January, 2003 Tax Newsletter

Do You Need a Living Trust?
 

A living trust can (1) provide peace of mind for an older person living alone, (2) be an essential element in saving estate taxes, (3) avoid the inconvenience and expense of probate, and (4) keep your assets private from the public.

However, your circumstances and tolerance level for handling property in a way that may not be or comfortable should dictate whether a living trust is for you.

Even if it is, it doesn't eliminate the need for a will, a power of attorney and a medical directive, which allows you to determine who will make health care decisions if you're incapable of doing so.

The common perception is that the greatest value of a living trust is to avoid the inconvenience and expense of probate.  But is probate necessarily all that bad?  In some states probate is not as burdensome or costly as in others.  In these states the cost of the trust and the inconvenience of changing the title and beneficiary designation on assets may outweigh any savings in the probate process. 

Probate may not be a mere formality, especially when the executor is a relative without legal experience. Probate estates are reviewed by competent officials appointed by judges.  Their job is to help individual executors administer the estate, and they're there to protect the beneficiaries from an executor making a mistake or walking away with the assets. Actually transferring property into the trust is essential to avoid probate. Some trusts are living trusts in that they are created during the life of the person who establishes them, but they have no assets in them until property pours into them under a will or from life insurance or retirement funds that list the trust as a beneficiary.  Assets that are transferred under the will, rather than through beneficiary designations, still must go through probate before they are transferred to the trust.

Before concluding that a living trust is for you, it is important to understand what a will does, what a trust can do, and how important the titling of assets is.  Some knowledge of the probate system and the tax system is essential before you can decide how much, if any, planning is required.  You need to know the risk of not planning in order to know whether you need some.  A likely candidate for a living trust would be an older person who has no relatives nearby.  This accomplishes two objectives - avoiding probate and  planning for incapacity.  A living trust can be advantageous when mental capacity is an issue.  But a durable power of attorney, one that appoints an agent when the person granting the power becomes incapacitated, usually can suffice.

Most estate planners are in agreement that living trusts are important when a couple's assets reach $1 million. That's the current federal estate tax exemption, and it applies to essentially all the couple's property, not just the amount that passes under a will.  In the case of a married couple, it usually comes into play only with the death of the second spouse because an estate, no matter how large, can be transferred to the surviving spouse with no estate tax consequences.

Any amount in excess of $1 million is subject to the estate tax, but trusts can be created so that the couple's children or other beneficiaries inherit as much as $2 million tax free through the use of living trusts.  The exemption is scheduled to increase gradually to $3.5 million in 2009, with the tax being phased out in 2010 only to return the next year with a $1 million exemption unless Congress extends the repeal or raises the exemption.  The uncertainty of what the future holds in this area adds to the confusion and complexity of planning.

The decline in the stock market and the increase in the estate tax exemption combine to eliminate the need for estate tax planning for many people.  A probated will that leaves everything to the spouse and to the children if he or she is not alive might work just as well, without the complexity of having a trust.  However, a trust may be indicated if there are minor children, a disabled beneficiary, or a spouse who doesn't manage money well.  Also, an increasingly common scenario is a second marriage situation. A trust should be considered there to make sure that the second spouse is provided for during her lifetime, but at her later death, the assets go to the children from the first marriage.