Living Trusts -- not just for avoiding probate
Dec 06 '02
The Bottom Line Living trusts can be useful (even for purposes other than advertised), but are not a panacea.
What is a living trust?
A living trust is a revocable trust which you create and fund while you're alive. (Well, duh....)
OK, so what is a revocable trust?
A revocable trust is a trust from which the grantor can take money or property out, usually, at his/her whim. (OK, the grantor, in this case, is the person who funds the trust.)
Fund?
This means to put money or property into the trust.
OK, wise guy, so what is a trust?
Now, we're starting to get a little technical. A trust, in general, is a separate legal entity, which is managed by trustees, and which will eventually distribute its assets to beneficiaries.
Why do you use the Q&A format?
I dunno. It seemed like a good idea at the time.
How does it work?
Suppose a married couple have more than the estate tax exemption (currently $1 million) in assets. They create the trust and put all of their assets into the trust. (They still need a will, to take care of assets that they forgot to put in the trust or that cannot be put in trust.) This makes little difference in day-to-day life. In particular, there are no income tax consequences -- income from trust assets is reported and taxed exactly as if earned by the grantor. (On the other hand, when we recently refinanced our first mortgage, the Simple Refinance did require that the house not be in trust.)
When one of them (say, the wife) dies, the trust splits into an A (for above ground) trust for the husband and a B (for below ground) trust for the wife. The B trust is funded with $1 million in assets -- so no estate tax. The A trust gets the remainder of the assets -- there's an unlimited spousal exemption, so still no estate tax. This is done without going through probate, a public, expensive, time-consuming court-managed process to determine where the assets of the deceased go. As both of the (excellent) existing reviews in this topic point out, there can be advantages to going through probate, which I will not go into here. (A married couple can also have separate living trusts, in which case the A trust created in this process just merges into the surviving spouse's living trust.)
The A trust is still a living trust, and can be used to avoid probate when the husband dies.
The B trust is not a living trust, and is usually set up with the people who would have be the primary heirs in the will (if both had died) being the trustees, and (at least) contingent beneficiaries, but the surviving spouse can get the income and principal of the trust if needed. (As an aside, to the extent the B trust does not distribute income, it is subject to Federal income tax (almost certainly at a higher rate than the beneficiary would be taxed), and state income tax (sometimes in more than one state).
For someone who is not married, or for the A trust created here, the heirs are usually alternate trustees, so that the assets can be managed in the case of temporary (or permanent) incapacitation of the grantor.
OK -- do I really need a living trust to do this?
Well, to do everything, yes, but....
The estate tax management for married people can be done just as easily by creating (or funding) the B trust in the will.
Asset management during periods of incapacity can be handled (although not quite as well) by a durable power of attorney, which is a good idea, in any case. In some jurisdictions, you can have a "springing" power of attorney, which only takes effect during periods of incapacity.
If you don't want people to know who gets the assets when you die, you can just leave the money to a trust which will distribute it. (Remember, wills are public, while trust instruments are not.) If you didn't set up a living trust you can't stop the itemization of the estate from becoming public.
Things a living trust cannot do, in spite of the literature you may receive from companies trying to sell you them, include:
Specifying a guardian for a dependent (not the tax definition) child. That can only be done through a separate document, and with the approval of a court.
Specifying a conservator in the event of your incapacity (for person decisions, or assets outside the trust). That requires a durable power of attorney or durable power of attorney -- health care (the latter is also known as a living will), and may require the approval of a court.
Eliminate disputes from heirs/beneficiaries. Trusts can be disputed, as well as wills. There is a slight advantage in that terms of a trust are not public, but a prospective beneficiary can argue that the trustor was not of sound mind or was unduly influenced in regard the drafting of the trust, as well as in regard the drafting of a will.
How do I know this?
Well, I haven't read the Nolo Press books on estate management, but....
We set up a living trust for my mother-in-law, primarily for asset management. She was selling her house to move closer to us, and we were all worried about her not being fully competent to complete the transactions. We used a lawyer to draft the trust, and also have the durable power of attorney.
As you may recall from my profile page, my mother recently died. However, in 1993, my parents set up reciprocal living trusts, but did not fund them. Her will provides that her trust (acting as the B trust) is to be funded up to the estate tax allowance, with the remainder going to my father. In addition, some of her life insurance named the trust as beneficiary. I won't go into the terms of the trust agreement, but they seem typical from my reading and research on the web.
Do we have a living trust?
Well, no. At the present time, our total assets are well under the estate tax exemption, and California does not have an inheritance tax. Also, our experience with dealing with the estates of my wife's mother's brother and husband, suggest that probate can be quite quick and painless in California. In addition, neither of us has children, so where the money goes after our deaths doesn't seem as important.
However, writing this makes me wonder.
References
(None of my reviews, this time.)
Google reports http://www.heritagelivingtrust.com/ and http://www.radichdesign.com/ltrust/ as web sites of companies selling living trusts. They are unlikely to provide any negatives (in fact, one of them states there are no negatives).
The existing reviews in this topic (as I write this) are http://www.epinions.com/finc-review-6EF2-4161FF4-39A5DC2B-prod2 and http://www.epinions.com/finc-review-4CC8-8270A1-39A6FE46-prod1 .
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Epinions.com ID:
Arthur.Rubin
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Member: Arthur Rubin
Location: Brea, CA, USA
Reviews written: 97
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About Me:
Expert in mathematics, computers, income tax, with a wide variety of interests.
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