THE 5 MOST COMMON ESTATE PLANNING MISTAKES AND HOW A LIVING TRUST FIXES THEM
By Kent Phelps, Esq.
Thinking A Will Is Enough
So you have a will. Here is what happens when you die:
Probate has been defined tongue in cheek as "a lawsuit you file against yourself after you die with your own money for the benefit of your creditors." YOUR WILL DOES NOT AVOID PROBATE!
On the contrary, if you have a will, the original must be filed with the court and judged to be authentic and valid under state law. There are six primary negative aspects to putting your heirs through the probate system:
1. Loss of Control - Instead of administering your estate within the family, your heirs must now rely on a judge to oversee the administration of your estate within the court system.
Although you designate a personal representative (this is what we call the "executor" in Arizona) in your will, the personal representative operates under the supervision of and must report to the judge.
2. Delay - The average probate in Maricopa County is taking 18 months to resolve. While the time a probate takes to conclude depends upon many factors, the fact remains that you are competing with all the other matters on the judge's docket for time and attention. You are at the mercy of the court.
3. Loss of Privacy - The documents filed in a probate matter, including the final inventory of all of your assets, is public record.
There are companies and individuals that make a living combing the public probate record looking for potential customers. Some of these are legitimate but pesky. Others are plain exploitative.
Probate is 'a lawsuit you file against yourself after you die with your own money for the benefit of your creditors'
4. Cost - While probate can be expensive enough (certainly more expensive than a plan that avoids probate) if just one attorney is hired to assist the personal representative, the real expense comes when both the personal representative and beneficiaries "lawyer up."
With multiple attorneys involved, probate expenses can quickly get out of control. As demonstrated by Charles Dickens' novel, Bleak House, you don't want an estate plan where, at the end of the day, the lawyers are the only winners.
5. Family Conflict - It is common sense that if you want to avoid disputes in your family, you do not want to force your family members into an adversarial process, which is what our court system is by its very design and nature.
Also, "no contest provisions" (which disinherit a beneficiary who files a court action disputing your will) are typically unenforceable in a will.
Such provisions, as well as alternative dispute resolution procedures such as mediation and arbitration, can be incorporated into a revocable living trust. If keeping harmony in your family is important to you, a courtroom is usually the last place you want to be.
6. Windfall - With a will, a beneficiary will typically be entitled to receive all of their share of your estate even if they are as young as 18 years old.
If the will does provide for staggered distributions based on age, it means the court will have to stay involved, and reports and accountings must be filed with the court by the personal representative every year until all distributions are made.
THE FIX: Revocable Living Trust
Transferring your property to a revocable living trust (aka "Living Trust" or "Family Trust") will keep your estate out of court. The best way to understand a trust is to think of it as a contract between three parties - a grantor (also referred to as a settlor or trustor), a trustee, and a beneficiary. Each has a specific role:
Grantor - The grantor is the creator of the trust and makes the rules. I like to refer to the grantor as the "legislative branch" of the trust. The grantor is also the one who transfers their property to the trust.
Trustee - The trustee is in charge of the trust and carries out the grantor's instructions. The trustee enforces the rules of the trust. I refer to the trustee as the "executive branch" of the trust.
Beneficiary - The beneficiary has the best job of all. The beneficiary gets to enjoy the property of the trust, so I refer to the beneficiary as the "citizen" of the trust.
Makes the Rules, Donates the Property
Enforces the Rules
Enjoys the Property
With a typical revocable living trust structure, you (and your spouse if you are married) fill all three of these roles. You create the trust for your own benefit and remain in charge of your own assets during your lifetime.
This is why it is called a revocable "living" trust.
Since you fill all three roles, during your lifetime the IRS disregards this trust altogether, so you do not need to file a tax return for your trust. Your tax reporting obligations do not change.
"You create the trust for your own benefit and remain in charge of your own assets"
You can amend the trust any time to remove or add beneficiaries, change successor trustees, accommodate changes in the law, or generally make any other change to the trust you want.
This is why it is often referred to as a "revocable" living trust.
When you transfer your property to a trust, you technically no longer own it - your trust does. So when you die, you don't have an "estate" and your heirs don't have to go to probate court to obtain ownership of your property.
Avoiding probate saves your loved ones the trouble, expense and time of a costly, time-consuming court proceeding that could invite conflict into the family.
Failing To Fund The Trust
Even with a revocable living trust, you still need to change title of your "probatable" property to the trust to avoid probate.
In Arizona, if the value of all of your personal property is > $75,000 OR your real estate has a value (net of debt) > $100,000, your property must be transferred to the trust to avoid probate.
This is one of the most common mistakes we see when a new client comes to us with an existing trust.
So often, estate planning attorneys and online document preparation services fail to follow up with their clients and customers to make sure all eligible property is transferred to the trust.
It is also important to remember that when additional property is acquired after you have a trust that it is also titled in the name of the trust.
If your property acquired both before and after you sign your trust is not transferred to the trust, your heirs will end up in probate court even though you executed a trust.
THE FIX: My Guardian Angel Membership
We place a high importance on the requirement to transfer your property to your trust (referred to as "funding" the trust) after you sign the trust agreement.
So we include a free year of our My Guardian Angel Membership with the purchase of any estate plan (a $204 value).
This benefit ensures that our team will work diligently with you after your signing meeting to make sure all your eligible property is transferred to the trust.
Putting Children On Deeds and Bank Accounts
We have seen people who, in order to avoid the expense of implementing an estate plan, will make their children signers on their bank and investment accounts. We have also seen them put their children on the deeds to their homes.
They do this so that if something happens to them, their children will have immediate access to the account without having to go to court.
The obvious problem is that if the child is not trustworthy and becomes desperate, they can empty your bank account or sell your property from underneath you. Let's assume, however, that the child is trustworthy and would never do that.
There are multiple less obvious problems with this "solution".
YOUR CHILD'S CREDITORS ARE NOW YOUR CREDITORS!
First, your child's creditors are now your creditors! If your child defaults on a debt obligation, your account can be seized.
If your child files bankruptcy, the bankruptcy trustee can take control of your account.
If your child is late paying their taxes, the IRS (without a court order!) can garnish your bank account.
If your child has a falling out with a business partner or is in a car accident and a judgment is obtained against them, the judgment creditor can take your account.
In one case we know of a mother who put her daughter on her bank account as a simple way to ensure the account could be accessed if something happened to her.
The daughter subsequently defaulted on a home equity line of credit and the credit union that held the loan garnished the mother's bank account.
This should be reason enough not to use this method as a substitute for having an estate plan, but there are others.
Making your child an owner on your accounts or properties may be considered a taxable gift. Depending upon the balance in the accounts or the value of the properties, it could have adverse gift and estate tax consequences to you, your child, or your other children.
If you become incapacitated, or after your death, while you may have trusted your child to share the cash in these accounts equally with their siblings, they have no legal obligation to do so. If they do not carry out your wishes, it could result in, at the least, bad feelings in the family or, worse, a lawsuit.
By executing a durable general power of attorney, you can give authority to your children (or whomever you want) during your lifetime over your finances and property without giving them ownership of your accounts.
A properly drafted power of attorney will allow them to continue to pay your bills and make sure your financial needs are met if you are incapacitated. If necessary, they can sell or refinance your home to pay medical bills.
In a power of attorney, you are referred to as "principal" and the person you designate as your "attorney in fact" is referred to as "agent."
We typically recommend a durable general power of attorney, which is effective as soon as you sign it. Since the authority you give your agent is significant, we instruct our clients to keep the original in a safe place and carefully control copies.
In addition to a power of attorney, you can utilize a revocable living trust during your lifetime as a way to give your children (or whomever you want) authority over your property as desired without the adverse consequences discussed above.
You may designate your child now as your co-trustee, giving them all the access to your finances and property you want to give them now without exposing your property to their creditors or adverse tax consequences.
Even if sharp mentally in their later years some clients prefer to hand over the day to day finances to their children. This is an effective way to do it without the downsides of adding them to your accounts.
INCORRECT LIFE INSURANCE BENEFICIARY DESIGNATIONS
Most people have life insurance policies personally owned that name their spouse as the primary beneficiary and their children as secondary beneficiaries.
This structure can create a number of problems:
If children are minors at the time of death, a conservatorship will have to be established through the court system and remain in place until they turn 18.
A child will get a large pay-out with no strings attached on their 18th birthday.
Life insurance distributions will be available to your adult children's creditors and unprotected from other crisis events your adult children may face such as addictions or other personal dysfunction.
Life insurance is included in your estate for estate tax purposes. Most people are under the impression that life insurance is tax free. The death benefit paid from life insurance will be income tax free, but depending upon your net worth and without proper planning, it may be subject to a hefty estate tax.
A LIFE INSURANCE "NO NO!"
A case we are familiar with involved a parent who died with a life insurance policy that had a peculiar beneficiary designation. The parent had designated the beneficiary of her life insurance policy as "my estate".
This had the effect of forcing the children into probate court to get the life insurance money! The children had to file a probate action and go through the probate process just to obtain the life insurance pay out.
This is an example of failure to properly fund the trust. The whole ordeal could have been avoided by filling out a simple change of beneficiary form provided by the life insurance company and designating the trust as the beneficiary instead of the estate.
With the My Guardian Angel Membership you receive when you purchase one of our estate planning packages we help you fund your trust with your insurance policies and make sure mistakes like this are avoided. Keep reading to see how...
Designate the Trust as Beneficiary
If your net estate (including life insurance!) is below current estate tax exemptions (currently $5.6million per person), simply making your properly drafted revocable living trust the beneficiary of your life insurance policies will resolve the issues raised above.
Funds can be held in trust for under age children without court involvement.
Funds can be paid out over time to young adult beneficiaries consistent with the schedule you decide on in the trust.
Funds can be protected from crisis events your beneficiaries may experience.
Making the trust the beneficiary of your life insurance is easy. Simply complete a change of beneficiary form provided by your life insurance company.
Use an Irrevocable Life Insurance Trust (ILIT)
If your net worth including the value and death benefit of your life insurance is over the estate tax exemption of $5.6million for an individual ($11.2million for a couple), you should create an Irrevocable Life Insurance Trust (ILIT) and make it the owner and beneficiary of your life insurance.
When an ILIT owns your insurance it is not included in your taxable estate. It also provides the same protections and flexibility to spread out distributions as a revocable living trust.
Not Transferring Our Values With Our Money
Sometimes a client will say, "I don't care what my kids do with the money when I'm gone - I'll be dead!"
As we talk through this topic, however, the client comes to realize that while they may not care what their children do with their money, they do care what their children become as a result of the way they use the parent's money.
We believe that we cannot separate the two. The way our children use our money may have an impact - perhaps a dramatic impact - on who they ultimately become.
Ignoring this fact can have unintended negative consequences and create dysfunction not just for your children, but for future generations.
"The way our children use our money may have... a dramatic impact on who they...become"
We have all heard stories of lottery winners, athletes, Hollywood stars, and heirs to fortunes ruining their lives after coming into a large sum of money.
You may be thinking, "but I don't have as much as those people." It is all relative. Inheriting $100,000 can create as much opportunity for damage for one person as coming into $100 Million could for another.
Most cultures have a proverb similar to the one we have in the U.S.: "Shirtsleeves to shirtsleeves in three generations."
This refers to the cycle most families find themselves in where, no matter the dollar amounts involved, wealth is usually squandered in three generations.
Squandered wealth and ruined lives are a choice, not an eventuality. With proper value-transfer planning, this cycle can be avoided.
Give Meaning to Your Money Beyond It's Purchasing Power
It's a movie about a young adult named Jason whose wealthy grandfather (played by James Garner) just died. Jason thought his inheritance was going to be money, and lots of it.
However, the grandfather structured his estate plan in such a way that before Jason could obtain any of his grandfather's wealth, he had to come to appreciate 12 gifts.
The list of gifts from the movie may be helpful for you as you brainstorm what values you may want to transfer:
Gift of Work Gift of Dreams
Gift of Money Gift of Giving
Gift of Friends Gift of Gratitude
Gift of Learning Gift of a Day
Gift of Problems Gift of Love
Gift of Laughter Gift of Family
If you watch the movie, you will notice the extensive planning and arrangements the grandfather and his attorney implemented to help the grandson become a responsible, contributing member of society. Your plan to incorporate your values does not have to be so rigid or elaborate.
LETTER OF WISHES
We provide a Letter of Wishes with our trust packages to help clients pass on their values to their loved ones and future generations.
Clients have used their Letter of Wishes to tell the story of how they struggled financially early in life and why they were ultimately able to achieve financial success.
The Letter of Wishes has also been used by clients to convey love, family values, religious faith, educational values, financial instructions, and political beliefs.
The Letter of Wishes is a powerful - yet flexible - tool to use in your estate plan to convey values in a non-dogmatic fashion so the trustee can accommodate unforeseen changes in circumstances.
It is also simple. You can write it at your leisure when you are ready. But do not procrastinate!
Many people think they are doing the right thing when they hide their wealth from their children and do not tell them how much they are going to get.
They do this thinking that if they told them, their children might stop working or get complacent while they wait for mom and dad to die.
This is a mistake and a good way to promote dysfunction and contention in the family after you are gone.
Studies clearly show we should talk to our children - young and old - about money. The healthiest approach is to turn all the cards face up.
Giving your children some of their inheritance while you are alive to see how they do may also be a good idea. We like to tell clients that if you are going to give a gift, it is better to give it with a warm hand than a cold one!
We hope you enjoyed our Special Report: The 5 Most Common Estate Planning Mistakes and How to Avoid Them. If you would like to print the Special Report, just right click anywhere on this page on your desktop and choose "print".
We also hope you will take a moment to browse our estate planning packages: