Brief History of Living Trust Marketing

One of the first to examine the benefits of living trusts was Norman Dacey in his book, How to Avoid Probate!, published in 1965. More recently Alexander Bove's book, The Complete Book of Wills and Estates, provides an excellent source of estate planning information.

Unfortunately, during the 1980s, a trend emerged that shifted the emphasis from the "how-to" books of earlier decades to what can only be described as a marketing blitz. Lawyers and financial planners have found many of the attributes of living trusts make these trusts attractive for mass marketing. Unfortunately, some marketing tactics, such as "special no-charge seminars," turnout to be nothing more than a high pressure sales pitch. A California lawyer has aired a 30-minute commercial where he claims that "anyone who owns a home" should have a living trust.

These ambitious entrepreneurs pale in comparison to what some attorneys have called "living trust factories." These outfits sometimes solicit customers door-to-door, and for approximately $1,000, sell a massmarketed living trust document that consists of little more than bolerplate language. James Quilinan, chairman of the estate planning, trust, and probate law section of the California state bar, calls some of these factories "outright crooks."

The living trust phenomenon has even spawned a secondary industry. The American Family Living Trusts of Rancho Cordova, California, has advertised a training program in insurance industry magazines promising, "You can learn to sell living trusts in less than one day."

The preceding information is offered as a caveat to those considering a living trust as a vehicle for estate planning. But a warning is merely a warning, and should not discourage taxpayers from considering the potential benefits of a living trust. For certain persons, depending upon the assets in their estate, where they live, and personal preference, a living trust can be a very smart move.

Fundamentals of Living Trusts

A living trust is essentially the same as other trusts. There are three parties to the creation of any trust. First, the grantor or settlor is the person who creates the trust by having a trust agreement drawn-up that details the grantor's wishes for the management and disposition of the property contributed to the trust. After the trust agreement is written, property must be transferred from the grantor to the trustee. This process is known as funding the trust and only after the trust is funded does the trust come into existence.

The second party involved in the creation of a trust is the trustee. The trustee is the person who controls and manages the trust's property and is responsible for the assets' safekeeping. The trustee operates in a fiduciary capacity, and usually the trustee's principal concern is the maintenance of trust corpus and not the production of trust income.

The third and final party to a trust is the beneficiary. Beneficiaries usually fall into two broad categories. The first category of beneficiaries are those who receive the income that results from the successful management of the trust property, and these persons are often referred to as the income beneficiaries. The other category of beneficiaries are those who will receive the trust property itself, and these persons are referred to as remaindermen. A beneficiary may be both an income beneficiary and remainderman. When funded, the trust becomes a separate entity recognized for certain legal purposes as if the trust were the owner of the trust property.

The issue of who owns the trust property is actually a little more involved. When the trust is funded, legal title vests with the trustee, but equitable title vests with the beneficiary. Legal title allows the trustee to manage the trust's assets, but equitable title gives the beneficiary a legal remedy should the trustee mismanage the trust's property.

This issue of split-title to trust property is considered key to the formation of a trust arrangement. Under the "doctrine of merger," if both legal and equitable title rest in one individual, fee simple ownership is created and a trust relationship cannot exist. For this reason, a sole trustee normally cannot also be the sole beneficiary.

Some states will allow a trust arrangement to exist even if the grantor is both sole trustee and sole beneficiary. The reasons a grantor may use this type of trust arrangement have more to do with asset control than with estate planning. One reason for using this type of trust arrangement to control proerty might be a situation where the grantor fears being deemed incompetent. The living trust allows the grantor to have already named a successor trustee. Another reason for this type of trust arrangement might be to shield the grantor's assets from creditor's claims. But, if the purpose of the living trust is estate planning and inter-generational asset transfer and the grantor is the sole beneficiary, the principal rationale for creating the living trust would not exist.

The typical living trust, and the reason for its name, is a trust created while the grantor is still alive. It often names the grantor as trustee or co-trustee and sometimes even names the grantor as a co- beneficiary but is usually limited to an income beneficiary. A simple example of these circumstances would be if Father wished to give rental property to Son, but Father wishes to manage the property and retain its income for his lifetime. Father could have a trust document drawn-up naming himself as trustee and granting himself the right to receive the income produced for life. The trust would come into existence as soon as the deed was transferred to the trust thereby funding the trust.

Avoiding the Will/Probate Process

The principal estate planning benefit, and by far the most frequently cited benefit of living trusts, is the ability of the living trust to pass assets from one generation to the next without having to go through the time, trouble, and expense of probate. Probate is the legal proceeding in which the court approves the decedent's will and supervises the distribution of the estate's assets.

Probate is bypassed at the taxpayer's death because title to the assets in the trust have already passed to the trust while the deceased was still alive. The assets in the living trust are not included in the decedent's probate estate and are not distributed by the decedent's will, but the assets may be included in the decedent's taxable estate.

To continue with the Father/Son example, at Father's death the trust document will provide for a successor trustee who will be instructed by the trust agreement to distribute the rental property to Son. Assuming all the trust income has been paid to Father, Son will receive the rental property tax-free just as if he had inherited the property by will.

Considering the avoidance-of-probate issue is the most frequently cited reason to create a living trust, an examination of why people fear this proceeding seems appropriate.

The Time Factor. One frequently cited reason for avoiding probate is the time involved. The probate process may take anywhere from seven to 16 months with one year often cited as the average time period for settling an estate that has gone to probate. Until distributed by the executor, the estate's heirs may not have the benefit of the use of the estate's property.

The reason the probate process is so lengthy is partially due to the fact the estate's assets must remain intact to service the claims of estate creditors. With a living trust, the transfer of assets can take place almost immediately upon the death of the grantor, or the assets can be retained in trust and distributed at any time desired by the grantor.

It should be noted, however, that the creditor-claim-making procedure of probate is actually a major advantage of the probate process. The decedent's creditors usually have only four to six months to inform the executor of their claims against the estate. Once the estate is settled, these creditors cannot press their claims against the estate's heirs. On the other hand, decedent's property transferred by trust has no such time limit within which a creditor can press a claim. So, an heir who receives a trust distribution may be sued for a decedent's debts many years after the estate is settled.

The Cost of Probate. Another frequently mentioned reason for avoiding probate is the cost. Cost appears to vary widely depending upon the state in which the deceased held the property and the type and amount of assets. Attorney fees are usually a statutorily prescribed fixed percentage of the probate estate. This percentage fee applied to the probate estate can be as little as 2.5% in North Carolian or Virginia and as much as 6% in New York or Pennsylvania. Also, assets considered part of the probate estate can vary from state to state. For two identical estates, one may be valued for probate purposes for as little as $600,000 in Texas or as much as $1,000,000 in California.

A good first step in a taxpayer's analysis of whether to create a living trust is to consult Kay Ostberg's book, Probate: How to Settle an Estate, to estimate the probate estate settlement costs in a particular state. If a living trust is used, a sizeable portion of the taxpayers assets will no longer be in the probate estate, but some assets will probably remain. So, probate may not be completely eliminated by using a living trust, but the costs associated with probate can be greatly reduced.

Some attorneys, however, will agree to fees based on hourly rates instead of the fixed probate estate percentage. This further complicates the decision of whether to create a living trust, but if a taxpayer is shopping around for living trust price quotes, this would be a good opportunity to find out about hourly rates.

The Cost of a Living Trust Agreement. The living trust agreement itself can cost $500 to $3,500 or more depending upon the complexity of the estate. These price quotes are only for the trust agreement. To complete the trust process, assets to be included in the trust must be re-titled. This can be a time consuming and difficult process for the unsophisticated taxpayer. If the trust property is not proerly re- titled, the property will not be included in the living trust and will not escape probate. Real property should probably be re-titled by an attorney at an additional cost of about $150 per property. The taxpayer's lack of understanding concerning the re-titling process has caused many trust agreements to be worhless because the taxpayer was either unaware the property needed to be re-titled (a fairly common occurrence) or the re-titling was not done properly.

Lack of Privacy. Another often cited reason for avoiding the will/probate process is the lack of privacy involved. When a will goes to probate, it becomes a public document and an inventory of all the decedent's assets must usually be made public. In some states, however, only interested parties have access to the asset inventory. Not only is an inventory of the estate's assets made public, but because the will is also a public document, the assets' disposition is made public. So, not only is the decedent's privacy invaded, the heir's privacy is also compromised.

A Better Protective Shield. A somewhat more obscure but still noteworthy advantage of living trusts compared to the will/probate process is the living trust's ability to withstand challenges from embittered heirs better than wills. David Larsen in his book, You Can't Take it with You, said "Only rarely have heirs been able to invalidate living trusts...." As with avoiding probate, this ability of living trusts to withstand challenges has much to do with the fact that title to trust assets has already passed from the decedent to the trustee while the decedent was still alive.

Multiple Jurisdictions. A final factor many taxpayers consider in their decision to use a living trust to avoid probate involves property held in multiple states. If a taxpayer owns property in many states, probate proceedings will have to take place in each state. However, if these properties are held by a living trust, they simply bypass the probate process.

Non-Probate Advantages of Living Trusts.

Since they may be altered, amended, or revoked by the grantor, a living trust allows the taxpayer to create unique and flexible property disposition arrangements. A taxpayer who is a business owner may find it desirable to pass ownership while still alive to enable him or her to monitor the progress of the new owners and give advice. If persons to whom the taxpayer wishes to leave the business appear not to be capable of effectively managing the business, the terms of the living trust can be modified to provide for new beneficiaries or some form of professional management.

Successor Trustee in the Wings. Another benefit for estate planning purposes is the living trust's ability to designate a successor trustee should the grantor/trustee become incapacitated. Normally, if a taxpayer should become incapacitated, the court would provide for a conservatorship of the taxpayer's property. The conservator designated by the court may not share the same views toward management of the taxpayer's property as the incapacitated taxpayer. With a living trust, the taxpayer not only can appoint a successor trustee who shares similar views toward the property's management, but the grantor can also write fairly specific instructions concerning the administration of trust property into the trust agreement itself. The combination of these two features can provide considerable peace of mind for some taxpayers, especially elderly taxpayers who fear ill health.

Factors to Consider with Non-Revocable Trusts

As mentioned, even though title is passed to the trust when the trust is funded, thus avoiding the probate estate, these assets may still be included in the assets of the taxpayer's taxable estate. Merely re- titling assets into a trust is not the same as the grantor truly giving up all control and enjoyment of the assets. In order for trust property to not be included in the grantor's estate, the property must be a true gift to the trust. Returning to the Father/Son example, if Father wishes the trust property not be included in his taxable estate, he must give up all control over the trust by modifying the typical living trust agreement into a non-revocable trust that usually must have an independent trustee. Under these circumstances, the property given to the trust would be considered a true gift for tax purposes and the trust's assets would be excluded from the Father's taxable estate.

This lack of inclusion in the Father's taxable estate is not the estate planning/tax relief tool it may appear to be. No substantial tax savings will occur (besides the $10,000 per donee, per year gift exclusion) because when Father gives up all control over the trust, the assets transferred to the trust will be considered a gift and applied against the taxpayer's unified credit at that time. A single unified credit and tax rate is applied to property transfers by both gift and inheritance. When property is transferred by gift, part of the credit is applied against the gift tax and is no longer available for property transferred through inheritance.

Since the tax rate for transfers by gift is the same as those for inheritance, there is little tax incentive to choose transfers by gift over inheritance unless the trust property is likely to appreciate quickly in value. If property is likely to appreciate quickly, the property's value for gift/inheritance purposes is determined at the time the trust is funded, thus avoiding any further appreciation being included in the decedent's estate. However, under the present tax code, gift transfers within three years of death are considered part of the decedent's estate.

There are reasons other than tax consequences why a taxpayer may prefer a non-revocable trust over a revocable one. If a taxpayer is certain of the desire to give certain property to an individual but does not wish to make an outright gift because of the donee's age or other reasons, a non-revocable trust will give the property to the donee with the added safeguards of placing certain restriction on its use. At this point, another warning is necessary to ensure the grantor is absolutely positive concerning the terms of the non-revocable trust because there is, of course, no going back once the trust is funded.

Other Factors to Consider

Living trusts are required to file separate tax returns; therefore, additional time, effort, and money must be expended for an adequate accounting during the year and for a timely filing of the trust tax return at year-end. Depending upon the complexity of the trust, the accounting fee can be substantial. Also, if the grantor wishes to use the assistance of a corporate trustee as the sole trustee or as a cotrustee, additional fees will be incurred. As with accounting fees, trustee fees vary according to the complexity of the trust. Both accounting and trustee fees must be considered in the living trust decision because these fees will reduce the expected savings from avoiding probate.

Recommendations

The answer to the question of who should use a living trust as part of their estate planning appears to depend on five major factors. They are: 1) dollar value and complexity of the estate's assets and their disposition, 2) time involved in settlement of the estate, 3) privacy concerning estate assets and their disposition, 4) potential incompetency of the taxpayer, and 5) contensciousness of the heirs to the estate. These factors tend to behave in a similar manner for decision making purposes. However, as the complexity of the estate's assets and their desired disposition increases, the cost, time, and effort involved in both the living trust and will/probate process increases. Generally speaking, however, as these five factors move from less or less likely to more or more likely, the greater the potential benefits of living trusts.

A taxpayer considering a living trust may wish to consider where along each of the factors he or she falls. This hopefully will provide a framework within which the taxpayer can more rationally make a decision. The taxpayer will have to weigh each factor and balance personal preference considerations, such as privacy or contentiousness, against monetary considerations, such as state percentage probate fees compared to trust fees.

Using this framework, for a small, simple, non-contentious estate where privacy, competency of the taxpayer, and the time involved in estate settlement are not crucial factors, the taxpayer is likely to conclude the will/probate process proves simpler and less expensive than transferring the estate's assets through a living trusts. On the other hand, for large, complex, contentious estates where privacy, competency of the taxpayer, and the time involved in estate settlement are crucial factors, the taxpayer is likely to conclude a living trust meets his or her needs better and proves less expensive than the will/probate process.

After all is said and done, the single most important factor attributing to the increased use of living trusts is the peace of mind they offer to taxpayers while they are still alive. Time, trouble, and expense are all factors a rational person would consider in a normal decision making process. But, planning for the disposition of assets after death is not necessarily a completely rational process. The certainty concerning final disposition of a taxpayer's assets may outweight any rational considerations.