A trust is another frequently used estate planning device that manages the distribution of a person’s estate.
Mechanics of a Trust
To create a trust, the owner of property (grantor) transfers the property to a person or institution (trustee) who holds legal title to the property and manages it for the benefit of a third party (beneficiary). The grantor can name himself or herself or another person as the trustee. A trust can be either a testamentary trust or a living trust. A testamentary trust transfers the property to the trust only after the death of the grantor. A living trust, sometimes called an inter vivos trust, is created during the life of the grantor and can be set up to continue after the grantor’s death or to terminate and be distributed upon the grantor’s death.
Unlike a will, which in some cases can be drafted without the help of an attorney, a person never should draft a trust without the aid of a lawyer. Many complex laws regulate trusts. Trusts must be carefully structured if they are to take advantage of beneficial tax treatment. An experienced attorney always should assist in drafting a trust so that it is valid, meets the needs of the estate, and does not conflict with any previously drafted will.
Advantages and Disadvantages of a Trust
Trusts have many advantages over wills. The advantages depend on whether a living trust or testamentary trust is chosen. All trusts have the advantage of allowing the grantor to determine who receives the benefit of the money, when they receive it, and what conditions must be met. If a spouse is unable or unwilling to manage assets, if children are minors or are unable to handle money responsibly, or if a beneficiary is disabled, creating a trust can be a better way of passing on assets. Living and testamentary trusts are an especially popular way of providing for beneficiaries’ future educational or medical costs.
Some advantages are particular to living trusts. First, a living trust can give its grantor substantial tax advantages. Second, possessions held in a living trust are not subject to estate administration by the probate court after the grantor dies. Survivors do not have to reveal the details of any possessions held in trust through the public filing process that takes place during probate. In addition, if the grantor owns real estate in another state, establishing a living trust for the title to that property may allow survivors to avoid probate in the other state. A living trust can free the grantor from the burden of overseeing his or her financial affairs because a trustee manages all the assets of a living trust. More importantly, a living trust allows a trustee to manage the trust funds in the event that its creator becomes incapacitated or mentally or physically unable to oversee his or her possessions. If a living trust contains all of a person’s assets, then he or she may not need a will, and his or her survivors may be able to avoid probate. If only part of a person’s possessions are held in living trust, then a will is necessary to distribute those items in the estate not placed into a trust. However, a pour-over provision in a will can place any possessions remaining upon death into a pre-existing living trust.
The primary disadvantage of a living trust is that it involves the loss of some flexibility and control over one’s assets. Unlike wills, which become effective only at death, a living trust becomes effective immediately upon its creation. For the person who wants to retain unrestricted control over his or her estate, a will or a testamentary trust is a better estate planning tool because it can be changed at any time prior to death.
The primary advantage of a testamentary trustis that it allows the grantor to retain unrestricted control over his or her estate. A testamentary trust becomes effective only upon the death of its grantor. Like a will, a testamentary trust can be changed at any time prior to death.
The primary disadvantage to testamentary trusts is that they do not take advantage of the beneficial tax treatment given to living trusts. Because a testamentary trust only takes effect when the grantor dies, the grantor cannot enjoy any tax advantage during his or her life. Also, most testamentary trusts must go through probate.
Revocable and Irrevocable Trusts
A living trust can be either revocable or irrevocable. As implied by their names, a revocable trust can be changed or revoked after its creation, while a person signing an irrevocable trust gives up the right to change or revoke the trust. A revocable trust quite often is devised to supplement a will and/or to name someone to handle the grantor’s affairs should the grantor become incapacitated. A trust usually must be made irrevocable if the grantor wants to avoid income or estate taxes. Tax authorities consider the grantor of a revocable trust to be the owner of the property because he or she still controls the property. For this reason, income from assets held in a revocable trust must be reported as income to the grantor for income tax purposes. At the death of the grantor, property in a revocable trust is included in the estate for calculating estate taxes.
An irrevocable trust often is designed to be the beneficiary of a life insurance policy. Such a life insurance trust also can spell out how the policy’s money is distributed to survivors. In addition, irrevocable trusts often are set up to manage money given to minors and to charities. Finally, an irrevocable trust can be used to transfer assets to another person in the event that the grantor requires expensive medical care. Although doing so may protect the grantor’s family by ensuring that the cost of medical care does not wipe out the family fortune, it also may make the grantor ineligible to receive federal and state medical assistance.
With few exceptions, the estate of a person who dies owning property in his or her name cannot legally be distributed without first going through probate. Only if all of a decedent’s property is held in joint tenancy with right of survivorship (pursuant to a written agreement) or in trust can survivors avoid probate. Probate can operate with court supervision, called supervised administration, or without court supervision, called independent administration. Informal probate also is available. Some simple, small estates may be collected upon affidavit.
Regardless of the type of administration, the first duty of the probate court is to determine whether the decedent left a valid will. The person in possession of a decedent’s will must deliver it to the clerk of the court that has jurisdiction of the estate. If the decedent left a valid will, the court oversees the process of settling the estate according to the terms of the will. If the decedent did not leave a will or if the probate court determines the will is invalid, the probate court applies the state inheritance laws, described earlier, to the estate.
Collection of a small estate upon affidavit is available if the estate, not including the homestead and exempt property, is $50,000 or less, no petition for the appointment of a personal representative is pending or has been granted, and 30 days have elapsed since the death of the decedent. The assets of the estate, not including the homestead and exempt property, must exceed the known liabilities of the estate. An affidavit containing the information required by law is filed with the clerk of court and it is approved by a judge.
If the value of the assets of an estate, excluding homestead and exempt property, does not exceed the amount to which a surviving spouse and minor children are entitled as a family allowance, an application may be filed by or on behalf of the spouse and children requesting the court to make a family allowance and to enter an order that no administration of the estate is necessary. A family allowance is that amount sufficient for the maintenance of a surviving spouse and children for one year from the time of the decedent’s death.
There also are summary proceedings for small estates after a personal representative has been appointed. Summary proceedings only are allowed if the value of the estate does not exceed the amount required to pay the claims against the estate.
Independent administration permits the personal representative to administer the estate without most court orders or filings. Unless disputes arise between the beneficiaries or with third parties, or unless requested to intervene by the personal representative or an interested party, or unless the law explicitly provides for some action by the court, the court is involved only to open the estate; enter an order granting independent administration; approve the inventory, appraisement, and list of claims against the estate; and close the estate. The process reduces the time involved in probate. If the will so specifies or if any of the distributees of the decedent do not agree on independent administration, the court must supervise the administration.
An executor, or personal representative, or any person named as a devisee or legatee in a will may apply for the informal probate of a will. The application may be filed with the court 30 days after the testator’s death. Specific requirements must exist in order to apply for informal probate. For example, all of the estate’s known debts must have been satisfied. A judge may deny the application for informal probate if the requirements are not satisfied or if he or she determines that formal probate is necessary.
Supervised administration requires the personal representative to make required filings with the court, such as an estate inventory and periodic accountings. The personal representative also must obtain court approval to perform certain duties such as purchasing, exchanging, selling or leasing estate property.
Avoiding Death Taxes
A carefully created estate plan can considerably reduce the tax burden on an estate. Under Texas and federal tax law a decedent with an estate worth more than $600,000 must file an estate tax return and possibly pay federal and Texas estate or inheritance taxes. The federal government’s inheritance tax scheme is quite complicated. Under federal tax law a person is allowed to leave $600,000 tax-free to one or more individuals, other than a surviving spouse. The surviving spouse is entitled to receive an unlimited amount tax-free. If the estate is a very large one, however, and the entire estate is left to the surviving spouse, that surviving spouse may lose the option of giving $600,000 tax-free to individuals of his or her own choosing. An experienced tax attorney can help an individual avoid paying unnecessary estate taxes.
Regardless of whether the recipient pays state or federal estate taxes, there may be income tax consequences for the recipients under a will.