THE LIVING TRUST

During the past few years, the "living" trust has come to the forefront of estate planning as a probate avoidance device. Although the living trust has been around for over a century, recent publicity about such trusts have brought them into prominence.

WHAT IS A LIVING TRUST?

The living trust is based on a very simple principle: Under our legal system, probate is required only when a person's assets are titled in his or her name at death. Following an individual's death, only the court appointed executor or administrator of the estate, acting under court authorization, may transfer title to assets.

Joint tenancy is the method most commonly employed to avoid probate. While it is true that assets held in joint tenancy pass to the surviving joint tenant without probate, joint tenancy has significant limitations and is not recommended for most individuals. First, holding property as joint tenants may eliminate significant estate tax saving opportunities. Second, a noncontributing joint tenant obtains an interest in the property. Third, a surviving joint tenant may have to pay a higher capital gains tax on appreciated assets which are subsequently sold. And lastly, it is impossible to implement complex estate plans (for example, estate plans calling for trusts where there are children from prior marriages) through the use of joint tenancy.

This dilemma is solved by placing ownership of assets in trust rather than in joint tenancy. When an individual's assets are held in trust (the individual is then referred to as the "grantor"), there will be no assets in his or her name at the time of his or her death to be probated. Moreover, the successor trustee named in the trust instrument carries out the grantor's instructions to hold and/or distribute trust assets following the grantor's death. This is very similar to how an executor would handle an estate administered under the terms of a last will and testament. In most states, the grantor is also permitted to serve as trustee of his or her own trust, thus, preserving management and control of trust assets during his or her lifetime.

Living trusts may also be drafted so that they are revocable and amendable. Therefore, if circumstances or relationships should change, your trust could be modified or revoked to reflect these changes.

In sum, the living trust allows an individual to avoid probate without the complications of joint tenancy while at the same time reserving management and control of trust assets. As indicated below, the living trust, like other types of trusts, may also be utilized by a skilled attorney to save hundreds of thousands of dollars in estate tax.

LIVING TRUST AND TAXES

One of the most widely encountered misconceptions in estate planning is the notion that using a living trust somehow saves income taxes. This is simply not true. By definition, a living trust is subject to revocation by the grantor at any time, and he or she retains the power both to change the trust and to terminate it entirely and take back the trust property. The trust assets will, therefore, be treated as being owned by the grantor at death for estate tax purposes, and the trust income will be reportable by the grantor during his lifetime. Accordingly, the savings to be realized from a living trust are strictly probate expenses, expenses associated with incompetency proceedings and possibly Federal estate taxes.

As in the income tax area, a living trust will not save an unmarried individual Federal estate taxes. For a single person with an estate below $2,000,000 there will be no Federal estate taxes. If the estate exceeds $2,000,000, there will be an estate tax, and other planning techniques should be implemented to avoid this tax. For married individuals, however, both spouses may not be entitled to the exemption equivalent of $2,000,000 [1]  unless a trust is implemented. In other words, a married couple's combined gross estate without a trust, in most cases, cannot exceed $2,000,000 without incurring Federal estate taxes. A properly drafted living trust can increase the exemption equivalent to $4,000,000 for married couples and a trust can save the heirs as much as $900,000 ($2,000,000 * 45%) in estate taxes for an estate worth $4,000,000 or above.

It is important to understand that life insurance proceeds are included in calculating the value of a gross estate and are subject to estate tax.

ADVANTAGES OF THE LIVING TRUST

AVOIDING PROBATE . One of the principal advantages of the living trust is avoiding probate costs and delays. The significance of this factor varies greatly from one state to another. In Nevada, for example, probate procedures are quite cumbersome and expensive, and living trusts are used widely by individuals with moderate and large estates.

PRIVACY . Some people are particularly concerned about the privacy of their business and family affairs and choose living trusts for this reason. Whereas a will is filed with the probate court (or its equivalent) and becomes a public document, subject to inspection by any curious individual, a living trust represents a contractual arrangement between the grantor and the trustee and ordinarily never becomes open to public inspection. The privacy available through a living trust is undoubtedly one reason why many prominent individuals choose this vehicle.

AVOIDING GUARDIANSHIP OR CONSERVATORSHIP . A sometimes overlooked advantage of the living trust is the avoidance of incompetency proceedings. As an individual grows older, the possibility of senility, incapacity because of a stroke, or other disability which would render the person unable to manage his or her affairs becomes a real danger. Moreover, there exists the further possibility of an elderly person's falling under the domination of an unscrupulous individual who may seek to take financial advantage of him or the situation.

The conventional legal remedy is for the court in the state where the individual resides to appoint a fiduciary to take charge of the person's assets. This fiduciary is usually called a "guardian" or "conservator". Although the practice varies from state to state, the establishment and operation of a guardianship or conservatorship ordinarily is both expensive and cumbersome. In addition, the family is subjected to the unpleasant prospect of having an elderly member declared incompetent or its equivalent.

A funded living trust may avoid the necessity for a guardianship, conservatorship, or the equivalent if a person becomes incompetent. If that happens, the trustee for the living trust--or the successor trustee if the grantor is acting as sole trustee assumes the management of the trust assets. Typically, the trust provides liberal guidelines calling for the support and maintenance of the grantor during lifetime, thereby enabling the trustee or successor trustee to step in and carry out these provisions without the expense and delay of a court-supervised guardianship or conservatorship.

HEADING OFF A WILL CONTEST . Another potential advantage of a living trust is sometimes overlooked: It can be extremely useful in heading off a will contest where one is anticipated. Ordinarily, the will of a person who has died is filed for probate, and notice is sent to the heirs and to the beneficiaries named in the will, all of whom are afforded an opportunity to contest the will. In most states, grounds for contest include defects in the execution of the will, unsoundness of mind of the person executing the will, duress, undue influence, and fraud.

If an individual dies with all of his or her assets in a living trust, it is much more difficult to contest a trust than a will. If the trust has been operating during the individual's lifetime--particularly with a bank, or even another individual as a co-trustee or sole trustee--it is difficult for a contestant to assert that the deceased person executed the trust without knowing what he or she was doing. The contestant must overcome not only the fact that the trust was executed but also the fact that numerous assets were voluntarily transferred to the trust and that the decedent acquiesced in the operation of the trust over what was perhaps a long period of time. For these as well as other procedural reasons, a living trust, though not invulnerable, is much more difficult to challenge than a will.

FACILITATING POST-DEATH SALE OR DEVELOPMENT OF REAL ESTATE . Another situation where particular facts may dictate using a living trust is the case of an individual who has significant real property holdings. In many states the procedure for real property sales by an executor is cumbersome.

The typical procedure is for the executor to enter into a proposed sales agreement and then to present the agreement to the probate court for approval. Some states, such as Nevada, allow potential buyers to come into court and make bids which are higher than the one accepted by the executor. This procedure is intended to protect the estate beneficiaries against an executor who fails to obtain the highest bid. It can, however, have the effect of deterring a purchaser who would be unwilling to spend the time and effort to negotiate a purchase agreement only to have it disapproved by the court or superseded by a higher bid.

Moreover, certain types of real property, such as unimproved land, are often sold commercially with low down payments and subject to relatively complicated arrangements involving options to acquire additional land or to release property which has been sold from liens, and so forth. In general, the trustee of a living trust has a much wider latitude in entering into unconventional transactions than a court-supervised executor. The importance of this latitude depends upon the probate law of the state involved.

AVOIDING MULTIPLE PROBATES . If a grantor owns real estate in more than one state, a separate probate proceeding must be commenced in each state where real estate is located. Multiple probates can be avoided by placing all out-of-state real property into a living trust. Many people consider this factor alone, when it applies, to justify creating a living trust.

DISADVANTAGES OF THE LIVING TRUST

ADDITIONAL COSTS . One principal disadvantage of the living trust is that its drafting and funding is more expensive than merely executing a will. After the provisions of a will have been worked out and made final, the will is executed and filed away. In contrast, after a living trust has been executed, it is necessary to transfer to the trust all of your investments and property.

For real estate, this requires the execution of deeds conveying the property to the trust. Similar documentation is required for promissory notes secured by deeds of trust or mortgages. Bank accounts and certificates of deposit should also be transferred, as well as stocks, bonds, and partnership interests. For an individual with extensive holdings, this process can be lengthy and expensive--in terms of legal time, filing fees, and transfer charges. However, the costs are often minimized where the grantor is willing to do some of the work. A grantor can usually handle most of the transfers either by himself or with the assistance of his stockbroker or insurance agent. Brokers and insurance agents will typically transfer stocks, bonds and insurance free of charge. This usually leaves only real estate transfers that must be prepared by third parties. Deeds can typically be prepared for a cost of $100-$200 plus filing fees.

Although a living trust can be more expensive initially, the savings and peace of mind realized in avoiding probate and/or the possible estate tax savings realized by implementing a trust, in most cases, make the living trust a good investment.

POUR-OVER WILL

A person whose estate plan will be carried out through a living trust does not need a lengthy will. Indeed, if all goes well, all of this person's assets will be in the trust so that no will need be offered for probate, thereby eliminating probate proceedings entirely.

Such an individual ordinarily has what is called a "pour-over" will. The will typically contains certain outright bequests (furniture, furnishings, and other tangible property which may not be transferred to the living trust), appoints an executor, and transfers all remaining property to the living trust (which contains the main dispositive provisions of the individual's estate plan).

The reason for such a will is to provide a safety net where all of a decedent's property has not been transferred to his living trust during his life. For example: there may be a slip-up in transferring one or more of a person's assets to the living trust; the individual may acquire a new asset and forget to put it in the trust. With a pour-over will the asset would be transferred to the trust at the Testator's death by virtue of the language in the will.

CONCLUSION

As this article sets forth, a living trust has several meaningful advantages over a will, including eliminating or greatly reducing probate costs and potential estate tax savings. In deciding whether to use a living trust, one must weigh these advantages and savings against the increased cost of designing and implementing a living trust.