Trust Questions

Contact Arthur Geffen: ageffen@dallasestateattorney.com

Q.        For whom are living trusts most appropriate?  What are the pros and cons?

A.        For starters, while it is true that probate can be expensive and time-consuming in some other states, in Texas, we have a streamlined system of probate.  As long as you hire a lawyer with experience in probate court, you have a well-written will, and nobody files a lawsuit after your death, then probate is typically not so bad.

Stories you read in the paper may lead you to believe otherwise.  The heirs of multi-million dollar estates frequently fight it out in court for a larger inheritance.  Also, bookstores carry dozens of books which talk at length about the delays and high costs associated with probate.

Even so, living trusts are useful estate planning tools, and they do have their place in many people’s estate plans.  If you find any one of the following benefits appealing, then a living trust may be appropriate for you.

Benefit #1:  No Court Involvement.  When a person dies, most properties pass either under a person’s will or under a living trust.  Some properties–such as life insurance, IRAs, and certain types of bank and brokerage accounts–pass directly to named beneficiaries.  If property passes under a will, then the will must be probated at the courthouse.  Probate typically entails hiring a lawyer, filing a number of papers with the court, attending one or more hearings, and providing a written inventory to the court valuing the properties which passed under the will. 

Some people don’t want this type of involvement with the court, so they opt for a living trust.  By transferring all properties which would otherwise pass under your will to a living trust, you can avoid the court entirely.  For estates which don’t owe estate taxes, there is usually less work for the lawyers, and that translates into reduced estate administration costs. 

Benefit #2:  Privacy.  As mentioned above, when a person dies with a will, an inventory must be filed with the court.  You may not want your friends, neighbors, or the media to be able to read a listing of what you own and what it is worth.  After all, an inventory is a public record.  With a living trust, your properties and their values are all kept private.

Benefit #3: Plan For Future Incapacity.  You may be worried that one day you won’t be able to manage your own finances, and you may want to name someone to handle these types of matters for you.  You can address this potential problem with a power of attorney or with a living trust.  A power of attorney will usually be accepted by banks, title companies and the like, but there is always the risk that an institution’s legal department will reject it.  The same person who may be denied the ability to use a power of attorney will likely be allowed to do anything he or she wants when acting as trustee of a living trust.

Benefit #4: Harder to Challenge.  If you are planning to disinherit one of your children or grandchildren, you may be better off with a living trust because there is nothing filed at the courthouse.  Also, it is a little harder to contest a living trust than a will.  Many people are interested in doing as much as possible to prevent a successful challenge to their estate plan.

Benefit #5: Avoid Out-of-state Probate.  If you own property in another state, you can avoid a costly probate proceeding in that state by transferring the property to a living trust. 

Before you establish a living trust you need to understand the downsides, which include the following:

Disadvantage #1:  Time-consuming to Set Up.  Depending on how many different types of properties and accounts you own, it can take quite some time to switch everything over to the name of your living trust.  Also, some financial institutions in Texas are not geared up to handle living trusts, so you can expect a little trouble and frustration in getting the trust fully established.

Disadvantage #2:  Complicated.  Wills are usually shorter and simpler to understand than living trusts.  Also, with a will, you can sign it and forget about it.  But with a living trust, you need to put your property into the trust and run your life out of it for as long as you live.  For many people, this downside outweighs all the potential benefits.

Disadvantage #3:  Time-consuming to Revoke.  A year after you set up the living trust, you may decide you don’t want it any more.  At this point, you will need to return to every bank and brokerage house, and undo everything you had done to establish the trust.  You can expect more lawyers’ fees too.

Disadvantage #4: Post-Death Costs Not Eliminated.  If you have a taxable estate (which is generally an estate over $1,000,000), there will be a lot of work to be done after death regardless of whether probate is required.  Typically, there are tax returns to file, trusts to establish, assets to value, and more.  Avoiding probate will only marginally reduce the cost of administering a taxable estate.

Disadvantage #5:  May Still Need to Probate Will.  If you leave just one bank account or one piece of real estate out of the trust, probate will still be necessary.  And probate takes about as long when there is one asset as when there are twenty.

Q.        What is the difference between a Living Trust and a Bypass Trust?

A.        A Living Trust is a revocable trust created while a person is alive, whereas a Bypass Trust is typically an irrevocable trust created at death.  A Bypass Trust can be created by a Living Trust or by a will. (Yes, a Living Trust can create a Bypass Trust, but a Bypass Trust would never create a Living Trust.) 

A Living Trust is simply an ownership arrangement where property is held in the name of a “trustee” rather than in the name of the person who really owns the property.  People almost always create Living Trusts for their own benefit, with the goals of avoiding probate, addressing the possibility of future incapacity, and keeping matters private.

Normally, the person who creates a Living Trust names himself or herself as trustee and as beneficiary.  Upon that person’s death, all or a portion of the property which remains in the Living Trust passes according to the terms specified in the trust agreement.

Bypass Trusts are most often created when a husband or wife dies in order to save taxes when the other spouse passes away.  When a married person dies and leaves everything to his or her spouse, that surviving spouse may then be too wealthy to pass everything to their beneficiaries tax free.  Being “too wealthy” means the married couple is worth over the present estate tax exemption.  The Bypass Trust is a way to shelter the first spouse’s exemption from taxation when the surviving spouse dies, thereby doubling the amount that can be left tax-free.

Bypass Trusts do have non-tax benefits though, and for some people, saving taxes is not the motivating factor in creating one.  For instance, Bypass Trusts protect the trust property from creditors’ claims, and they allow the deceased spouse to direct where the trust property passes when the other spouse dies.

There are some exceptions to the statements contained in this answer.  For instance, Bypass Trusts are not always created at death. Some wealthy people create them during life, and other people use their estate tax exemptions for different purposes rather than the creation of a Bypass Trust.  Also, in answering your question, I have assumed that when you said “Living Trust,” you meant the standard type of revocable trust people across the country regularly create and not another unusual type of trust which may be created while someone is living.

Q.        What are the tax advantages to setting up an irrevocable trust to own an insurance policy?

A.        Although life insurance is generally not subject to income taxation upon the death of the insured, it is subject to estate taxes if the insured owns the policy (or has other ownership rights).

Owning a life insurance policy results in all or a portion of the insurance proceeds being included in the insured’s estate and therefore taxed when death occurs, thereby substantially defeating the purpose of buying the life insurance.  Estate tax rates go as high as 55%.

While it is true that life insurance which is received by a spouse is not subject to estate or inheritance taxes because of the unlimited marital deduction (assuming the surviving spouse is a citizen of the United States), those same proceeds will be included in the spouse’s estate later on when he or she dies.  Therefore, life insurance trusts are often a good idea even when there is a surviving spouse to receive the proceeds.

Life insurance trusts offer a number of significant advantages over outright ownership.  For starters, the trust will insulate the proceeds from the claims of creditors and from spouses in a divorce. 

Also, life insurance trusts can be written to last for children’s lifetimes and then pass without estate taxes to additional trusts for grandchildren.  This is a feature commonly referred to by estate planning lawyers as “generation skipping planning.”  Your children shouldn’t be alarmed by the words “generation skipping” because you are not skipping them.  Your children can serve as trustees of their trusts, and they can be given the power to make distributions to themselves or their children according to fairly liberal standards.  Normally, trusts like the ones being described would allow your children to make distributions for their health, education, maintenance and support.  And your children would be the ones determining how much money it takes to maintain and support themselves.  Even though the life insurance proceeds will be held in a trust, your children would not be prevented from using the trust funds.

Even if Congress and the President repeal the estate tax in the next few years, people will still create trusts because trust property never becomes commingled with other property owned during a marriage (unless your children distribute the money from the trust to themselves), and the trust funds will generally be unreachable by creditors (as long as the trust property remains unencumbered inside the trust).