With proper guidance, drafting, and implementation, your living trust estate plan will be effective to avoid probate, unnecessary taxes, and court control of your assets at your death or in the event of incapacity. However, without proper guidance, it is easy to make mistakes. First of all, incorrect assumptions or lack of prioritizing may lead to the failure to create a living trust.
But once the process to create a living trust has been started, mistakes may occur in the planning, drafting, or implementation phase. The following is a summary of a few significant estate planning mistakes.
Selecting Joint Tenancy vs. Living Trust
Unfortunately, many people attempt to avoid a timely and costly court probate procedure on their homes by placing them in Joint Tenancy. Many people do not realize that this practice can have serious negative consequences for several reasons. If you add your child as joint tenant, your children’s share of the property becomes subject to the children’s creditors. And if your relations change, it is possible your children could force a sale of your property since they have an equal right in ownership. Though joint tenancy can avoid probate on the first spouse or joint tenant to die, the estate must go through probate upon the death of the surviving spouse or joint tenant. Joint tenancy simply delays probate until after the last surviving joint tenant dies. If both joint tenants were to die at the same time, the property would have to be probated.
Furthermore, lifetime gifts of property do not receive a stepped-up valuation like inherited property. When a parent adds their child as a joint tenant to their property, it’s considered a gift, which does not get a stepped-up tax basis. Although the one-half share eventually inherited from the parent will receive a stepped-up basis (eliminating the capital gain tax on that portion), the gifted portion on the other hand does not receive a stepped-up basis thereby exposing the child to significant capital gains tax upon sale. By simply making the living trust the owner of the property, probate is entirely eliminated and all capital gains taxes are completely eliminated at the parent’s death.
Misconceptions – Believing that a Will Functions as a Living Trust
Unlike a living trust, a Will must go through probate, which is a costly and lengthy court-controlled process of administrating your estate after you die. All probate actions are public and require letters of notice to invite creditors, potential heirs, The State, and other possible claimants to file claims against your assets. Having just a Will is of no use in the event of temporary or permanent incapacity. Certain powers of attorney and appropriately drafted provisions in a living trust are needed to handle property, finances, and medical decisions during incapacity, otherwise the expense and hassle of a court conservatorship action may be necessary.
Improper Funding of the Trust
A particularly common misconception is that your estate plan is complete once all of your estate planning documents have been signed. However, to avoid probate, you must correctly transfer your assets to your living trust, as leaving out assets can defeat the purpose of your estate plan. Nearly all your assets must be transferred to the trust; this way, your successor trustee can access your accounts to pay your bills, handle your financial affairs, and eventually distribute the assets to your beneficiaries without any involvement of the probate court. This includes ensuring most financial accounts, real estate, and corporate entities are owned by the trust. And you must ensure proper beneficiaries are named on tax deferred retirement accounts and life insurance. In some cases, the trust can be named beneficiary, and generally, with few exceptions, you should not change the title owner of tax deferred accounts and life insurance.
Sloppy Drafting or Lack of Consideration
Failure to make a careful distinction between percentage allocations versus specific gifts can lead to beneficiary distribution problems. For example, in leaving a specific dollar amount to a specific beneficiary, the funds may have already been exhausted, or the gift may end up being an inappropriate amount, depending on actual size of the estate at death. Or, a specific real property bequest may no longer be possible if the property had been encumbered or sold prior to death. Or it may be worth far more, or less, than when the trust was initially drafted. Percentage allocations often alleviate these potential problems. Next, the trust should not fail to designate contingent beneficiaries. For example, if your child dies before you, should that child’s share of the inheritance be distributed to your grandchildren, or only to your surviving children? Also, you may want your trust to regulate distribution to age 21, 25, or 30, rather than leaving assets outright at age 18 to heirs prone to mismanagement or who may quickly squander their inheritance, or who may be subject to creditors or an ex-spouse. Finally, appointing the wrong person to act as successor trustee can lead to unnecessary disputes between the beneficiaries and trustee.
Outdated/Inappropriate Type of Trust
Trusts requiring a mandatory A-B trust split after the death of a spouse were very common prior to 2006. In some cases, this was beneficial for reducing estate tax. Currently however, the federal estate tax exemption is much higher at $11.4 million, so estate tax avoidance may no longer be an issue. Specifically, estates under $11.4 million could suffer from a loss of step-up in tax basis after the death of the surviving spouse if there is an unnecessary mandatory A-B trust split. For couples with a trust drafted prior to 2006, and whose estate is unlikely to exceed $11.4 million at death, a good solution may be to convert an older A-B trust to a Disclaimer A-B trust, which allows the surviving spouse to delay the decision of whether to split the trust, until nine months after the death of the first spouse, at a time when estate tax rates, exemptions, values, and other figures may be better ascertained.
Attempting to Do it Yourself
Relying on the advice of non-attorneys for estate planning and trust drafting is a mistake. Serious omissions or errors often go unnoticed, until after you die. For example, you might own a business or a vacation home, be a part of a blended family, have a child with special needs, or be married to a non-citizen, and these are just a few of many circumstances which require special attention. Omission of critical language could subject your estate to many thousands of dollars in unnecessary taxes and administration expenses. Failing to properly fill out or to provide the proper forms to the County could cause an unnecessary reassessment of your property taxes.
When you have a well drafted and properly funded living trust, the process of administering your estate after your death is as easy as possible for your heirs. If mistakes are made either in the planning, drafting, or implementation of your trust, it could create a very expensive (an entirely unnecessary) surprise for your heirs. Remember, your estate plan will eventually need to take care of the people you care about the most.
Michael K. Elson is a prominent estate and trust attorney located in Encino and Valencia and provides estate, business and asset protection planning, including trusts, LLCs, corporations, probate, and trust administration. Mr. Elson provides estate planning for income property owners and has been writing articles for the AOA magazine for over 15 years. He may be reached at www.living-trust-attorney.com or by calling (818) 763-8831. This article is a broad overview of some estate planning options. Since each person’s circumstances are unique, and there are many intricate exceptions and periodic changes in the law, the mere reading of the material herein does not create an attorney/client relationship between the author and the reader.