Funding Trusts and Probate Avoidance

 

 

Funding Trusts and Probate Avoidance

 

When setting up a trust, most clients share a common goal – they want to save time and trouble. Put another way, most want to avoid probate. Probate avoidance strategies are useful because they circumvent probate’s pitfalls: filing in probate or surrogate’s court, publishing in a newspaper, waiting for challenges to the will or appointment of the administrator, and dealing with the delays that accompany any court process.

And unfortunately, a will doesn’t avoid probate.

If probate avoidance is a priority for you, carefully consider how to fund your trust. Should you transfer all of your accounts into your trust or should you name your trust as the beneficiary? I conclude the response is to change the ownership to the trust on some accounts and name the trust as the beneficiary on others. Let’s look at an example to explain when and why:

Real-World Example

Charlie and Diane (C&D) have created a revocable trust plan. They are now 65 years old and have two adult children. Their health is good and they enjoy privacy in their business matters. They are proud of their nest egg, so it’s important to them to protect it from unforeseen future risks as much as possible. 

Among other assets, they have: 

  • bank accounts
  • brokerage account
  • IRAs
  • 401(k)s, and 
  • life insurance 

C&D created a revocable trust so that they could privatize and make the administration process easier. They want efficient, private control, private accounting, and private distributions to their heirs. They want to be in a position to minimize taxes and protect their children’s inheritances.

Ownership considerations: If they keep assets as joint, there will still be probate when the second of them passes. If they put their children down as joint owners, they expose the estate to more risk factors that they cannot control – the debt, divorces, disabilities and other uncertainties involved in the lives of their children, their spouses and families. 

Beneficiary considerations: If they simply name each other as beneficiaries on assets, they may miss the opportunity to shelter assets from taxes and risks like second marriages and old-age illnesses. If they make their children beneficiaries, then they may forfeit control of the outcome of their estate.

Often folks do not realize that unless they use the trust as owner or beneficiary, their estate is still going to go through probate or be exposed to the very risks they were trying to avoid. 

Funding the trust – the act of transferring assets to the trust as an owner or naming the trust as a beneficiary is what will give the protection they want. Why create a trust if you’re not going to use it? But does that necessarily mean ownership in the trust? No. 

Here is a 3-point pattern that we recommend:

  1. Ownership. The best practice is to have C&D’s trust own their assets that can be owned by trusts. IRAs and 401k’s cannot be owned by a trust. C&D will get an A+ in estate planning by having their trust own everything possible.

    But I grade on a curve:
  2. Transfer on Death. For single persons and couples who are healthy and not advanced in age (not yet 80 for most purposes), payable on death arrangements (transfer on death and other beneficiary designations) are a strong arrangement. Coupled with having at least one account owned by the trust, C&D will have a solid set-up.TOD and POD arrangements done right can also earn an A+ in trust funding.Effect of Transfer on Death:
    • One dies, the survivor owns the asset but the trust is still the beneficiary.

      If we want the trust to own the deceased’s portion of an account for tax reasons (like sheltering for future estate tax avoidance), the survivor can disclaim the half they would have received from their spouse. Disclaimers can be mismanaged, so See #1 – trust ownership – to be sure you get the outcome you are looking for.
    • C&D both die – the account they once owned is now payable to the trust. If the institution has an account under the trust name, the institution pays the former joint account over to the trust account and the trust owns the asset.
  3. Beneficiaries. Trusts make good insurance and annuity beneficiaries. If the trust is designed to be an IRA beneficiary, then it should be the contingent beneficiary of the IRA after the spouse in most cases. If no spouse, the trust can be the beneficiary. If the trust is not designed for IRAs, then C&D need to name individuals.

What should Charlie and Diane do? 

Since C&D have a trust designed for all assets, including IRAs: 

  • They should take the time to re-title their accounts. 
  • They will sign forms putting all of their personal property and even intangibles in their trust.
  • They will name each other and then their trust as alternate IRA beneficiary. 
  • They need to take care of their real estate (See our post on Funding Real Estate to Trusts) as well as any business interests or other unique assets. 

And, Charlie and Diane need to stay current in their planning and be sure their trust is keeping up with the law and current strategies.

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