Last quarter I explained the probate process and promised this quarter to write about how to avoid probate and to explain the advantages of preparing a revocable trust-based estate plan.
When a loved one dies it can be difficult to access their assets, handle their mortgage and other debts, close out digital accounts and generally wind up their affairs. With a proper trust-based estate plan, you can ensure your loved ones have ready access to your assets in the manner and proportions you desire and can also minimize taxes. Moreover, this will help your spouse and children avoid the time and expense of going through the probate process.
Types of assets
How an asset is transferred when a person dies depends on the type of asset and how it was titled prior to death.
Jointly owned assets. A joint account or an asset titled jointly generally passes to the surviving joint owner(s) on the death of the first owner to die. For example, if husband and wife maintain a joint checking account and husband dies, wife automatically owns the account outright without having to do anything further. If the joint asset is real estate or a vehicle, there are other documents required to sell the asset after the first joint owner dies, but typically these documents are routine and simply designed to apprise the buyer of the death of one of the joint owners. A court proceeding (like probate) is not necessary.
Assets that pass by beneficiary designation. An asset that passes by beneficiary designation is transferred to the named beneficiary. Life insurance policies, retirement plans and transfer on death accounts are examples of these types of assets. If the primary beneficiary does not survive the owner, then the asset passes to the contingent beneficiary. If no contingent beneficiary exists, then the asset will typically pass to the decedent’s probate estate.
Assets owned individually. Assets owned by a person in their name alone generally must pass through probate court. If the decedent left a valid Will, the individually titled assets will pass to the beneficiaries named in the Will. If the decedent did not leave a valid Will, the assets will pass to certain family members, as determined by state law. As I explained last quarter, probate is a legal process requiring the assistance of an attorney and is presided over by a judge. The job of the probate court is to ensure certain people are apprised of the decedent’s death, to identify the decedent’s probate assets, to provide a forum for the decedent’s creditors to make claims, to determine whether the decedent had a valid Will, and to determine to whom the assets will be distributed. This process is public, which means anyone can request copies of the filings and learn quite a bit about the decedent’s assets, debts, family members and other personal information.
Assets owned by a trust. Assets owned by a trust are governed by a trust agreement spelling out how the assets are to be managed and distributed. If a person dies after placing their assets in a trust, the assets of the trust pass to the beneficiaries named in the trust agreement, either outright or in separate trusts established for their benefit. The trust does not need to be approved by a court and the terms of the trust agreement and the identity of the trust assets are kept private. I like to think of a trust like a box you can place assets inside. When you die, the assets in the box pass to the people you named in your trust. While you are alive, the assets of the trust are managed for your benefit, and you can take assets out or put assets in whenever you like. Any income earned by the assets is reported on your own tax return and you can continue to deduct your real estate taxes and mortgage interest even if your home is owned by your trust.
How a trust works
A trust involves three people: the grantor (also known as the settlor), the trustee and the beneficiary. The grantor is the person who establishes the trust. The trust is established by creating a trust agreement with the trustee. The trustee is charged with following the directions laid out in the trust agreement and manages the assets for the benefit of the beneficiary. The beneficiary is the person for whose benefit the assets are being held, and the beneficiary generally receives distributions from the trust. In a typical trust-based estate plan, the client starts out as all three people. The client is the grantor establishing the trust with himself or herself as the trustee, for their own benefit as the initial beneficiary. These types of trusts are revocable, which means they can be amended (changed) or revoked (terminated) at any time by the grantor, while the grantor is alive. The trust generally becomes irrevocable when the grantor dies, which means it cannot generally be changed.
Even if you have a revocable trust, you will still need a Will, known as a “pour-over Will.” The pour-over Will simply provides that all assets titled in your individual name (if any) are poured into your revocable trust. Think of the pour-over Will like a safety net. In the event you acquire an asset that hasn’t been placed in the trust, the pour-over Will sweeps it into the trust.
The terms of the trust are up to you. Aside from the tax planning your attorney will recommend, the provisions of the trust relating to how the assets are to be distributed on your death are up to you. After your trust is established, the next step is to move your assets into the trust and make your life insurance payable to your trust. If you are married, it is generally better to make your retirement accounts payable to your spouse directly for income tax purposes, otherwise retirement assets can be made payable to your trust. If your assets are held in your trust or payable to your trust on death, then any change you wish to make regarding how your assets are distributed can be made through an amendment to the trust.
Avoiding a DIY approach
Sometimes people are tempted to do their own probate avoidance type of estate planning by adding beneficiaries to transfer on death accounts or adding family members to joint accounts in order to avoid probate. This can work to an extent, but it may not produce the results you desire. For example, a widow with three children owns a home worth $300,000 and has three certificate of deposit (CD) accounts worth $100,000 each. If the widow adds all three children to the title to the house and each child to one of the three CD accounts, it would seem that everything passes to the children equally on her death. However, life is messy. It can be unwieldy (or impossible) to have four people on title to your home, especially if you have a mortgage. The three CD accounts may start out at $100,000 each on the day they are created, but Widow may need to take money out of one account to pay for a vacation or emergency expense and leave the other accounts intact. Perhaps the widow could add all three children to all three CD accounts so that she does not have to worry about keeping the balances even. However, what if one of the children predeceases her? The assets would be split equally between the two surviving children on widow’s death. But what if she would prefer that the deceased child’s children (her grandchildren) receive the dead child’s share? She must rely on her surviving children to take care of their nieces and nephews, which can sometimes lead to family strife, misunderstandings and hurt feelings. This is all avoided through the use of a revocable trust, which can be changed by you at any time.
As you can see, a revocable trust-based estate plan makes organizing your assets and arranging for your loved ones to receive them easy. Once your trust is established and assets are placed inside and your beneficiary designations updated, you can rest easy knowing that your plan is in place. Moreover, any time you wish to make a change it can be accomplished by a change to the trust itself.
For more information on this topic, please contact Christian Manalli ([email protected]) by e-mail or call (312) 648-2300.
