Third in a Series

In previous newsletters, I have discussed the probate process and why some people choose to avoid probate. As discussed in the earlier articles, the traditional methods of titling assets in order to avoid probate are popular and widely used, however, oftentimes raise other issues which are unintended. Therefore, in this newsletter, I will talk about a preferable method of probate avoidance if you decide that probate avoidance is right for you.

Recently, I met with Mr. & Mrs. White who fit a very typical scenario. Both husband and wife are retired and have built up a nest egg of about $350,000. They have three children to whom they wish to leave their assets equally and were very interested in avoiding probate. Initially, they were convinced that they wanted to avoid probate by naming their children as beneficiaries or joint owners on all of the assets. After understanding the pitfalls of joint ownership with children, they decided that joint ownership was not the appropriate plan to avoid probate. Instead, they chose a simple revocable living trust designed to avoid probate.

But, as with many clients, they really didn't understand what a trust was or how it works. A Trust Agreement is simply a legal document which has three parties to it: (1) the Settlor (that's you) who sets up the Trust; (2) the Trustee (often the same person as the Settlor) who administers the Trust according to its terms; and (3) the Beneficiary (again, usually the same person) of the Trust for whom the Trust is held. The most important part of establishing a trust is the funding, which is necessary in order to avoid probate. To fund the trust, you must change the title on all of your assets into your name as trustee of your trust. You still have complete control of your assets, you can still invest, buy, sell or transfer assets as desired, and income and dividends are still taxable to you on your social security number.

Since you avoid probate, your Will no longer operates to dispose of your assets upon your death. Rather, your trust now directs what happens to your assets when you die. For the Whites, their trust directs that upon the death of both spouses, the assets are to be distributed outright in equal shares to their three children. This is a very common estate plan.

Another advantage of using living trusts as a part of estate planning and probate avoidance are the significant estate tax savings which can be achieved when a married couple's combined assets climb over the $1,000,000 mark (the new estate exemption returns to this level in 2011). To illustrate that scenario, consider Mr. & Mrs. Black. Their estate was somewhat more involved and more valuable. Mr. & Mrs. Black had total combined assets of $2,000,000. They were able to completely avoid all federal estate taxes by using two separate living trusts, one for each of them. Let's see how that works.

Everyone has a "unified credit" amount that they can pass tax free during their lifetime or upon their death to anybody. In 2002, the exemption is $1,000,000. There is also a marital deduction available for married couples which allows assets to pass to a surviving spouse entirely estate tax free. In the case of the Blacks, if the husband dies first, he can leave all of his assets to his wife estate tax free by using his marital deduction. He has not used any of his $1,000,000 unified credit. When the wife dies, she has a $1,000,000 unified credit to offset tax on half of the assets, but the remaining $1,000,000 will cause federal estate taxes.

On the other hand, if they each had their own separate funded trust, each holding $1,000,000, probate could be avoided on the death of both of them and the $1,000,000 amounts in each of their trusts could entirely avoid federal estate taxation by using both Mr. & Mrs. Black's $1,000,000 unified credits. Therefore, not only can probate be avoided, but significant federal estate taxes can be saved by using simple trusts.

Probate avoidance using trusts can be a better way to hold your assets and also can allow you to achieve significant estate tax savings in the process. Therefore, whether your estate is very large or very small, you should consider using a trust to hold your assets because a trust can be a great probate avoidance, property management, and estate tax savings tool.