The popularity of living trusts has exploded in recent years, supplanting the will as the estate planning tool of choice for estate management and distribution. A living trust often reduces the cost, hassle, and time involved in post-death administration. A living trust accomplishes these goals because, if properly drafted and funded, it avoids probate. Living trust, therefore, make good sense and we recommend them for the majority of our clients.

Unfortunately, the living trust phenomenon has given rise to a new industry. Many states have become overrun by “trust mills”—companies that mass market living trusts by traveling from town to town holding seminars and promoting living trusts like time shares or diet programs. Trust mills have been especially prevalent for two reasons: (1) real estate prices—and hence probate fees, which are calculated as a percentage of the estate—are high; and (2) overburdened local district attorneys offices either do not have the time to prosecute the unauthorized practice of law or view this as a victimless crime.

While the quality of the “cookie cutter,” “one size-fits-all” documents produced by the trust mills varies, the vast number of drafting errors and ambiguities we have found in documents sent to us for review has been discouraging. Unfortunately, most errors are not discovered until after the trustor has died, when remedial action can be taken only through expensive court proceedings, if at all. Equally disturbing is the practice of some trust mills that use the preparation of living trusts as a front to peddle annuities and other financial products.

The fact is most people can obtain competent estate planning assistance from local attorneys for about the same cost as the trust mills charge. Moreover, the local estate planning attorney is far more likely to meet with you personally, customize your trust to your particular situation, be around to answer questions over the years, and be there at death or the onset of incapacity when legal advice and planning becomes critical.

WHAT IS A TRUST?

A trust is a legal relationship in which assets are transferred to a trustee to be used for the benefit of one or more beneficiaries. The person who establishes the trust is called the settlor, grantor, creator, or trustor. Upon accepting the assets as trustee, the trustee undertakes the obligation to use the trust assets in accordance with the trustor’s directions.

WHAT IS A LIVING TRUST?

A living trust is the name given to trusts created during the trustor’s lifetime. A living trust may also be referred to as an inter-vivos trust. A living trust is usually created for the trustor’s benefit during his or her life. After the trustor’s death, the trust assets are distributed or managed for the benefit of the trust beneficiaries, per the instructions in the trust document.

CAN A LIVING TRUST BE CHANGED?

Your living trust may be revocable or irrevocable depending on your objectives as conditions in your life change; you can alter or terminate a revocable trust at any time during your lifetime. A living trust that you create for your own benefit is usually revocable, contains safeguards in the event of illness or incapacity, and may continue after your death for the benefit of others. After your death, the trust becomes irrevocable.

A trust can also be irrevocable, meaning that it cannot be changed or revoked once it has been established. Unlike revocable trusts, one advantage of an irrevocable trust is that it can be arranged so that trust assets are not subject to estate taxes at the trustor’s death. Because of this, life insurance is often placed in an irrevocable trust in a manner that will remove the policy proceeds from the insured’s taxable estate.

CAN I SERVE AS TRUSTEE OF MY LIVING TRUST?

Usually, the trustor (you) will serve as the trustee of the trust while he or she is alive and competent. The trustor names a successor trustee to serve in the event of the incompetence or death of the trustor.

ADVANGTAGES OF A LIVING TRUST

* PROBATE AVOIDANCE

Probate is the process by which title to assets owned in your name alone are transferred after you death. Probate may be expensive and time-consuming depending on the value and type of assets in your estate.

* TAX PLANNING ON FIRST DEATH

In a properly drafted trust, on the first death the assets are split into various sub-trusts depending on the size of the estate. This allows the survivor to do a great deal of tax planning involving the discounting of various assets. For example, if a piece of real property was owned in the trust, on the first death a portion of the property could be funded into various sub-trusts in order to take advantage of fractional ownership discounts, and thus potentially lower estate tax liability.

In the situation of a three trust subdivision (survivor’s trust, marital trust, and credit trust), such a discount can only be taken when assets are funded between the survivor’s trust and the marital trust if the trust instrument is properly drafted by making the marital trust a QTIP trust. Discounting is always available if the asset was funded partially into the credit trust and partially into the survivor’s trust.

* PRIVACY

When your estate goes through probate, your will and other documents become public record. A living trust provides you with a greater degree of privacy because the trust provisions and the assets in your estate are not subject to public disclosure. However, with a living trust that becomes irrevocable at death, Nevada law states that all heirs and beneficiaries are entitled to a copy of the trust.

* EXPIDITES ASSET DISTRIBUTION

As a trust administration is not overseen by court, asset distribution to beneficiaries, or to sub-trusts in a married situation, is often much faster than asset distribution in a probate.

* PROPER MANAGEMENT OF ASSETS

A living trust may reduce the risk of inexperienced and unskilled management of property by allowing you to select a successor trustee to act in the future. Should you die or become incapacitated, the successor trustee takes over management of assets. In addition, the trust assets can be maintained in the trust after your death instead of being distributed outright to beneficiaries who may be unable to handle the management of assets themselves due to their age or other factors.

PLACING ASSETS IN THE LIVING TRUST

To achieve full benefit from a living trust, it is important that appropriate action be taken to transfer assets into trustee ownership. This process is often referred to as “funding” the trust. Funding a trust consists of retitling your bank accounts, bonds, stocks, real estate, and other assets so that the trustee of the living trust is the owner of the assets. Only assets that are funded into the trust will avoid probate.

SELECTING A TRUSTEE

The trustee is responsible for ensuring that the trust is administered pursuant to the trust. A trustee, particularly one who acts after your death or incapacity, should be available to handle all aspects of managing your assets and be willing to act for an extended period of time.

A family member, friend, professional, or bank can serve as a trustee during your life or after your death or incapacity. A trustee is usually not subject to court supervision, and a bond is only rarely required. Because of the varied challenges associated with this duty and the tremendous power a trustee is given, choosing a trustee requires careful consideration.

THE LIVING TRUST MYTH

All the talk and excitement about living trusts has given rise to certain misconceptions about living trusts. We will refer to these myths collectively as “The Living Trust Myth.”

Myth 1: “Living trusts eliminate costs, administration chores, and lawyers.”

This is the number one myth of living trusts. At one time, many estate planning attorneys, including ourselves subscribed to this myth. But then the clients for whom we had prepared living trusts over the years started dying. From our experience in handling hundreds of living trusts after death, we soon learned the truth: there is work to be done and there are costs and expenses involved. Does it cost as much, take as much time, and require as much work as a probate? In most cases, the answer is no. But a living trust does not waive a magic wand over your estate making all your administration troubles disappear.

What has fueled popularity of living trusts is the public’s fear of probate in particular, and its even more pervasive fear and distrust of attorneys and the court system. All too often, the trust mills and other non-attorney trust promoters exaggerate these fears to entice unsuspecting consumers into buying their living trust packages. Thus, to understand the allure of living trusts, one must first understand what probate is and why everyone is so afraid of it.

Probate is simply a court procedure whereby a court-appointed personal representative performs three distinct functions: (1) inventory and appraise the decedent’s assets; (2) pay the decedent’s debts and taxes; and (3) distribute the remaining assets to the decedent’s beneficiaries. People often wonder, “Why do we need probate?” Imagine for a moment the chaos that would result if upon death a person’s relatives, creditors, and the taxing authorities all started grabbing assets and fighting over who gets what, with no civilized system in place to resolve these issues. Probate is the system that developed in England in the Middle Ages to handle the disposition of a person’s assets at death Since our laws derived from the law of England, the probate system has been passed down to us and is still used today.

Living trusts avoid probate because, unlike a will, the trust does not have to be proved in court and the successor trustee need not be appointed by the court in order to take charge of a decedent’s affairs. In the typical case, the administration baton is simply passed at death from the trustor-trustee to a named successor trustee with no court involvement. The successor trustee then assumes the job of carrying out the trustor’s instructions as set forth in the trust instrument.

What functions does the successor trustee perform after the death of the trustor? There are three: (1) inventory and appraise the decedent’s assets; (2) pay the decedent’s debts and taxes; and (3) distribute the remaining assets to the decedent’s beneficiaries. Do these functions look familiar? They should. These are exactly the same three functions that must be done in probate!

In reality, the only difference between probate and post-death administration of a living trust is that probate is supervised by the court. There is a structured, formal system with rules for handling estate administration. Living trust administration is not supervised by the court. There are few, if any, rules. It is this informality that makes living trust administration cheaper, faster, and easier. It is also this informality that can result in confusion, mismanagement, lawsuits, and potential liability for the successor trustee.

To avoid these problems, the successor trustee must be knowledgeable about the operation of trusts or be willing to learn. He or she must also be well organized and committed to carrying out his or her fiduciary responsibilities in strict accordance with the terms of the trust and the Trust Law. Finally, the successor trustee must work closely with qualified professionals, an estate attorney and CPA, who will prepare required documents and tax forms and who will advise the trustee concerning the complex legal and tax issues that arise at death.

Myth 2: “Living trusts save estate taxes”

There is also a common misconception that living trusts save estate taxes. In the case of an unmarried individual, no estate tax savings result from a revocable living trust because the Internal Revenue code requires the inclusion of the trust’s assets in the trustor’s taxable estate.

Even for the married couple, living trusts do not save a penny in taxes. The estate tax savings that are so often touted by the trust mills can also be obtained through a well-drafted will designed to create a Tax Savings Trust (“bypass trust”) at death. The only difference between the two plans is that the Tax Savings Trust created by will requires a probate at the death of the first spouse to die, whereas the Tax Savings Trust creating under a living trust document does not require a probate. In other words, tax savings is not an additional advantage of living trusts. Rather, it is the same probate-avoidance advantage already discussed above. Thus, to market the living trust as a tax savings device is misleading.

Myth: 3 “Living Trusts Avoid Conservatorships”

Another common myth is that living trusts avoid conservatorships. A conservatorships is a court-supervised procedure, similar to a probate, except for a living person who has become incapacitated (the “conservatee”), rather than for someone who is deceased. It is true that no conservatorship will be needed for assets in a living trust because the successor trustee takes over without court appointment or supervision. However, by law, a trust established on or after July 1, 1987 is subject to mandatory accounting requirements. If the trust trustor is incompetent, to whom will the trustee account? Arguably, a conservator must be appointed by the court to review the trustee’s financial reports on behalf of the incompetent trust trustor. If the trust instrument is carefully drafted, this potential problem may be avoided. Unfortunately, many trust documents simply ignore this issue.

Myth 4: “Living trusts are private and avoid all court proceedings”

A living trust is essentially a contract. A contract signed under duress or as the result of fraud or undue influence, is subject to challenge. Although the law relating to challenges to living trusts is not as well developed as the law relating to will contests, living trusts are not beyond legal challenge by a disgruntled heir.

There may be other instances where court supervision or intervention is sought by the trustee or a beneficiary. The trustee may seek the court’s stamp of approval on accountings or certain proposed actions, such as the sale of a business, especially where there is a hostile beneficiary. As mentioned above, where a trust instrument is ambiguous or improperly drafted, a trustee or beneficiary may petition the court for interpretation of the trust instrument or to reform it. A trust beneficiary may also ask for court intervention where the trustee has refused to make an accounting or where the trustee has acted in violation of the trustee’s fiduciary duties. In fact, suits against trustees of living trusts for mismanagement and breach of trust may be the growth industry of the next decade for law firms who handle probate and trust litigation.

CONCLUSION

On balance, living trusts remain the estate planning tool of choice for disposition of assets after death and for effective estate tax planning. We believe in living trusts and prepare hundreds of such documents each year for a large number of our clients. However, we also believe in educating our clients about the dangers of the Living Trust Myth. We want our clients to make an informed decision about their estate plan based on fact rather than marketing hype.

If you are wondering whether a living trust is right for you, please call us for an initial consultation. If you, or a friend or relative, had a living trust prepared by a trust mill, paralegal, or other non-attorney source, we would be happy to review it. We look forward to hearing from you.