurance policy, Bill did not have a will in place when he died.  Still, his assets passed to his wife under the state’s intestate statute.

Since assets left to one’s spouse after death is not subject to estate taxes, Mary ends up owning all the assets without having to pay any estate taxes.

Their assets comprised of:

Their home (owned free and clear) worth                   $  355,000
Stocks                                                                                     $      65,000
IRA accounts                                                                       $   275,000
Life Insurance (paid to Mary on Bill’s death)            $1,500,000
Bill’s Car                                                                                $     10,000
Mary’s Car                                                                            $      11,000
Personal property                                                               $      26,000
Joint Savings account                                                      $      45,000

                                                                            TOTAL $ 2,287,000

However, let’s take a look at what would happen if Mary died in 2011 without an estate plan:

In 2011, Mary still owns all of the assets above, but she paid Casey’s grad school tuition in 2010 for $18,000 and gave Tom a gift of $12,000 (free of gift tax) in the same year.  Mary also spent approximately $54,000 of the insurance proceeds in addition to the gifts to the kids.

So her assets are currently worth:

Home                                                                                   $      355,000
Stocks (value depreciated)                                              $        60,000
IRA accounts                                                                      $      275,000
Proceeds left from Life Insurance                                 $   1,446,000
Proceeds from Bill’s Car                                                   $        10,000
Mary’s Car                                                                           $          8,000
Personal Property                                                              $        26,000
Joint Savings (after tuition and gift to kids)              $        15,000

                                                                                TOTAL $2,195,000

Potential Estate Tax:

  $ 2,195,000
- $ 1,000,000      2011 federal personal estate tax exemption

  $ 1,195,000
x              .55       federal estate tax rate
$      657,250   estate tax owed

If Mary dies without a will or estate plan, her assets would still pass to her children under the state’s intestate statute, but the tax hit would be $657,250!

Planning before Bill’s death could have prevented this outcome.  He could have set up a life insurance trust to hold the proceeds of the life insurance.  If he named Mary as life beneficiary and the kids as remainder beneficiaries, the funds would be kept out of Mary’s estate while still allowing her to benefit from the proceeds. 

Still, even after Bill’s death, Mary could have implemented a gifting strategy (by using the annual $12,000 exclusion amount) to trusts for her children in order to slowly reduce her estate over the years.  However, in this illustration, Mary dies 2 years after Bill, so creating a life insurance trust before Bill’s death was the most practical way to save on estate taxes.

This is only one of many scenarios and estate planning solutions which could minimize or even eliminate estate taxes.  It does not take into consideration state inheritance taxes (CA has none) or probate costs (CA has very high probate costs) which could significantly add to costs.

In order to find the best solution for your individual circumstances, contact an experienced estate planning attorney to discuss your options.