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Estate Tax
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If a couple has assets in excess of $2.5 million, a living trust is a marvelous vehicle for estate tax planning. It is also quite helpful in circumstances where the next of kin is complicated or out of state real estate is owned in a state that does not have transfer on death deeds.
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by Francis J. Niehaus, JD, CFP
Revocable living trusts are not beneficial for everyone - other means of transferring assets to heirs might be more appropriate for you. In recent years, the living trust has come to be represented by some promoters as an estate planning tool that is necessary for everyone. It is often described as a document that solves almost all estate planning concerns. Unfortunately, incomplete explanations are given and fear tactics are sometimes used in the promotion process. Understanding some basic facts about living trusts, probate and non-probate assets, the Probate Court process, estate planning, and taxes will help give you a base of information to make the decision as to whether a living trust is right for you.
Following are some background facts that can provide a helpful base of information.
A living trust is a legal contract that creates an entity (the trust) allowing for the transfer of assets (such as real estate, bank accounts, securities, automobiles, etc.) from individual ownership into this legal entity. A living trust becomes operative during the settlor's lifetime, unlike a testamentary trust that is formed in an individual's Will to become operative upon death.
The maker of the trust is called the settlor, grantor, or trustor. The person agreeing to receive the assets and carry out the terms of the trust contract is called the trustee. The trustee can be the settlor, a family member, friend, or corporate entity such as a bank or trust company. Often the settlor is the initial trustee until death or incompetence, so the settlor maintains control over the assets. A succeeding trustee is called a successor trustee. The successor trustee administers the trust according to its provisions and ultimately makes distributions of the trust assets to the beneficiaries who may be individuals or charities, usually at the death of the settlor or upon the happening.
Historically a trust was used to 1) assist the settlor in the handling of his own affairs or 2) provide for others with conditional dispositions. For instance, a settlor could restrict an inheritance so a wayward child would only obtain money under certain circumstances or over a long period of time. As time passed, settlors created trusts to take advantage of various laws, such as those related to gift and estate tax, special needs for disabled children, etc. These trusts were specifically drafted to meet the needs for which they were formed.
More recently, living trusts have been espoused for their ability to create a more streamlined process for distributing assets after death by avoiding Probate Court procedures. Although a funded living trust is one vehicle that avoids probate, it is not the best solution for everyone's estate planning needs. Living trusts can be more complex and expensive than other probate avoidance vehicles. To put this in context, let's look at what Probate Court is.
Probate Court is the process by which assets held in a decedent's name only are transferred to those named in the decedent's Will (or if there is no Will, to the decedent's next of kin of the decedent according to state statute). Assets with beneficiary designations or those held as joint tenants with rights of survivorship (JTWROS) are not probate assets. For example, life insurance, pension plan benefits, 401(k)s, IRAs, pay on death (POD) bank accounts, and transfer on death (TOD) assets pass to the beneficiary(ies) listed and are not probate assets. (TOD designations are relatively new for deeds, brokerage accounts, and automobiles.) Also, any assets held as JTWROS are not probate assets and pass to the surviving joint tenant by virtue of the survivorship rights, not according to the distribution provisions of the decedent's Will. These include bank accounts, deeds, stocks, brokerage accounts, or other assets held as joint tenants with rights of survivorship.
It is common for a couple to have no probate assets, since many couples hold their property jointly with rights of survivorship and have each other as the primary beneficiary on all other assets. Since two automobiles can be transferred to a surviving spouse in Ohio without involving Probate Court, it is common for the first spouse to die with only non-probate assets and hence no probate estate. In a case like this, a living trust would be entirely unnecessary for the avoidance of Probate Court.
"Everything is tied up in Probate Court," is a commonly held but inaccurate belief. Real estate, investments, and bank accounts can be liquidated soon after the executor or administrator is appointed. Initial distributions to beneficiaries can generally be made quickly, provided there are adequate assets to pay all debts and claims against the estate. The estate cannot be closed immediately, because creditors in Ohio have six months from the date of death to file a claim against the estate. Estate taxes are due nine months from the date of death. Most estates are completed within a year.
The Probate Court costs in Hamilton County, Ohio are $225 no matter how large the estate. Even if a resident died in Hamilton County with a $50 billion probate estate, Probate Court costs would still be $225.
Attorneys customarily charge either based on a percentage of assets or on a project/hourly basis. If consents are received from all parties affected by the fee, the most a lawyer can charge in Hamilton County (Ohio) without a hearing before the judge is:
- • 5.5% of the first $50,000 of probate assets
- • 4.5% of the next $50,000
- • 3.5% of the next $300,000
- • 2% of the assets above $400,000
- • 2% on real estate that is not sold
- • 1% on non-probate assets includible on the estate tax return
Although some attorneys charge based on this percentage of assets basis, many attorneys charge for estates based on the amount of time and expertise required to complete the work. Comparison of potential charges by attorneys is advisable. Attorneys are hired by the executor, who should find out how the attorney charges for estate administration before engaging the attorney’s services.
Executors can be compensated for the responsibility taken and the time and expertise necessary to complete the estate process. Executor fees are set by Ohio statute and are similar to attorney fees, except the percentages are somewhat lower:
- • 4% of the first $100,000 of probate assets
- • 3% of the next $300,000
- • 2% of the assets over $400,000
- • 1% on real estate that is not sold and on non-probate assets included on the estate tax return (except for survivorship assets, for which there can be no fee)
Some executors consider their services to be a gift to their families and choose to forego the fee. Other estates are more complicated, or past services have been rendered, which factor into the executor’s decision to take all or part of the fee. It is entirely the executor’s decision.
Having this understanding of probate and non-probate assets and the Probate Court process should help you in considering whether you need a living trust.
The following are the main factors you should consider when deciding whether a living trust would be a beneficial estate planning tool for you. In looking at each of the following considerations, keep an eye toward the long term costs and benefits of various estate planning tools.
Although living trusts save no estate taxes for individuals, they are popular vehicles for estate tax savings for couples with assets in excess of the federal applicable exemption amount (currently $2 million). These couples can save hundreds of thousands of dollars from the use of credit shelter trusts used for saving federal estate taxes.
Sometimes living trusts are formed for use primarily for the settlor's benefit. Occasionally, an elderly person may have no one close or trustworthy enough to allow for a power of attorney, but is looking for protection of assets and other services. In this case, he or she may name a bank as trustee or successor trustee to handle his or her financial affairs. These trusts are established with lifetime use in mind, not probate avoidance.
If you have considerable assets and want to specify conditions and a timeline for the distributions of these assets to beneficiaries, a trust may be a useful tool. For example, if you want your assets to be distributed to your children in thirds at ages 25, 30, and 35, a trust is the most practical, flexible, and preferred way to accomplish this.
These trusts can be living trusts or testamentary trusts (in your Will).
If you are like most people, probate avoidance is one of many priorities of your estate planning goals. In arranging for probate avoidance, you should consider all of the estate planning vehicles that allow you to bypass Probate Court, including: beneficiary designations, survivorship assets, and living trusts. For the most part, using beneficiary designations and survivorship ownership can be less costly and complex than creating and funding a living trust. Other times, beneficiary designations and survivorship ownership are not easily used or the distribution plan is so complex that a living trust is the most convenient vehicle to avoid the probate process and meet your estate distribution goals.
Notice to all next of kin is necessary if any assets pass through Probate Court. Therefore, if you have a very complicated next of kin situation (for example, an estate where the next of kin number over 50 individuals, some of whom are minor children), avoidance of probate through use of a trust may be the best option.
For some people, privacy is a major issue driving their desire to have assets pass outside of Probate Court. Positioning assets to transfer by beneficiary designations, as joint tenancy with rights of survivorship, or by a trust will provide privacy.
There are times when a client desires to disinherit an heir and does not want the usual estate proceedings. A trust can be used in some situations as a firewall against possible disruptive legal actions of an heir who is a non-beneficiary.
A trust has a longer claims period but can be beneficial.
If you have out of state real estate holdings, a living trust can allow for a more manageable distribution process, particularly where transfer on death deeds are not permitted in the state where the real estate is. Consider how out-of-state real estate holdings, including time shares, will pass at your death. This is very important for estate planning purposes and gets overlooked.
Keeping fees to a minimum makes sense. If an individual can accomplish his/her goals of asset distribution without the need for Probate Court involvement, that can help in most cases. Whether you avoid Probate Court or not, you will probably still have some legal expenses related to the transfer of assets since estate tax return(s), 1041 estate income tax returns, deeds, etc. might be necessary. For those estates involving trusts, note that trustees can also charge fees for their work. In Hamilton County the fees generally charged by corporate trustees approximate 1% for the assets held in trust. There are minimums that might cause the percentage charged to be higher.
Life circumstances change - sometimes after the death of the first spouse. Trusts (such as a B/family trust in a typical A-B trust situation) become irrevocable. This can be advantageous or not, but certainly should be considered.
A trust may become unnecessary due to estate reduction and estate simplification that often occurs prior to death.
Making the right estate planning decisions can, in some federally taxable cases, save hundreds of thousands of dollars. Taking the time to understand the basics of estate planning can help you to make informed decisions about whether to use a living trust for the distribution of your assets. Be sure your estate plan takes care of you in the future and maximizes the amount you pass to heirs at your death. Following are some steps to take in assessing your need for a living trust.
Which are probate assets and which are not? (Remember, if an asset has a beneficiary designation or is held as joint tenants with rights of survivorship, it is not a probate asset.) Having a list of all of your assets with beneficiaries and contingent beneficiaries and joint tenant holders helps you to keep all relevant information in mind when making your estate planning decisions.
Analyze your needs with the factors to consider. Prioritize what is most important to you.
Creating and funding a living trust is an initial expense paid to reduce possible future fees. Is it worth the expense? What is likely to happen in the future? Will estate reduction occur? Should you spend money now to possibly save additional expenses later? It depends on the facts. The bottom line is that you need to analyze the situation closely and compare the costs of each.
In order to make the most beneficial decision, it is always best to consult an attorney who understands estate planning and taxes. It is helpful for you to learn as much as you can about estate planning, just as you would about your health. But just as you seek advice from your doctor to ultimately make medical decisions, ask a lawyer to help you in your estate planning decisions, especially about the need for a living trust.
©Francis J. Niehaus 9/06
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