Congratulations, you prepared your estate plan, including your family trust. You now believe that your assets are safe from probate, and they will pass to whom you’ve designated, in the manner you’ve designated. Everything, in your mind, has been taken care of. However, is this truly the case? Review some of the following common pitfalls and misconceptions below about trusts, to ensure your estate plan is ready and able to function as you intended.
A trust is a legal entity, created by a Trustor for the purposes of 1) avoiding probate, 2) reducing estate taxes, and 3) designating the who’s and how’s of the manner in which your estate will be passed on to your beneficiaries. However, for the trust to be able to provide these levels of protection, the trust must be funded. In other words, you must transfer your assets and accounts into the trust, to enable your trust to be able to function. Indeed, a trust without any assets or accounts can be viewed as mere fancy words on paper, void of any real power.
It should be noted that it is not necessary to transfer all of your assets/accounts into your trust, and each person’s circumstances will vary. Some assets are able to avoid probate based on the title in which they are held, or by the use of pay on death beneficiary designations. In addition, probate may be avoided if the total value of your estate is less than a certain amount, which in California is currently set at $150,000.
Due to the high cost of real estate in California, most people are advised at a minimum to transfer their real property into their trust. A surprisingly common mistake can be forgetting to transfer your house, or in particular, your new house after a recent move, into your trust. Failure to do so can leave your house exposed to shockingly high costs and fees in the probate process, all of which could have been avoided.
Another pitfall in establishing one’s estate plan is the notion that the language of your will or trust will take precedence over the language in your beneficiary designation forms. Say, for example, years ago when you set up life insurance, you named your nephew as the beneficiary to your life insurance. Now, when establishing your estate plan, you instead decide to name your child in your will or trust as the beneficiary to all your assets, including your life insurance proceeds. In the event of your passing, which beneficiary will receive the life insurance proceeds?
Even though your estate plan was established more recently, the person you named on your life insurance beneficiary designation (in this case, your nephew) will prevail in receiving the insurance money. This is because by law, the insurance company is required to make payment to the person named on the beneficiary form, regardless of the language of a person’s will or trust. Payable on death beneficiary forms are utilized in many situations, such as with life insurance or retirement accounts. As such, it is of utmost importance to ensure your payable on death forms are current, and the beneficiaries named on these accounts in your estate planning documents mirror the beneficiaries listed on the forms.
I’ve often heard the belief that placing your assets in trust eliminates your estate from tax liability, particularly estate tax liability. An estate tax is a tax which may be levied against your estate, and is paid from the estate prior to the distribution of your assets after your passing. Some have dubbed this the “death tax,” mocking the government’s reach into one’s pockets, even after death.
Luckily, California is one of the states which does not impose an estate tax at the state level. With respect to the federal estate tax, many California estates are exempt from this tax as well. As of 2017, only estates with combined gross assets and prior taxable gifts exceeding $5,490,000, are subject to the federal estate tax. All other estates valued under this amount are exempt.
With regard to the federal estate tax, merely transferring your assets into a living, revocable trust does not automatically shield your estate. This is because a revocable trust allows the Trustor to retain control over the trust’s assets, and the ability to revoke the trust at any time. As such, the assets within a revocable trust are still considered part of your (taxable) estate. To reduce the value of your estate prior to one’s death, you may consider gifting, transferring, or re-titling of assets, so certain assets are no longer considered part of your estate.
While a revocable trust may not shield your estate from the federal estate tax, there are various types of irrevocable trusts, including the Irrevocable Life Insurance Trust (ILIT), the Qualified Personal Residence Trust (QPRT), and the Charitable Remainder Trust (CRT), which are designed to assist you in shielding your assets under these circumstances. In addition, assets once held by a married couple in a revocable trust, may later be transferred by a surviving spouse into an irrevocable sub trust. This allows a married couple to take advantage of recent tax laws which allow couples to shelter twice the amount of assets from the federal estate tax.
As evidenced above, understanding how your trust can and cannot function presents a myriad of issues, not only during the initial preparation of your trust, but also in the years to come afterwards. One of the most unfortunate estate planning mistakes is to have your trust prepared, and then neglect to review or update your estate plan as time passes. Circumstances, life, and the law change. At the Law Office of Christine Padilla, we welcome you to contact us to establish or review your estate plan, to ensure your wills and trust will truly function as you intended. – Christine Padilla, Attorney & Owner.