The purpose of creating a living trust is often not only because they want to set up a trust for their beneficiaries, but because they want to benefit from the advantages a living trust offers. However, there are some disadvantages to creating a living trust as well, and it’s important to understand the various advantages and disadvantages to a living trust before creating one.
A living trust is simply a way of transferring control of a property from an individual (the grantor) to the trust, and is controlled by a trustee (often the grantor as well, at least until he or she dies). One of the advantages of this is that the grantor can name heirs to the property held in trust. This property can then be transferred to the heirs without going through a probate court. This saves the heirs both a lot of money and time. It also guarantees that the transfer of property is private – probate records are open to the public. By avoiding probate costs and even some tax costs, the heirs may not have to sell any of the property to cover the various costs associated with the grantor’s death. A living trust can also set out instructions, in advance, as to how the property is to be managed if or when the grantor becomes unable to do so.
Probate Avoidance
Probate is the state-run process administered by the Circuit Court in the county of a deceased person’s residence at the time of death which oversees the administration of estates. Even that description is a mouthful. In reality, the probate court’s function is to check up on the executors or administrators of estates to make sure they are doing their jobs correctly. Sounds quite reasonable, doesn’t it? In theory, it probably is. Unfortunately, like many activities run by the government, this one is often mired in beauracracy and “red tape.” Many times, an overwhelmed executor will devote months and months to the probate process only to finally give up and hire a probate attorney to handle the daunting task. No offense to probate attorney, but once they are hired to handle the probate process, every dollar that goes to pay their bills is one dollar that will not go to the estate’s beneficiaries.
A Revocable Living Trust enables you to transfer many, if not the bulk of your assets out of what is called your “Probate Estate” during your lifetime. That means that after your death, very few, if any, assets will be subject to the probate process, thus greatly reducing, or even eliminating the need for your loved ones to spend months paperwork or hiring an attorney to do the paperwork for them.
Estate Taxes
The estate tax is levied upon estates (passing to someone other than a spouse) which are in excess of what is called “the estate tax threshold.” The IRS considers almost every conceivable asset when calculating whether or not an estate is over this threshold, even life insurance proceeds. The tax is levied upon every dollar in excess of the threshold at tax rates as high as 45%. For years, this threshold was $600,000.00 until Congress finally decided to start ratcheting it up in order to reduce the number of estates subject to the tax. Under current tax law, the threshold will remain $2 million through 2008 and jump to $3.5 million for 2009. Come 2010, the estate tax is scheduled to be “repealed,” but only for one year. If additional legislation is not passed by 2011, the threshold is scheduled to drop back to $1 million. In short, the estate tax threshold is a moving target and the future is uncertain.
A Revocable Living Trust does not automatically protect all assets from consideration for the estate tax. What it does for the typical married couple is to allow the second spouse to die to utilize the estate tax thresholds allotted to both spouses. For example, let’s assume John and Mary Smith have two children and a combined estate of $3 million. While they are both alive, each is allotted the applicable estate tax threshold, let’s say $2 million for the sake of our example. However, if John dies first, leaving everything to Mary (a transfer that is exempt from estate tax since Mary is his spouse), she is now the proud individual owner of a $3 million estate. John’s threshold has gone unused and is lost forever. Upon Mary’s death, again assuming the $2 million dollar threshold, she wants to pass the $3 million to her kids but her estate has to pay hundreds of thousands of dollars in estate taxes before the kids get a dime. If John and Mary had created the correct type of Revocable Living Trust prior to John’s death, Mary could have preserved John’s threshold and combined it with her own so that upon her death a combined $4 million could have been passed to the kids tax free.