Trusts, Wills, and Estate Planning
[Note: This material was prepared by an Arizona attorney relying primarily on Arizona law. While much of the material will also apply to other states' laws, you should consult a lawyer in your locality for more specific information.]
- Purpose of Estate Planning.
For most people, there are five major considerations in choosing between estate plans:
- Avoiding probate
- Minimizing taxes (estate taxes and income taxes, including capital gains taxes)
- Controlling the future uses of the assets
- Costs and other practical considerations
- Protecting against future incapacity as well as death
At one time, the first two concerns motivated most estate plans. Today the prospect of long-term nursing care and tremendous medical expenses, coupled with a concern about the possibility of future mental incapacity play at least as large a role in most plans.
- "Living" Trusts.
One of the most popular and enduring options for sophisticated estate planning is the Living Trust. Sometimes referred to as a "Revocable" or "Inter Vivos" Trust, this instrument creates a separate entity with specific and very individualized rules for its operation. Normally, it is completely revocable or amendable by its creator (referred to as the "Trustor") during his or her lifetime (though that may not always be advisable), and the trustee may be virtually any person, entity or combination of persons and entities. Some of the principal advantages of the Living Trust are:
- Flexibility and Control.
The Living Trust offers the Trustor the maximum control over his or her assets in the present and in the predictable future. It provides the opportunity for directing the general uses of the trust assets after the death of the Trustor, and can be designed around the specific needs of the Trustor's family. A trust can be a way to ensure that money is available for the education of children or grandchildren, or for extraordinary care required for a disabled child or spouse.
- Management of Assets.
One option for a Living Trust is to select a corporate trustee. Many banks maintain trust departments which can be selected to manage the trust estate. The Trustor may choose to act as Trustee himself, but the availability of professional asset management is attractive to many individuals.
- Protection during Illness or Incapacity.
The Living Trust can be constructed to provide for management of assets during any period of illness or incapacity of the Trustor. This flexibility will normally avoid the necessity of conservatorship proceedings in the future, and will provide for the smooth transition of control from the Trustor to a trusted, selected individual or entity.
If the Trustor dies, the Living Trust continues to function as planned, with no break for the Probate process. Assets in the Living Trust normally are handled exactly as they were prior to the Trustor's death, and the trustee may be directed to either make the income available to a specific person or persons, or to distribute the assets outright and end the trust.
- Avoiding Probate.
Assets that belonged to the Living Trust before the death of the Trustor do not need to be taken through the Probate process. In addition to the saving of time (even a simple Probate will normally take six months or longer), this may save considerable expense to the successors. A Living Trust is particularly advantageous where the Trustors own real property in more than one state, since a separate ancillary probate proceeding may be required in each state where real property is located.
Only persons with an interest in the Living Trust need be notified of the proceedings, the assets held in trust, or their values or ultimate disposition. No publication of notices, Court filings or public hearings are normally required.
- Tax savings.
Federal estate taxes are levied on any estate exceeding $1,500,000.00 (for decedents dying in 2004), and the tax liability approaches 40% of the amount over that threshold. A Living Trust for a married couple can easily be structured to avoid estate taxes on a combined total of $3,000,000.00, and can retain flexibility to adjust the amount to be sheltered depending on the estate tax exemption level in the year the first spouse actually dies.
Not only can a Living Trust be structured to help minimize Estate taxes, it is also a very useful tool for taking advantage of a little-understood capital gains tax break for married couples. By holding their interests in the trust as community property, couples can qualify for the entire elimination of the tax on capital gains accruing between the original purchase of the assets and the death of the first spouse, while still enjoying most of the benefits of the joint tenancy arrangement usually utilized to avoid Probate. Property held between spouses in joint tenancy normally only qualifies for half the "stepped-up" basis on the death of the first spouse.
- Security Against Challenges.
Since the Living Trust usually will have been in place for a considerable period of time before the death of the Trustor, and since there is no Court proceeding initiated to determine the validity of the trust document, it is normally much more difficult for disinherited relatives to challenge the estate plan.
A Living Trust is usually "funded" by transferring most or all the Trustor's assets into the name of the trust. The trustee is then directed to utilize the income from those assets exclusively for the benefit of the Trustor during the Trustor's life, but even these common provisions may be altered to provide for each Trustor's unique circumstances.
A variety of Living Trusts have received wide popularity. Some of the most common phrases used to describe specific trust instruments include "Supplemental Benefit" Trusts, "Spendthrift" Trusts and "Crummey" Trusts. Some of these instruments, which are designed to deal with specific problems, require that the trust be irrevocable and unamendable, even during the lifetime of the Trustor, in order to achieve their desired purpose.
Another popular subcategory of Living Trust, the Charitable Remainder Trust, may permit the Trustor(s) to convert highly appreciated assets into higher-yield holdings, thereby improving the Trustor's income flow, while avoiding tax on capital gains generated by the sale. The ultimate beneficiary of such a trust must be a charitable organization, but the Trustor who intends to leave some portion of his or her estate to charities may want to carefully consider this variation or its near relative, the Charitable Lead Trust. Even the Trustor who had not intended to make charitable bequests may find that the present benefit of such an arrangement makes the charitable trust attractive. Furthermore, the Trustor who utilizes charitable trusts receives a substantial charitable deduction for current income taxes.
- Flexibility and Control.
- "Testamentary" Trusts.
A trust may be created by a Will, rather than during the lifetime of the Trustor. Such a trust is normally called a Testamentary Trust, and has no vitality or effect until the Probate of the decedent's Will. While a Testamentary Trust will not be useful in avoiding Probate (since the Will must be admitted to Probate in order to set up the trust), it may nonetheless be a valuable estate planning tool. Testamentary Trusts are especially useful for providing for the continuing care of disabled children, spouses or other relatives, where there is some reason not to establish a Living Trust. For some individuals (especially professionals with potential lingering malpractice exposure) it may actually be desirable to go through the Probate process so that potential creditor's claims may be cut off; for such a person, the Testamentary Trust may be a viable option.
With the obvious exception of the avoidance of Probate, most of what has been said about Living Trusts applies as well to Testamentary Trusts. Whether Living or Testamentary, a trust is a marvelously flexible way to provide for control over the use of assets, even after the death of the original owner.
Even persons with Living Trusts will normally have a Will. The "pourover" will usually provides for all the Probate assets to be transferred into the trust created during his or her life, and distributed according to its provisions. In this way, assets that were not titled to the trust, or which have been removed from the trust inadvertently or purposefully, will still be covered by the trust's provisions. Your Will is the proper place to provide for the selection of a guardian and/or conservator for the decedent's minor children or incapacitated spouse or children. Many people also choose to declare their preferences for burial arrangements, organ donations and other post-death concerns in the Will.
Of course, a Will is the instrument used to create a Testamentary Trust, where that is the appropriate arrangement. It may be advisable (for the reasons described above) for even the Trustor of a Living Trust to arrange to have some assets taken through the Probate process to cut off potential creditor's claims. Finally, the preparation of a Will is normally much less expensive than the preparation of a Living Trust, and may be all that is necessary for persons with modest estates and ordinary wishes for distribution of assets after death.
- Durable Powers of Attorney.
In order to obtain the legal authority to make medical and financial decisions for an incapacitated family member, it may be necessary to seek Court appointment as a Guardian and/or Conservator. The Court process will almost certainly seem unduly invasive, expensive and slow.
Advance planning for possible future incapacity should include consideration of a durable power of attorney. Such a power can be either general (permitting the surrogate "attorney-in-fact" to handle all financial and medical matters) or may be limited in any way the grantor wishes. A durable power of attorney expressly survives the future incapacity of the grantor, and may be structured to only take effect in the event of such incapacity.
If properly drafted, a durable power of attorney should prevent the possibility of any future Court proceedings to declare the grantor incapacitated and appoint a surrogate to act in his or her behalf. In addition to saving time and money in the long run, this assures that the grantor's choice of persons is able to act, rather than relying on the attorneys and judges to select a person at a later date.
Several cautionary notes need to be sounded about durable powers of attorney. The power granted to the attorney-in-fact is extremely broad, and the opportunity for misuse or abuse correspondingly high. The person selected as attorney-in-fact must be completely and unequivocally trustworthy. Second, due consideration should be given to selecting an alternate attorney-in-fact, in case something might happen to the first choice of surrogate. It should be obvious that the alternate attorney-in-fact must also be completely trustworthy.
Finally, language should be included in the durable power of attorney indicating that the attorney-in-fact has certain specific powers, such as the power to convey real estate, buy and sell government securities and have access to the grantor's safe deposit box, if such powers are intended to be conveyed, since many institutions require such specific mentions of powers pertaining to assets within their control. By the same token, the power of attorney should clearly indicate that the broad powers should not be construed to include the power to transfer all the grantor's assets to the attorney-in-fact, since such broad power would have negative tax consequences to both the grantor and the attorney-in-fact.
The durable power of attorney, alone or coupled with a Living Trust, is an extraordinarily powerful planning tool. The importance of specific language, the danger of abuse and the need for some oversight and review make it important that an attorney be consulted in preparing and executing a durable power of attorney.