One of the "hottest" estate planning techniques in recent years has been the living trust. They continue to be promoted as the best way to avoid costly probate; avoid federal income and transfer taxes; protect assets from creditors during the lifetime of the grantor; avoid will contests among surviving family members; among other benefits. While living trusts offer substantial benefits in the right situations, those listed above are generally not among them. Living trusts are creatures of state law rather than federal tax law; as such, their provisions, benefits, and limitations vary considerably from state to state.
Technically speaking, a living trust is a revocable trust in which the grantor retains all of his or her interests in trust property for life. The grantor may serve as trustee or co-trustee, but typically appoints a successor to serve in that capacity if the grantor becomes incapacitated. Since the grantor retains beneficial enjoyment of the trust assets, and the right to appoint a new trustee, or revoke the trust in its entirety, all of the taxable income of the trust is considered that of the grantor, and all of the trust assets are includible in the grantor’s gross estate for federal estate tax purposes. Upon death of the grantor, the trust typically becomes irrevocable and the assets are administered and distributed under the type of provisions (the dispositive provisions) that an individual would typically have in a will.
Since trust assets are fully available to the grantor to satisfy the grantor’s liabilities, living trusts typically fail as asset protection devices. Assets held in a living trust for the benefit of a grantor are "includable assets" for purposes of qualifying and individual for Medicaid. As such, trust income is treated for Medicaid (and Social Security purposes) as if it was received directly by the grantor. In addition, living trusts can be challenged by disgruntled heirs just as wills may be. In some states, the challenge period for trust may be longer than that for wills, thereby exacerbating, rather than eliminating, the potential problem.
The probate cost benefits of a living trust are almost entirely dependent on the state in which the grantor lives. Some states have very high probate costs, in which case a living trust may more economical. In low or even moderate probate cost states, the current cost of setting up a living trust, funding it properly by making lifetime transfers of property into the trust (investments, bank accounts, automobiles, certain real property, etc.), making all subsequent substantial property purchases in the name of the trust, and general administration may easily outweigh the future cost of probate. In addition, the probate process only addresses those assets that pass from a decedent to a beneficiary under a will.
Assets that pass by operation of law (joint tenancy with right of survivorship) or by contract (life insurance and employee benefit plans, for example) are not included in probate and do not provide a probate cost savings by being held in a living trust. On the other hand, a living trust may be entirely appropriate for those assets held outside of the deceased’s state of residence. In this case, those assets may have to be probated in both states. Passing the asset via a living trust may, indeed, save probate fees. In this case, the trust would be funded with only those assets subject to probate in multiple jurisdictions.
A decedent’s last will and testament is a public document; any interested party (other family members, friends, the media) can obtain a copy of a probated will. A living trust, however, is not a public document. For those concerned about privacy, a living trust may be well worth the cost.
Assets held in trust may be easier to administer than those held in an estate. Since assets passing to beneficiaries under a will are subject to probate, settlement and distributions may take longer to begin and end under a will than passing through a trust. In addition, an executor must obtain proof of his or her authority from the court in order to administer an estate. Obtaining this authority may take several weeks after a decedent’s death. A trustee typically needs only a certificate of trusteeship, which is issued at the time the trust become effective.
A living trust may be very appropriate for an elderly couple who require outside help in administering their affairs. Children are frequently appointed trustees. In those cases where the couple serves as their own trustee, appointment of a successor upon the first death allows another party to help the elderly surviving spouse manage his or her property. In addition, it is generally easier to get professional management of investment or real property through a trust than under a power of attorney. Asset management is particularly important if the grantor becomes incompetent or is otherwise incapable of handling financial affairs.
There is common misconception that if an individual establishes a living trust, that it is not necessary to have a will. A living trust provides only for administration and disposition of property held by the trust. Property not in the trust (very common when the living trust is not properly funded when established, or when later acquired property is not placed in the trust) still passes under a decedent’s will, even if only to the trust (a "pour over" will). In addition, a will does far more than pass property; it provides for custody of minor children, for example, and provides for guardianship of incapacitated dependents. Thus, a will is always used in conjunction with a living trust.
Is a living trust an appropriate document for you? As with so many other legal and tax questions, the correct answer is, "It depends!" Consult with qualified legal and tax experts to determine if you or your family would benefit from such a document.
©2011 Ronnie C. McClure, PhD, CPA