March 30, 2017

Wills and Revocable Trusts: One Size Doesn't Fit All

Photo of Dawn HallmanEveryone needs an estate plan, but a good estate planner recognizes that every client's situation is different. There is not a "one-size-fits-all" rule about when certain estate planning tools are necessary, including the need for a revocable living trust.

Trusts

A revocable living trust (an "inter vivos trust") is established during the client's lifetime. The client holds assets in the name of the trust while they are alive and usually reserves the right to change the trust. Because the client may serve as trustee and beneficiary, most clients find no difference between managing the trust and managing their own property outside of trust. Even though property is held in the trust's name, the client retains the right to buy, sell, or give property away.

Who Needs a Trust?

The estate planner must determine whether a trust is right for the client, and this depends on several factors, such as:

  • Second Marriage
  • Incapacity Planning
  • Special Needs Child or Beneficiary
  • Divorce
  • Minor Children
  • Large Settlement Recipient
  • Death of a Spouse or Beneficiary
  • Children are not Self-Supportive
  • Spendthrift Issues
  • Large Inheritance Recipient
  • Owing Real Property in More than One State

Benefits of a Revocable Living Trust

A trust avoids probate. When a settlor dies, the successor trustee immediately takes over management of the trust and administers the trust according to its terms. Court involvement is not required.

A trust avoids guardianship. If a settlor becomes incapacitated, the successor trustee takes over management of the assets without court involvement. Additionally, if used with a power of attorney, the trustee and attorney-in-fact are not required to account to the court annually, as they would have to in a guardianship proceeding.

A trust maintains anonymity. Unlike a will, which is filed with the court in a probate proceeding, a trust does not become a matter of public record.

A trust helps manage the client's affairs. If a client becomes incapacitated, a trust allows the successor trustee to step in and manage trust assets. The trust may also allow the temporary appointment of someone to manage trust assets in the client's absence. This may be necessary, for example, if the client takes an extended vacation or is deployed overseas. Corporate trustees are often used for this purpose.

Trusts are easy to manage (compared to probate). Do not be fooled — trusts are not "easy" to draft, but compared to probate, well drafted trusts are easy to administer. Since there is no one-size-fits-all plan, every trust should be tailored to that client's specific needs and estate planning objectives. Most states require no witnesses or other specific language to effectuate the living trust and/or an amendment to it. However, best practices dictate certain procedures that should be followed.

Trusts are good for "far-flung" assets. If a client owns real property in more than one state, some form of probate will likely be required in each state. A trust avoids the necessity for a probate in all states.

How a Living Trust Works

A living trust enables a client to control the distribution of their estate — just like a testamentary trust or last will and testament. Unlike these other tools, a properly funded living trust completely avoids probate. When a client establishes a living trust, the attorney usually transfers (or assists in the transfer) all of the client's assets to the trust. This process is called trust funding. Once the trust has been funded, then technically, the client no longer owns the assets individually. The assets are owned by the trust.

Common Misconceptions

There are many things that people get wrong about the living trust, or don't understand correctly. These include:

My estate is not large enough to need a trust. The old school of thought was this: If an estate was not above the estate tax exemption amount (unified credit), then there was no reason for a trust. This is simply not true. A trust is still necessary for a number of reasons: It avoids probate; it provides more control and flexibility over the client's assets; and when used in conjunction with a durable power of attorney, it avoids a guardianship.

I will give up control of my assets. With a revocable living trust a client retains full control of his or her assets. The trust continues to use the client's social security number and does not file a separate tax return while the settlor is alive.

Joint tenancy will protect me from probate. While is it true that on the death of the first joint tenant a probate does not occur, upon the second death or in the event of a common disaster, a probate will almost always be triggered. Also, when a client owes property jointly with a child, the client exposes that asset to the potential creditors of the joint-owner child. There may also be some tax consequences regarding the asset's carryover basis.

I will not have to probate because I have a will. This is probably the most common misconception. A will is simply a set of instructions to the probate court regarding how the client wants their property to be distributed. A will does not avoid the probate process.

What a Living Trust Will Not Do

Living trusts are important estate planning tools. In recent years, many people have come to expect them to work wonders. Below is a list of miracles that trusts will not perform:

  1. A trust does not make a will unnecessary. Clients still need simple a will to take care of the assets they fail to transfer to the trust or for assets that they acquire shortly before death. If they have minor children, the clients probably need a will to appoint a guardian.
  2. A trust does not affect operation of law transfers. Like a will, a living trust does not control the disposition of jointly owned property, life insurance payable to a beneficiary, or other non-probate property. Operation of law transfers control, regardless of the terms of the trust.
  3. A trust does not protect assets from creditors. During the settlor's lifetime, creditors may attach to trust assets.
  4. A trust will not protect assets absolutely from disgruntled heirs. While it is harder to challenge a living trust than a will, a relative can still bring suit in trial court to challenge a living trust on the grounds of lack of mental capacity, undue influence, duress, or for other reasons.
  5. A trust will not entirely eliminate delays. A living trust may lessen the time it takes to distribute assets after a client's death, but it will not completely eliminate all delays. Many state laws impose a waiting period for creditors to file claims against estates of people with living trusts. The period usually is not as long as the time required to probate a will, but it can stretch into several months. The trustee will still have to collect debts owed to the estate after the settlor's death, prepare tax returns, and pay bills and distribute assets, just as an executor would. All of this takes time.
  6. A trust cannot always fully disinherit a spouse. In some states, a spouse cannot take an elective share of the trust assets. In Oklahoma, however, a revocable living trust does not protect assets from the spousal election. A spouse may elect against a revocable trust and take his or her intestate share. To disinherit a spouse, the client must have a prenuptial agreement or advanced planning beyond a traditional revocable trust.

Wills

A living trust does not make a will unnecessary. Clients still need simple a will to take care of assets they fail to transfer to the trust, or for those that they acquire shortly before death. If they have minor children, they probably need a will to appoint a guardian. A will is a set of instructions to the probate court about how the client desires to have his or her property distributed, but a will does not avoid the probate process. In fact, a will ensures probate.

When executing a trust, it is important to execute a pour-over will. This is an essential component to a complete estate plan because it "pours over" any unknown or subsequently acquired assets from the probate estate into the trust. Traditionally a "pour-over will" is used as a precautionary measure when a trust is done. However, planners should not rely on a will to fund the trust. If you use a pour-over will to fund the trust, then the trust may then be public record, as it may be incorporated by reference and become part of the probate. This is especially true if the will is contested. Additionally, the assets that are part of the probate will be public record.