Benefits of a Living Trust Over a Will
What Is a Revocable Living Trust?
A Living Trust is a legal document that operates much like a Will in determining the distribution of your assets upon your death. However, unlike a Will, a well-drafted Living Trust avoids probate, avoids costly and time-consuming court proceedings, protects your privacy, and eases the burden placed upon your loved ones in a time of extreme emotional stress.
What Is Probate?
The purpose of probate is to clear ownership of an asset. The court orders any debts to be paid and all property to be distributed according to the terms of your Will or, if you have no Will, according to the terms designated by the state in which you live.
What Is Wrong With Probate?
Probate Is Expensive:
Probate fees are generally based upon the percentage of the gross estate and can consume between 4% to 10% of the value of the estate before any property is distributed to your loved ones.
Probate Is Lengthy:
Probate can take anywhere from 6 months to 2 years before it is completed, and once it is started, it cannot be stopped. Thus, the assets are tied up in the legal process and funds from your estate can only be distributed according to the conditions set forth by the probate court.
Probate Makes Your Private Affairs A Matter Of Public Record:
Probate files are open to the public. Consequently, any unscrupulous individual can learn where your assets have gone and how much your beneficiaries will receive.
Why Is a Will Not an Effective Estate-Planning Tool?
Two problems that cause a Will to be an ineffective estate-planning tool are:
- A Will is only effective at your death
- A Will must go through probate before your assets are distributed
Joint Tenancy vs. Living Trust
Joint Tenancy:
In the United States, joint tenancy is the most common form of ownership. People are commonly not aware of the other possible forms of ownership available. The particular form of ownership that you might choose to hold title to your home, business, and investment assets can have various effects when you die.
In joint tenancy, two or more individuals jointly own a property or asset. When one dies, the ownership of the property automatically passes to the surviving joint tenant or joint tenants. The property will eventually be subject to probate. Also, your share of property held in Joint tenancy cannot be passed on using either a Will or a Trust. There are many serious disadvantages to Joint Tenancy besides being unable to direct where the property will go.
Problems with Joint Tenancy:
Many people avoid probate by the holding of assets in joint tenancy. However, joint tenancy has many serious disadvantages.
For example, sharing joint tenancy with children can be risky. If you hold an asset in joint tenancy with one or more of your children and one of them has tax problems or an automobile accident that results in a lawsuit, the asset is subject to loss, because the asset is a part of the child's estate. Additionally, you would have to ask permission from your children if you wanted to re-finance, and one child could refuse and stop you. The children also have equal right to occupy the property by living with you.
Joint Tenancy Can Accidentally Disinherit Children:
The surviving spouse could remarry. The Property could then go to their new spouse, if the new spouse is made a joint tenant. In this case, if the surviving spouse were to die first, the children of the new spouse could end up with the home, rather than your children. Under Joint Tenancy the survivor takes all, and this may accidentally disinherit your children. Understandably, this is probably not your desired outcome.
Furthermore, you can lose half of the potential stepped-up valuation. Joint tenancy of property rather than community property can mean that half of the potential step -up valuation is lost. This can result in very costly tax consequences and unnecessary capital gains taxes on half the gain that would be due on the sale of the asset.
With joint tenancy probate is eventually inevitable. Even though joint Tenancy avoids probate on the death of the first spouse, the entire estate must go through probate on the death of the second spouse. Placing your children as joint tenants, as we explained above, involves risk and negative tax consequences. Even when people decide to use the joint tenancy method to avoid probate, they never seem to get all of their assets completely into joint tenancy. As a result, eventually some of their assets have to pass through the frustrating probate process.
Joint Tenancy with Children Is Risky:
The children's creditors can take the property if they win judgment against them. If a joint tenant child was unable to pay a debt or was involved in an accident, owed the IRS, or if a judgment was rendered against them, the parent joint tenant also would be subject to the child's creditor problems. Therefore, the parents could well lose their assets to satisfy their child's creditors or judgments.
Joint Tenancy and Estate Tax Exemptions
You also lose your $675,000 federal estate tax exemption at death:
The deceased spouse's tax benefit is lost. The $675,000 federal estate tax equivalent exemption is, in effect, "thrown away" and cannot be claimed. This could subject the estate to unnecessary estate taxes on every dollar over $675,000 being taxed at a minimum of 37%. One of the greatest disadvantages of a husband and wife holding assets in joint tenancy is that upon the death of one spouse, the assets flow directly to the surviving spouse, causing one exemption to be lost.
The surviving spouse is left with his or her own $675,000 exemption. Everything over $675,000 will be taxed on the death of the surviving spouse, beginning at 37% and going up to 60%. An A-B Trust preserves the tax benefits of this exemption.
The only way to preserve the $675,000 estate tax exemptions of both spouses is to create an A-B Living Trust.
Living Trust:
With a Living Trust the property is under complete control of the trustees while being owned by the Trust. With real estate held by more than one person, a deed could be written that would transfer title of the partial share of an undivided interest into the name of the Living Trust.
To hold assets as community property inside a Living Trust is the “most advantageous“ form of ownership. In this way you get maximum stepped-up valuation upon the death of a spouse.
People today often move from state to state. If a husband and wife move to a community property state, even if only for a short period of time, they should take advantage of their rights within the Living Trust. The Living Trust is still valid when a husband and wife move to another State but some changes may be required, It is important to review all estate planning documents, such as the Durable Power of Attorney, Living Wills and so on with an attorney, to ascertain that they comply with the laws of the new state. If they are moving from a Community Property state to a Separate Property state, then there are substantial tax advantages that should be preserved in order to maintain full stepped-up valuation upon the death of a spouse.
Assets specifically identified in the Trust as separate property (in Separate Property Agreements) are separate property.
With a Living Trust, the property is under complete control of the trustees while being owned by the Trust. With real estate held by more than one person or party, a deed would be written that would transfer title of the partial share of an undivided interest into the name of the Living Trust.
Other owners can leave title in joint tenancy with others. When you place your interest in real estate in the name of your Living Trust, you sever the joint tenancy and create a tenancy in common with other owners. Therefore, you avoid probate for your heirs and still have the right to leave your interest in the property as you desire.
Estate Tax Implications and Living Trusts
When Both Grantors Are Alive:
When both Grantors are alive they are the Settlors, Trustees, and the Beneficiaries, thus extra accounting and trust tax returns are not required.
The Credit Shelter or A-B Trust:
The sole purpose of this trust is to shelter the $675,000 gift or estate tax exemption of the first to die (the deceased spouse), by placing up to $675,000 worth of assets into the Credit Shelter (or B) Trust. Currently, the client and his/her spouse are each entitled to leave up to $675,000 (increasing to $1,000,000 per individual in 2006) of property free of federal tax. However, if the client gives his or her entire estate to the spouse, the estate loses out on the $675,000 exemption. This can be expensive. For example, if the combined estates of the client and spouse are $1,300,000, the estate could pay an extra $243,750 of tax.
The tax savings could even be greater if the surviving spouse were to live through a period of inflation before he or she died, because the assets placed in the Credit Shelter Trust are not taxed on the death of the surviving spouse. For example, if the $675,000 worth of assets were to grow in value to $750,000, this could save an additional $37,000 in taxes. If that $100,000 worth of growth was held in the A Trust, it would be taxed at 37% on the death of the surviving spouse. In other words, $200,000 worth of growth in the B Trust would mean a tax savings of $74,000, and so on.
To avoid payment of unnecessary death taxes, $675,000 of property should go into a trust for the children, grandchildren or others, while giving the surviving spouse the right to recieve the income from the trust’s assets for life. The principal is usually available for basic needs. In addition, part of the principal can be made available annually, without strings attached, up to the larger of 5% of the Trust Assets or $5,000 (whichever is greater).
The Marital Deduction:
The marital deduction is a significant estate tax savings. Since January 1, 1982, married individuals can leave an unlimited amount of assets and wealth to the survivor spouse free of federal estate taxes.
Outright interest and two other kinds of property interests now qualify for the marital deduction: Qualified Terminable Interest Property (QTIP) and a spouse's interest as a life-income recipient of certain charitable trusts.
Form 706 Estate-Tax Return:
The federal estate-tax return, Form 706, must be filed on gross estates of $675,000 or more. If no taxes are owed, no Form 706 is necessary, but if estate taxes are due, the Form 706 must be filed within nine months, and any taxes due must also be paid then. If there are federal estate taxes to pay or defer, the surviving spouse and successor trustee must submit Form 706 and if he or she has an A-B or A-B-C Trust, taxes can be deferred until the death of the second spouse, but Form 706 must still be filed after the death of the first spouse.
There are special extensions for closely held business property. A 14-year period for payment of that part of the estate tax attributable to the decedent's interest in a closely held business is allowed if the value of that interest in the decedent’s estate exceeds 35% of the value of the adjusted gross estate.
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