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Financial Life Advisor
The Advantages and Disadvantages of a Living Trust - Demystifying Trusts part 2 of 3
The Living Trust has probably gotten more negative press than any other trust. Most of the problems stem out of lack of information and aggressive attorneys’ marketing their services. It is not uncommon for people to think of a trust as a magical pill which provides asset protection and tax savings all in one. In fact, the Living Trust provides neither tax advantages nor asset protection. If you are asking yourself the question, “Why would you want a Living Trust then?” you are not in the minority.
Setting up a Living Trust can end up saving people money, but it does not save money on income or estate taxes. The main reason cited for setting up a living trust is to avoid probate. Probate is the legal process of re-titling assets after someone dies. Depending on the size of the estate and State in which the probate is performed, a Living Trust can save significant money in probate costs.
One of the ways probate costs can spiral is when someone dies and owns real estate property in multiple States. All personal property is probated in your State of residence upon death. Real property is probated in the State it exists. So, for instance, if someone lives and owns a house Texas; also owns a mountain cabin in Colorado; and the family ranch in Montana, three separate probates must be carried out. If these three pieces of real estate were held in a Living Trust, then only the Texas probate would be required (and only for assets not in the Living Trust).
In some States, such as California, probate can be a very expensive proposition. In Texas, with a properly drawn will, the probate process can be relatively inexpensive. Therefore, the cost of setting up a Living Trust should be weighed against the cost of probating an estate. There are other reasons people may want to avoid probate though.
The probate process by itself is a completely public process. The will is entered into the public record, and potential heirs and creditors are given notice. Anyone who wants to view this process either during or after the fact can have access to public records at the courthouse. A Living Trust provides more privacy. Since the assets in the Living Trust are never put into the public record, it is much more difficult for anyone to find out what happened.
During the notification period of a probate, potential heirs can “contest” the will. This means they are saying that the will entered into the court record is not valid. There could be numerous reasons the will is being contested. A claim that a newer version was made or that the deceased was unduly coerced into signing a will which was counter to what they had wanted. A will contest during probate has stronger legal footing than trying to “bust a trust”. With a trust, someone actually has to sue the trust. There is no set time in which the trust is being “reviewed”. In a will contest, the probate process is looking at carrying out the wishes of the deceased and trying to make sure they have complete information before assets are given to heirs.
Another good reason to have a Living Trust is that it helps administer an estate in the event of incapacity. If someone becomes disabled or is losing mental function, the trust document can have provisions to have a new trustee take over control of the assets. Handling of financial affairs can also be achieved normally with a Power of Attorney (POA). It should be noted though that the POA has some drawbacks. Upon death, the POA is no longer valid by definition. Also, from a practical perspective, the POA is usually heavily scrutinized by institutions before acceptance because of potential abuses and more frequent changes in the legal language required to be in a POA.
So let us review the reasons why someone would want a Living Trust. Probably the most common reason to have a Living Trust is to avoid probate costs. In high probate cost States, this is a valid concern. In low probate cost States, it usually does not justify the cost and hassle for probate savings alone. If probate would be required in multiple States though, a Living Trust generally makes sense. If the privacy of avoiding probate is a concern, the Living Trust is the only option for certain types of assets to keep them out of probate. The other major non-financial reason to have a Living Trust is to help manage affairs in the event of a disability or other incapacity.
Now that someone has decided a Living Trust may be appropriate, it is important to review some of the problems people have after setting up a Living Trust. The attorney who sets up the trust will always remind people that the trust only works if it is funded. If property is not transferred into the trust, then the trust is effectively worthless. It only governs assets which are titled to the trust. After spending a couple thousand dollars to set up a trust, it would be unfortunate (but not uncommon) to still have to probate the entire estate. Over time, as new accounts are set up or assets are acquired, they must also be titled to the trust.
One of common frustrations voiced by people who have a Living Trust is that it can make financial transactions a little more difficult when dealing with trust assets. For instance, mortgage companies may require real estate to be removed from the Living Trust to refinance a mortgage. Having an attorney create two quit claim deeds and executing them can be a huge hassle. Also, whenever an account is set up, it is not uncommon for a company to want to see either the trust documents or a trust certification. For these reasons, it makes sense to only have major assets inside the living trust. To put it simply, it is more trouble than it’s worth to have a $1,000 asset titled to the trust.
In the next blog posting, I will be discussing some of the common reasons trusts are used in estate planning. Find out by reading Part 3 of 3 in the Debunking Trusts series, “Trust Applications for Estate Planning”.
If you missed Part 1, “What is a Trust and Why Do People Want Them?” click here to read it.
Posted by Ben Gurwitz on 25th January, 2010 | Comments | Trackbacks
Tags: Financial Planning, Jan 10, Estate Planning
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