In the last fact sheet we talked about a more used estate planning tool, life insurance. Now we will discuss a less used tool, the trust.
Trusts Created by First to Die
Trusts can be effective tools for assisting and making life easier for a surviving spouse. They can also be used as part of a strategy to reduce estate settlement costs. People might do an excellent job of managing their assets when they are active and alert, but when their health fails, they might wish to assign the management of their assets to a trustee through a trust instrument. If the estate of the first to die is large and will flow directly to the surviving spouse, especially if the surviving spouse is elderly and inexperienced in investing and managing assets, a trust might be the most desirable method of meeting the surviving spouse's and children's present and future interests.
What is a Trust?
A trust is a legal relationship. Unlike a corporation, a trust is not considered to exist as an entity separate from the people that own it and control it. A trust is created when it is signed, or it can be created orally. It can be funded anytime. In a trust, assets are entrusted to a trustee who holds legal title and manages the assets until they are distributed to the eventual beneficiary. The terms of the trust describe how income from the assets and principal are to be distributed and managed. The trustee can be a bank, a trust company, another professional, or one or more family members (spouse, son, daughter, or self). Usually the trustee is someone trusted by the trust creator (the settlor or grantor). The trustee should be capable of managing the assets entrusted to him or her by the creator, until the assets are distributed to the benefactors.
Beneficiaries can receive income from a trust during the trust's existence, and/or receive assets when the trust is dissolved. When a trust is set up by spouses, the surviving spouse usually receives the income from the assets that are in the trust; assets then go to the children when the trust is dissolved.
When a trust is created, the creator determines the conditions under which the trust will be dissolved. In the case of creating a trust with a child as the beneficiary, some creators wish the trust to be dissolved when the child is capable of wisely spending or investing his or her inheritance. A trust can also be dissolved when the surviving spouse dies. In both instances, the benefactors can receive income from the assets in the trust, and have limited access to the principal, if needed, before the trust is dissolved.
If assets are to be transferred to a trustee, titled assets (cars, trucks, stocks, bonds, real estate, savings/checking accounts, certificates of deposit, insurance policies, retirement accounts, etc.) should be retitled, as titles need to be changed with each respective titling agency. Some banks will institute an early withdrawal penalty if the title of a certificate of deposit is changed before the certificate matures. Assets without titles need to be signed over to the trust. Then, at the termination of the trust, assets need to be retitled and transferred back to beneficiaries. In regards to transferring assets, the same processes that happen through probate occur with a trust. Transferring property through a trust rather than through probate is not necessarily simpler and might or might not allow the heirs to receive a larger portion of the inheritance, but the trust process is usually quicker. However, transfer of property through a trust is more private, as there is no listing of assets and value of assets in the probate court or newspaper. Because the trust is a legal relationship not separate from the people that own and control it, assets transferred to a trust need to be put into the name of the trustee, not into the name of the trust. Transfers of title into the name of the trust might be a void transfer.
Types of Trusts
Assets can be transferred into a trust directly while one is living (these trusts are known as "inter-vivos" or "living trusts"), or assets can be directed into a trust by one's will (these are called "testamentary trusts"). Living trusts that can be changed or revoked by the settlor are called "revocable," while those that cannot be changed or revoked are called "irrevocable."
Revocable Living Trusts
Property placed in a revocable living trust can be returned to the creator by revoking the trust. Since the creator has the power to pull the assets back, when the creator's estate is settled, assets in a revocable living trust are inventoried, appraised, and included in both Ohio and federal estate tax calculations.
Irrevocable Living Trusts
When an irrevocable living trust is created, the creator has given the assets to the trustee. The creator no longer has control over the assets, or the legal right to control them in the future, unless the creator is the trustee. Assets in an irrevocable living trust are not subject to estate taxes unless the creator is also the trustee or has retained other rights.
In essence, the creator makes a gift to the trust when the trust is funded. Unless special provisions are included in an irrevocable trust, gifts to the trust will not qualify for the $13,000 annual exclusion. Therefore, the unified credit usually available to offset federal estate taxes at death might be reduced by the amount given to the trust. If that is the case, the amount used to offset gift taxes is no longer available to offset federal estate taxes, if needed, for assets outside the trust when the estate is settled. Those considering irrevocable living trusts need to seek council to explore tax consequences and strategies. They need to be aware that upon creating an irrevocable living trust, the control of assets placed in the trust has been transferred to the trustee for management until the assets are distributed to the eventual beneficiary.
Uses of Trusts to Save Money
Trusts have been used to minimize federal estate taxes while providing security to a surviving spouse. One strategy to do this is to create a trust and write the wills of both spouses so that their assets pour over into the trust when the first spouse dies. In other words, the assets are willed to the trust rather than to the surviving spouse. The surviving spouse then gets the income from the trust and has limited rights to the principal, but the property in the trust is not in the surviving spouse's estate. This is one way to have the first to die spouse's assets pass through estate settlement and be charged estate settlement costs only once instead of twice if passed from the first to die to the survivor. This strategy no longer reduces federal estate taxes due to the portability of the federal estate tax exclusion, but it still reduces other estate settlement costs.
A new provision in the federal estate tax law might reduce the use of trusts in estate planning. In 2012, $5.12 million federal estate tax exclusion can be passed on to a spouse; this could result in a couple having a total of $10.24 million excluded from federal estate tax. Previously, before this portability, trusts were used to utilize both spouses' federal exclusion while providing for the surviving spouse. Now, couples with estates valued at less than $10.24 million can pass all assets to the surviving spouse without federal estate tax liability. For Ohio estate tax, trusts to utilize both spouses' Ohio estate tax exclusion can be used until Ohio estate tax is abolished on January 1, 2013.
Another very effective use of trusts is to make the trust the owner and beneficiary of life insurance. This might reduce estate settlement costs since the proceeds are not subject to Ohio or federal estate taxes (in certain cases), appraisal, probate costs, or attorney fees (in certain cases). Consult your attorney for additional ways that trusts might work for you.
Avoiding Probate for Privacy
To minimize estate taxes yet provide for a surviving spouse, a trust might be utilized. However, if a trust is used to avoid probate, it should be done in the appropriate situations and for the correct reasons. One appropriate reason for living trusts is privacy. When an estate is settled, property being transferred, along with its appraised value, is often listed in the newspaper and at the county courthouse. However, if the property has already been transferred to a trust, it is not owned by the deceased at the time of death; therefore, it is not listed in the newspaper or at the courthouse.
Living trusts are only one of several ways to avoid probate. Other methods include joint ownership of real property with rights of survivorship (JTRS), owning property such as retirement accounts with named beneficiaries, having payable on death (POD) accounts, giving before death, and owning life insurance policies with a named beneficiary.
Probate might also be avoided by using a transfer on death (TOD) designation for stocks, bonds, other securities, real estate, and automobiles. Unfortunately, the laws of Ohio are not uniform as to each of these asset categories. For example, with any security, you can specify that if the intended beneficiary predeceases you, the predeceased beneficiary's share will pass to the beneficiary's lineal descendants, per stirpes. However, with real estate, you have to specifically name the contingent beneficiaries.
Accordingly, if one of your children has another child after you set up the deed, you will need to prepare a new deed to reflect a new contingent beneficiary.
If these limitations are not of concern, you should be able to avoid probate for all titled assets without going to the expense of a trust.
Why Avoiding Probate With a Living Trust Doesn't Always Save Money
Typical probate fees are estimated to be between $150 and $400. Probate fees are negligible, so avoiding probate to avoid probate fees might not be appropriate.
Executor fees are another settlement cost. An executor in the probate process performs functions similar to those of a trustee for a trust. In general, the more time spent and the more management required of a trustee, the higher the fees (assuming the fees are accepted). Assuming that a family member is the executor or trustee, the fees are not a concern. However, trustee fees might be higher if a bank or trust company performs the function. Avoiding probate to avoid executor fees is not advantageous since trustee fees might be as much or higher than executor fees.
An appraisal is needed if tax forms have to be filed. An appraisal might be necessary when assets are placed into a living irrevocable trust, as gift tax forms might need to be filed. So the appraisal fee is often incurred even if probate is avoided with a trust instrument.
Attorney fees are often a large portion of estate settlement costs. However, attorney fees will be charged when property is passed on to others through the probate process or through a trust.
Also, to settle an estate, some attorneys charge by the hour. Others base their fees on a percentage of probate property only, and some base their fees on both probate and nonprobate property. Although the percentage charged for nonprobate property is generally lower than the percentage charged for probate property, one cannot automatically assume that nonprobate property will not be included in the attorney fee calculation.
Attorneys also charge to create and dissolve trusts. Property must be retitled into the trust when it is put in, and it must be retitled out of the trust when the trust is dissolved. Retitling might or might not be included in the fee charged by the attorney who created the trust. Therefore, attorney fees might not be reduced when avoiding probate by the use of a living trust. If you are considering a living trust to save attorney fees, consider the total cost of creating and dissolving the trust. In general, with a living trust, you pay attorney fees up front, but you also pay after death to dissolve the trust. If assets are handled by probate, the court oversees their retitling and transferring. If assets are put into a trust, an attorney has to do their retitling and transferring when the trust is dissolved.
Situations Where Avoiding Probate Saves Money
Totally avoiding the probate process with all property might be appropriate for those with estates in which no tax forms need to be filed and no estate taxes are due. Because no tax returns need to be filed, an appraisal is not necessary and attorney costs to file tax returns do not occur. Therefore, a simple, inexpensive probate avoidance procedure can save money for smaller estates. But remember that in this case, all property needs to avoid probate.
As of January 1, 2013, Ohio estate tax will not be an issue. In 2012, $5 million per person can be excluded from federal estate tax, but that might be reduced down to $1 million in 2013.
However, if the second spouse to die wishes to take advantage of the portability of the first to die's federal estate tax exclusion, it is likely that an appraisal will be necessary and tax forms will need to be filed in the first to die's estate settlement process.
Also, it might be appropriate to avoid probate when real estate property is held in two or more states. Out-of-state or out-of-country real estate requires what is called an "ancillary proceeding" in the state or country where the real estate is located. This is expensive and time consuming, and it is usually a hassle. Ancillary proceedings can be avoided by not having such property pass through probate. Therefore, consider transferring real estate outside your state of residence by a living trust, holding such property with rights of survivorship, or utilizing other probate avoidance procedures.
2007 Trust Code
Effective January 1, 2007, Ohio has a new set of statutes based upon the Uniform Trust Code. These laws are based upon the national model, but they have been modified to more closely resemble Ohio law. Up to this point, Ohio has had very few statutes dealing with trusts, leaving some issues open to some uncertainty. Described below are some of the issues addressed in the new laws.
Trust statutes can be overridden by the terms of the trust except for issues such as the requirements for creating a trust, the duty of the trustee to act in good faith, the requirement of a lawful purpose for the trust, the right of courts to have certain rights over the trust, certain obligations of disclosure, and the statute of limitations. Some of the disclosure obligations can be avoided if a beneficiary surrogate is named to receive the information in his or her place.
Although a handful of states allow creditor protection benefits for the person establishing the trust, Ohio still allows creditors to reach any retained interest of the person establishing the trust. Strong creditor protection is available for other beneficiaries of the trust. The only creditors that will be able to reach an interest in the trust will be a child or a current spouse with a court order for support, the State of Ohio, and the United States. A former spouse has no right to attach an interest in the trust.
The trustee is also be required to provide certain notices, accountings, and a copy of the trust agreement in certain circumstances.
Concluding Remarks
There are additional uses and kinds of trusts that are not discussed here. You and your attorney will need to decide if a trust is appropriate for you, and if so, which kind should be used.
These fact sheets should in no manner be considered as a replacement for consulting with estate planning professionals, nor should the general principles in these fact sheets be applied to specific situations without consulting an attorney.
Your Response
Fact Sheet 7
1. Trusts can, to a certain extent, allow the best of both worlds. A trust can allow the assets of a deceased spouse to pass indirectly to his or her children. This can result in the assets being liable to estate settlement costs only once instead of a second time in the surviving spouse's estate. However, the surviving spouse can have income from the assets, and he or she can have limited access to the principal, if needed.
True _______ False _______
2. The difference between a funded living trust and a testamentary trust is, the living trust is funded or comes into being during the creator's lifetime while a testamentary trust is funded by assets passing through the will.
True _______ False _______
3. When assets are put into a trust, they need to be retitled or signed over to the trust by putting them in the name of the trustee.
True _______ False _______
4. An advantage of a funded living trust is that the assets do not pass through probate, thus do not become public knowledge.
True _______ False _______
5. One advantage of a revocable living trust is that the creator can change or revoke the trust and get back the assets placed into the trust.
True _______ False _______
6. An advantage of an irrevocable living trust is that assets placed into the trust might not be subject to estate taxes.
True _______ False _______
7. With an irrevocable living trust, the creator usually loses control of the assets placed into the trust.
True _______ False ________
8. With an irrevocable living trust, there might be gift tax liability and/or a reduction of the federal unified exemption.
True _______ False _______
9. Probate can be avoided by . . .
• living trusts.
• joint ownership of property with right of survivorship (JTRS).
• having assets in a retirement account or in a life insurance policy with a named beneficiary.
• giving property directly, before death.
True _______ False _______
10. It might be appropriate to avoid probate with all assets if your estate value is small enough that no estate tax forms need to be filed.
True _______ False _______
11. It's appropriate to avoid probate with the property you own in another state, assuming your primary residence and the majority of the assets you own are in Ohio.
True _______ False _______
Answers
Fact Sheet 7
1. Trusts can, to a certain extent, allow the best of both worlds. A trust can allow the assets of a deceased spouse to pass indirectly to his or her children. This can result in the assets being liable to estate settlement costs only once instead of a second time in the surviving spouse's estate. However, the surviving spouse can have income from the assets, and he or she can have limited access to the principal, if needed.
True __X__ False _______
All questions on the response sheet are true, and all summarize some of the key advantages of trusts.
2. The difference between a funded living trust and a testamentary trust is, the living trust is funded or comes into being during the creator's lifetime while a testamentary trust is funded by assets passing through the will.
True __X___ False _______
Think of a funded living trust as one that is living or in existence while one is living. Think of a testamentary trust as one created by one's last will and testament (a will).
3. When assets are put into a trust, they need to be retitled or signed over to the trust by putting them in the name of the trustee.
True __X___ False _______
Creating and funding a living trust are not without hassle. If all assets are transferred to the trust, checks are written from the trust account rather than from the creator's personal account.
4. An advantage of a funded living trust is that the assets do not pass through probate, thus do not become public knowledge.
True __X___ False _______
Assets in a living trust do not pass through probate; therefore, they are not listed in the newspaper or in court.
5. One advantage of a revocable living trust is that the creator can change or revoke the trust and get back the assets placed into the trust.
True __X___ False _______
With a revocable living trust, the creator can dissolve the trust if he or she sees fit. If the creator changes his or her mind, or if circumstances change, the trust can be terminated and the creator can regain ownership of the assets placed into the trust.
6. An advantage of an irrevocable living trust is that assets placed into the trust might not be subject to estate taxes.
True __X___ False _______
If the creator no longer owns, has a beneficial interest in, or has control over the assets, those assets are not subject to estate taxes. Unless properly planned, however, the initial transfer to the trust will have used part of the federal estate tax exclusion; thus, this can result in higher federal estate taxes.
7. With an irrevocable living trust, the creator usually loses control of the assets placed into the trust.
True __X___ False ________
If the creator is not the trustee and cannot revoke the trust, he or she loses direct and legal control of the assets in the trust.
8. With an irrevocable living trust, there might be gift tax liability and/or a reduction of the federal unified exemption.
True __X___ False _______
Because funding of an irrevocable living trust involves giving assets to the trust, the transfer of assets is considered a gift for tax purposes. If the gift is more than $13,000 per person per year or the trust is not properly drafted, a gift tax form might need to be filed. The gift tax might be offset by using the federal unified credit, but the credit used will no longer be available to offset estate taxes, if needed, when the creator's estate is settled. If the total of lifetime gifts over $13,000 per person per year exceed $5 million, gift tax might be due.
9. Probate can be avoided by . . .
• living trusts.
• joint ownership of property with right of survivorship (JTRS).
• having assets in a retirement account or in a life insurance policy with a named beneficiary.
• giving property directly, before death.
True __X___ False _______
A living trust is not the only way to avoid probate. All the other items listed are ways to avoid probate.
10. It might be appropriate to avoid probate with all assets if your estate value is small enough that no estate tax forms need to be filed.
True __X___ False _______
Since Ohio estate tax will no longer be assessed in 2013, the concern for estate taxes and filing estate tax forms is for federal. In 2012, $5.12 million per person can be excluded from federal estate tax, but that might be reduced down to $1 million in 2013. However, if the second spouse to die wishes to take advantage of the portability of the first to die's federal estate tax exclusion, it is likely that an appraisal will be necessary and tax forms will need to be filed in the first to die's estate settlement process.
11. It's appropriate to avoid probate with the property you own in another state, assuming your primary residence and the majority of the assets you own are in Ohio.
True __X___ False _______
If one owns property in multiple states or countries, probate property will require going through an additional probate process. Ancillary proceedings in other states or countries are expensive and time consuming. Ancillary proceedings can be avoided if the property in the nonresident state or nonresident country is held in such a way as to avoid probate. The property could be held as JTRS, in a living trust, etc.
Contact James C. Skeeles at skeeles.1@osu.edu.
Contact Russell N. Cunningham at rcunningham@ohiocounsel.com.