Estate Planning Explanatory Letter

Most people are generally aware of the benefits of estate planning, but few comprehend the advantages of a Living Trust. This letter should answer some of those questions by describing what happens if a spouse dies (1) without a Will (intestate); (2) with a Will; (3) with a Will with a Testamentary Trust or (4) with a Living Trust.

I. WITHOUT A WILL (INTESTATE).

If you die without a Will, your half of the community property (not including life insurance, retirement plans or IRA's) automatically goes to your spouse. If you have any separate property (property you owned before your marriage or property you received by gift or inheritance during your marriage), a portion goes to your spouse and the rest is equally divided between your children (including children from a previous marriage). When each child reaches 18, the property is then given in a lump sum to that child with no regard for the child's experience, judgment, needs or level of responsibility. You will have lost the opportunity to distribute your property in a manner and to the individuals of your choice. You've also lost the opportunity to choose a guardian for your children or an executor for your estate. Probate expenses can total 5 to 10% of the estate, and it takes about six months to two years to close the estate to make sure all property has been properly transferred to the heirs.

II. WITH A WILL.

If you have a Will, at least you will be able to give your property to the individuals you and you can choose an executor to take care of your estate and choose a guardian or executor for your children, but you are still left with probate expenses and a delay in distributing the property (because of the time to close the probate). Furthermore, your minor children will receive their entire share in a lump sum at age 18 without regard to their level of maturity or responsibility.

III. WILL WITH TRUST.

Although there is no savings on probate expenses or time delay, you can avoid the possibility of your children receiving a lump sum when they reach 18 by establishing a Will with a Testamentary Trust. For example, you can direct that the Trustee gives one-third to the children when they are 18, one third when they are 22 and the balance at age 25. You can specify when income and principal can be used for each child. As another example, you can direct the Trustee to consider the child's health, education, support or maintenance in deciding whether and how much to give to the child. However, a testamentary Trust still remains under the jurisdiction of the Probate Court; as a result, every two years the Trust must submit an accounting to the Court.

IV. LIVING TRUST.

An individual with a substantial estate should definitely consider the benefits of a Living Trust. It makes little sense to work through life accumulating assets only to have much of your estate needlessly dissipated by estate taxes, probate fees and other expenses, all at the expense of your spouse and children.

The primary benefits of a Living Trust are: (1) federal estate tax savings; and, (2) avoidance of probate costs. For example, for a couple with property and insurance totaling $1,000,000.00 a Living Trust can save $150,000 in federal estate taxes and $50,000 in probate fees. If $5,000 is expended to set up the Trust, you will have saved your family $195,000.

A Living Trust (sometimes also referred to as an Intervivos Trust or Revocable Living Trust) is a major element in a sound estate plan. Unfortunately, this simple tool is poorly understood. Human nature being what it is, if we don't understand it, we will not use it.

The purpose of this letter is to take some of the mystery out of a Living Trust. The objective is to tell you, as directly as possible, some of the benefits available to you. Terms with which you may not be familiar are highlighted in bold print.

A. WHAT IS A LIVING TRUST?

A Living Trust is a legal document, prepared by an attorney. The Trust agreement will clearly state the terms and circumstances under which the Trustee must care for your property. It may also identify some of the property that will become part of the Trust.

The Trust agreement is a contract, a contract between you (you are known as the Trustor) and the Trustee. The Trustee may also be you or you may choose another person, or you may name a bank. Whoever serves as your Trustee is bound by the terms of the Trust agreement.

When the Trust agreement is signed, it takes on a life of its own just like forming a new corporation. This is an important distinction, one that provides many of the benefits.

During your lifetime, you retain complete control over the assets you have transferred into your Trust. You may add or withdraw property at any time. You may change Trustees. You may amend or cancel your Trust.

B. WHY SHOULD I HAVE A LIVING TRUST?

Because the terms of the Trust can be tailored to meet your specific requirements both during your lifetime and after, it provides benefits now, for the living, and for your beneficiaries, after your death. Some of the special benefits of a Trust include:

1. A Trust, because it is a separate legal entity, continues after your death.

2. A Trust, unlike a Will, is a private document. No one, other than those you specify, are entitled to know the terms of your Trust or the nature and extent of your assets.

3. Assets held in the name of a Trust are not subject to probate. In other words, at the time of your death, your assets are not frozen. The Trust continues its day to day business of collecting income and making disbursements for the benefit of those you have named. There is no delay during the transition from you, as the primary beneficiary, to those named as the secondary beneficiaries or remaindermen.

4. Because there is no probate, your estate may realize a substantial savings at the time of your death. Probating an estate requires the appointment of an Executor, and the settlement of your estate is under the jurisdiction of the Court. The cost of probate will generally run 5% to 10% of the value of your estate. A Trust saves most of this expense.

5. Assets deposited in a Trust will take on a new, stepped up basis upon death. This can result in a substantial income tax savings. If joint tenancy assets are not held in a Trust, only one half of the asset will receive the new income tax basis.

6. The proper use of a living Trust can significantly reduce the Federal Estate Tax due upon the subsequent death of a spouse.

7. If, during your lifetime, you should, for any reason, become incompetent and unable to care for your assets your Successor Trustee will continue to administer the Trust for your benefit. It will not be necessary to have the Court appoint a Guardian for your estate. This preserves your privacy and reduces expenses.

8. A Trust is an excellent vehicle to provide for and protect those who are not capable or suited for the responsibility of managing assets. This is particularly true for minor children or grandchildren. Here again, it will not be necessary to have a guardian for their estates.

C. WHY IS THE TRUST AGREEMENT SO LONG AND COMPLICATED?

There are two parts to a Trust agreement, one of which is of more concern to you than the other. The dispositive provisions are provided by you, and they are your major responsibility. These provisions tell your Trustee how you wish your property to be handled and distributed after your death. Most of us have quite straightforward ideas on this and it does seem quite simple. "When I die, my spouse is to receive all income and is to have access to the principal based on need. When my spouse dies, all assets are to be distributed to our children." Yet there are other questions to consider: Who is to receive income and under what circumstances? Who is to receive principal and under what circumstances? Who are the beneficiaries in the event those you have named are not alive to receive your property? What special considerations or circumstances must be considered at different times?

The second part has to do with the administrative provisions. The attorney's job is to take your dispositive provisions and blend them into the necessary legal language required to meet your objectives. In addition, the language of the Trust must contain the provisions necessary for the Trustee to carry out the requirements of the Trust in a practical and legal manner. The language must also reflect current tax law in order to achieve the greatest savings of current and future taxes, and just as important, the language must be artfully crafted to meet future circumstances not now anticipated.

The "boiler plate" language can be confusing to the layman and is even sometimes regarded as unnecessary to accomplish the purpose of the Trust. It is, however, essential that the Trustee, particularly the successor Trustee, have this language. Ask anyone who has been a Trustee how often they have had to refer to the terms of a Trust agreement and whether they have been thankful to have a well-drafted document. Any confusion can be reduced by having the attorney provide you with a brief explanation as to the purpose of each section.

Don't let the length of the document discourage you. Every word is there for a specific reason. You must have confidence in the qualifications of your attorney. Your main concern should be to clearly tell the attorney how you wish your property handled.

D. HOW IS THE TRUST FUNDED?

Drafting and signing the necessary documents is only the first step. A Trust agreement is worthless if the Trust does not hold assets. None of the desired goals (your estate plan, the benefits, the savings, the protection of beneficiaries) are realized if assets are not transferred into the Trust by putting them in the Trustee's name. This transfer is referred to as "funding."

Funding is actually quite simple, but you would be surprised at the number of Trusts that are not funded or are funded improperly. Sometimes this occurs because the client or the attorney has not followed through. Usually, it is because of reluctance on the part of the Trustor (you) to complete the final step. Both the client and the attorney are responsible for overseeing the proper funding of the Trust.

Remember, the Trust is a legal entity. Property must be transferred to the Trust in the same manner and with the same formality as if you were selling them. In other words, the transfer must meet all the legal requirements of a sale. The only difference is that you are transferring your assets from your name as an individual to your name as a Trustee. Except for the cost of preparing necessary documents, there is little or no expense associated with the transfer. Different assets have different requirements. For example:

1. Real property will be transferred to the Trust with a deed prepared by your attorney. The deed must be recorded.

2. Registered stocks and bonds will be transferred using a properly completed stock/bond power (available from banks or brokerage firms). Signatures must be guaranteed the same as for a sale. A notarized signature is not acceptable.

3. Bank accounts and other assets are transferred with an assignment prepared by the attorney.

While all of this may seem a bit of a bother, funding only has to be done once. Besides, nothing has really changed. The asset you once held in your name as an individual is now held in your name as Trustee. They are the same assets, essentially the same ownership, only now it is a protected asset.

E. WHAT HAPPENS DURING MY LIFETIME?

Aside from signing your name as a Trustee; nothing happens. Your assets are still yours, and you still control them. You still receive the income, and you still pay taxes on the income. You sell when you want to. You buy when you want to. Just remember to buy in the name of the Trust!

Having a Trust does not prevent you from making full use of your assets just as you did before you created it. You may still borrow funds by pledging assets. The only difference is that

you will sign the loan papers as a Trustee. Some lenders will ask you to also sign as an individual.

One common problem is that of purchasing or financing real property in the name of a Trust. Here is the simplest solution:

1. Tell the lender you are considering taking out the loan in the name of your Trust. If they understand immediately, you are fortunate enough to be dealing with an intelligent institution. If they look at you like you just landed from Mars, proceed to the next step.

2. If it is a new purchase, buy it in your individual name(s) just as you did before you had a Trust. When the purchase is complete, have your attorney transfer the property to the name of the Trust and record the deed.

3. If it is a loan on property already in the name of the Trust, have your attorney prepare two deeds. The first will transfer it from the Trust back to individual names to satisfy the Neanderthal lender. The second will transfer it back to the name of the Trust once the transaction has been completed.

This doesn't come up often, so accept it as a minor irritation necessary to fully and properly protect your assets.

When placing your home in Trust, you should take two additional steps. First, be sure to have your insurance agent name the Trust as an additional loss payee. Second, homestead the house in the name of the Trust.

F. WHAT HAPPENS WHEN I DIE, OR UPON THE DEATH OF MY SPOUSE?

This is where the estate planning aspects really come into play. The exact manner in which your assets are handled is a matter of personal preference, something you will want to keep in mind while discussing this with your attorney.

It is important for you to have a clear understanding of the alternatives available to you and the consequences of the alternative selected. You should insist that these be clearly outlined and that you understand them fully. This is not the time for you to feel intimidated or reluctant to express your true feelings with respect to the future disposition of your property.

Here are the three most important considerations in having a Trust drafted:

1. Your personal desires now and for the future.

2. The administrative provisions the Trust must be workable.

3. Tax savings.

Number 1 is your personal desires and preferences. You must remember this at all times. We have seen too many cases where number 3, the attorney's desire to save taxes, becomes the tail wagging the dog. Tax savings are available, and they are important, however, they should not override your personal requirements. There is nothing wrong with your passing up substantial tax savings as long as you understand the cost.

Some Trustors are reluctant to suggest a disposition of assets outside the "normal." Rather than risk having their advisors think them selfish or uncaring, they will agree to a standard distribution of assets. Don't fall into that trap. If you wish to treat beneficiaries unequally, by all means, do so. You know their needs, circumstances, and abilities better than anyone else.

So, with this preface, here is how the Trust is commonly divided at death:

1. When one spouse dies, a portion of the Trust becomes irrevocable. This portion is variously referred to as the bypass Trust.

a. The bypass Trust is made irrevocable primarily to keep it from being taxed again upon the death of the survivor. In spite of its irrevocable nature, the Trustee may have the discretion to pay out principal for the benefit of the survivor.

b. Upon the death of the survivor, the Trust would either continue for the benefit of children, or terminate and be distributed to the children.

2. The remaining assets are allocated to the Survivor's Trust, which continues to be revocable. This means the surviving spouse would have all the same rights, powers and privileges as before.

a. Because of this, the assets held in the survivor's Trust are subject to Federal Estate Tax. For this reason, when appropriate, the survivor is encouraged to use assets from the survivor's Trust to meet current needs or gift programs (as opposed to income or assets from the bypass Trust which will pass free from estate taxes).

b. Upon the survivor's death, the remaining property in the survivor's Trust may be distributed as provided in the Trust by a general power of appointment or under a valid Will.

There are, of course, a number of variations on these themes. In some cases, your attorney may well recommend establishing more than one Trust to meet your needs.

G. DO I STILL HAVE TO HAVE A WILL?

Yes! Your Trust disposes of the assets held in the name of the Trust at the time of death. Your Will allows your Executor to gather up assets outside of the Trust, probate them and make proper distribution. Usually, this document will be referred to as a Pour Over Will. The purpose is to gather assets and distribute them to the Trust.

The Will and Trust work together to take care of the disposition of all of your assets. To keep it simple, your Will merely transfers property to the Trust and the Trust will generally be the only document with dispositive provisions.

In addition to a Will, your attorney may well recommend associated documents for the protection of you and your assets such as a Living Will and a Durable Power of Attorney for health care and financial decisions.

H. HOW MUCH DOES ALL THIS COST?

It does cost more to have a Trust prepared than a Will. Costs will vary according to the complexity of your estate. The range is broad, but a very simple Trust might cost several hundred dollars while a multiple Trust estate plan will run into the thousands. The fee for drafting the Trust does not usually include the fees and costs for funding the Trust, that is, making sure all assets are properly transferred into the Trust. Ask for an estimate before you start.

Remember, the attorney is being compensated for time spent now. One of the reasons you are doing this is to save your estate far greater expenses when you die and to give you peace of mind for the rest of your life.

I. WHERE SHOULD I START?

Give us a call. We are here to answer your questions and to serve your interests.