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December 2017 Border Bulletin Article
Protect Your Estate
No matter how much you hate getting bogged down in complex paperwork, paying legal fees, and considering your mortality, estate planning is necessary. If you don't plan properly, your family might be left in a desperate financial situation, and your inheritance might not be distributed as you intend.
When planning your legacy, consider whether establishing a trust is in your - and your heirs' - best interests. A trust is a fiduciary arrangement where assets are held by one party (the trustee) for the benefit of another (the beneficiary). According to WealthCounsel's 2016 Estate Planning Awareness Survey, which had 2,036 respondents, 17 percent of Americans have one in place.
If well-constructed by a competent attorney, a trust can avoid a costly, lengthy, and public probate; minimize taxes owed by your estate; and potentially protect your assets from creditors. A trust also allows for your specific wishes to be honored before or after your death. For instance, you could arrange for your son to receive $2,000 for every month he's in college and $300,000 when you die.
The devil's in the details
Maj. Gen. Joseph G. Lynch, USAF (Ret), a retired judge advocate and MOAA's general counsel and corporate secretary, agrees establishing a trust can be a smart move, but warns about common pitfalls associated with them.
“There's often a huge misunderstanding about how trusts work and exactly what trusts do,” says Lynch.
There are several types of trusts, each with its own benefits and drawbacks, and it's important to understand the distinctions. For example, living trusts - trusts created during a person's (or grantor's) lifetime - can be set up either as revocable or irrevocable. A revocable trust allows the grantor to change the terms of the trust and even dissolve it.
Because the grantor retains control of the trust, it's essentially like any other asset they own, and therefore might be subject to creditors (including Medicaid) and estate taxes.
“People believe all trusts guarantee avoiding estate taxes, and that's not true,” says Lynch.
With irrevocable trusts, you give up all control over the assets in the trust even while you're alive; you won't be able to remove the assets or change the terms of the trust. You must be absolutely certain you won't need access to those funds or want to change distribution terms, if, say, your youngest child wins the lottery. Irrevocable trusts often are used to limit estate taxes and reduce tax liability generated from the trust's assets.
Feeding the trust
People often go through the time and expense of setting up a trust but neglect to transfer any assets into it, rendering it a useless piece of paper. Lynch encourages putting big-ticket items into the trust, like houses and investment accounts. This requires changing the names on deeds, bank accounts, car titles, etcetera.
Lynch warns “refinancing or getting a home equity loan may be difficult while the home is in a trust, but as long as the trust is revocable, you can pop the home back out, refinance it, and convey it back into the trust when you are done.”
A trust must have a trustee, an individual or corporation legally responsible for managing it in the best interests of its beneficiaries. A grantor can be the trustee, but too often, says Lynch, the grantor fails to name a successor who will take over if the original trustee dies or becomes incapacitated. Successor trustees often are family members, but a common mistake is delegating control to someone who has good intentions but lacks the expertise to manage complex investments or business holdings. Banks, attorneys, and financial advisors often manage trusts, but they do charge a recurring fee.
Above all, the trustee should be competent and someone who you believe will adhere to the terms of the trust. To avoid misunderstandings or squandered funds, make your wishes as detailed as possible and specify compensation for the trustee. Naming cotrustees also might prevent abuse.
Speaking of exploitation, watch out for unscrupulous folks who will take advantage of ignorance regarding how trusts work.
“There are plenty of schemes and shady practices in the trust area,” cautions Lynch.
For example, dishonest promoters will claim trusts set up in foreign countries like the Bahamas or Panama will legally excuse you from paying any taxes on them, but this most likely points to an illegal tax-evasion scheme. Ask family and friends for recommendations for a capable, honorable attorney.
Also be aware that a trust can be expensive to set up and maintain, and there are other ways to reap some of its benefits. To avoid extensive probate without a trust, assets like homes and bank accounts can be owned jointly with right of survivorship or include transfer-upon-death stipulations. Avoid putting life insurance and retirement accounts in probate by specifically naming beneficiaries.
If the primary goal is to avoid taxes, a trust might be overkill; current federal law allows an individual to leave $5.49 million to heirs ($10.98 million for a married couple) without paying federal estate or gift tax.
Although most states share the federal exemption, many have lower thresholds, so be sure to verify your state's current limits. (Refer to MOAA's state tax guide at www.moaa.org/statereport for more information.) In addition, probate and other laws relating to trusts are administered at the state level and vary with respect to cost, residency, and other requirements. There are potential state tax implications for the trust beneficiaries as well.
Also remember, having a trust doesn't mean you shouldn't have a will.
“Invariably, you won't have everything in a trust,” says Lynch, who advises keeping funds for daily expenses out of the trust. It's easy to miss some assets - for example, an old checking account that might be found during probate. These missed assets can be addressed generically with a provision in your will.
Trusts are a valuable estate-planning option, but they aren't foolproof and might even be an unnecessary, expensive complication. Turn to a reliable attorney and tax expert to decide whether trusting in a trust is right for you.
By Vera Watson, MOAA Website