A trust is a legal relationship which is created when a person transfers property to a trustee with the understanding that the trustee will manage the property for the benefit of one or more beneficiaries. We use the term “property” here in its broadest sense; it includes both real property—such as land and buildings—and personal property—such as bank accounts, stocks and bonds, and personal effects. The person who transfers the property to the trustee is called a trustmaker (also known as a settlor, grantor, or trustor). In the typical revocable living trust scenario, the trustmaker is also the (or a) trustee and initial beneficiary of the trust. The written agreement between the trustmaker and the trustee is called the trust instrument.

What is the difference between a revocable trust and an irrevocable trust?

If the trust instrument says that the trustmaker can revoke the trust or change the trust instrument, the trust is what we call a revocable trust. The trustmaker has complete control over a revocable trust. If the trust instrument does not allow the trustmaker to change the trust instrument or revoke the trust, we have what is called an irrevocable trust. Irrevocable trusts allow trustmakers to make gifts but keep the recipients from having complete control over the gifted assets. Trustmakers must give up control over assets that they place in irrevocable trusts.

What is the difference between a living trust and a testamentary trust?

A living trust is one that you create during your lifetime by making a trust agreement with a trustee and transferring assets into the trustee’s name. A testamentary trust, on the other hand, is one that goes into effect and is funded (i.e., assets are transferred to the trustee) following your death. Thus, a revocable living trust is one that you create and fund during your lifetime, and over which you have virtually complete control.

What is probate?

Probate is the court proceeding to transfer a dead person’s assets to the people who are supposed to get them. Simple in concept, but humbug in practice. Probate can easily take a year or more to complete, and the attorneys’ fees and other costs associated with probate could easily eat up 5% of a decedent’s gross estate. (“Decedent” is lawyer talk for someone who has assumed room temperature—i.e., a “dead person.”) If a decedent owned assets located in more than one state or country, it may be necessary to have a probate in each jurisdiction in which assets are located. If one probate is bad, you can bet that more than one probate is worse. In almost every case, probate is an awfully good thing to avoid.

How does a trust help me avoid probate?

Once assets are transferred to the trustee, the trustmaker no longer holds legal title to them—even if the trustmaker and the trustee are the same person. Thus, if the trustmaker dies, the trust continues, and the successor trustee (who is named in the trust instrument) takes over administering the trust. Since a trust can’t die the same way a person can, the trust assets will not be subject to probate upon the trustmaker’s death. Title to the trust assets simply remains in the trust, and the trust instrument tells the successor trustee (i.e., whoever the trust instrument identifies as next in line to serve as trustee) exactly what to do with them.

What is a conservatorship and can it be avoided?

Perhaps even more important than avoiding probate, a revocable living trust can avoid a conservatorship proceeding (sometimes called a “living probate”) in the event the trustmaker becomes incapacitated. Ordinarily, if a person becomes incompetent, a court must appoint a conservator to handle the person’s assets on his or her behalf. The conservator must then account to the court every year or so, and the whole conservatorship process ends up being costly and time consuming and almost always worth avoiding. On the other hand, if the incompetent person’s assets had been held in trust, the successor trustee could have stepped in—without court action—and picked up administration of the trust where the trustmaker left off. Conservatorships can also be avoided by ways of powers of attorney.

What is a power of attorney?

A power of attorney is a document in which give someone else the legal authority to act on your behalf. The agent named in your power of attorney is not a trustee, and your agent will not be held to as high a legal standard as would your trust if the agent were to make a mistake or do something you didn’t like.

Are there different kinds of powers of attorney?

Powers of attorney may be durable or non-durable, springing or evergreen, and general or limited.

A durable power of attorney which continues to be effective even if the person who signed it (called the principal) becomes incapacitated. A non-durable power of attorney is revoked upon the principal’s incapacity. All powers of attorney are revoked upon the principal’s death.

A springing power of attorney becomes effective upon the occurrence of some even on a date after it is signed. A typical trigger for a springing power of attorney becoming effective is the incapacity of the principal. An evergreen power of attorney, on the other hand, is effective from the moment it is signed until the principal either dies or revokes the power of attorney.

A general power of attorney grants the agent broad authority to do just about whatever the principal could do with his or her property, whereas a limited power of attorney grants authority to deal with a particular transaction or subject matter.

What is the estate tax?

The estate tax is a tax on your failure to spend your last nickel at the same time as you exhale your last breath. The tax is imposed on the value of everything you own when you die (including life insurance proceeds and retirement plan death benefits, along with your house and everything else you would expect to be taxed). If you are a U.S. resident, the law gives you an exclusion from the Federal estate tax that enables you to shelter a certain amount of assets from the tax. For many years, this exclusion translated into a $600,000 shelter. As of 2005, the shelter is $1,500,000, and, under current law, it graduates upward over the next several years until it tops out at $3,500,000 in 2009. This shelter, called the “applicable exclusion amount” (formerly known as the “unified credit,” if you are familiar with that terminology) will increase as follows:

2005 $1,500,000
2006 to 2008 $2,000,000
2009 $3,500,000

As of 2005, if the value of your estate is more than the applicable exclusion amount, the tax rate is 45% on the amount in excess of $1,500,000 but less than $2,000,000. The value in excess of $2,000,000 is taxed at 47%. The maximum rate will decline 1% per year for the next few years until it reaches 45% in 2007. The top rate will stay there through 2009. As of 2010, the estate tax will be repealed entirely. However, because of a quirk in the way Congress makes tax laws, as of 2011, the estate tax repeal will be repealed, and the law will revert to pre-repeal law. This means that instead of there being a $3,500,000 applicable exclusion, it will be $1,000,000 beginning in 2011.

What are the chances that Congress will repeal the estate tax once and for all?

It is anybody’s guess what will happen to the estate tax, but one thing is for sure: Congress is not done tinkering with the estate tax law. Five years from now, the law will probably be very different from the way it is now, and “the experts” differ over whether the estate tax will ever actually be repealed. Many believe that we will end up with a relatively large applicable exclusion (perhaps $3,500,000; perhaps more), but that the estate tax is here to stay. All we know for sure is that we need to stay tuned for change in this area. In a whitepaper dated March 1, 2001, the accounting firm of Price Waterhouse Coopers summed up the history and the future prospects of the estate tax as follows:

The history of the federal estate and gift tax system is one of repeated repeal, followed by re-enactment, interspersed with various reforms. Over the course of its history, the system has been repealed three times, only to be re-enacted when needed for revenue. In no case were estates “grandfathered” from estate taxes when the system was again passed into law. Clients who fail to plan today for estate taxes that may be assessed in the future, even if a repeal bill is passed into law, are engaged in a gamble that history indicates is unlikely to pay off.

So even if repeal really happens, and even if Congress passes another law to prevent the repeal of the repeal, it seems prudent to assume that simply living until 2010 provides no guarantee of avoiding the estate tax.

If I have a will, my family won’t have to deal with probate, right?

Having a will does not cause your estate to avoid probate. It may make probate simpler and less expensive, but it does not avoid the necessity of getting a court order for someone to have authority to administer your estate and carry out the terms of your will.

If I have a revocable living trust, do I still need a will?

The trustee of a revocable living trust administers only those assets that were transferred to the trustee. If you own something outside your trust when you die, the only way to get it into your trust after you’re gone (which may be very important if some of your beneficiaries are very young or unable to handle assets themselves), is to have a pourover will. A pourover will simply says, “I meant to put everything into my trust while I was alive; if I missed something, put it in there after I’m gone.” It is much better for you and your family to have all of your things in your trust during your lifetime, but since that doesn’t always happen, a pourover will can be a crucial safety net.
 

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