If you own real property or other valuable assets, there is great benefit in creating and maintaining a quality estate plan. With proper guidance, drafting, and implementation, your estate plan will be effective to avoid probate, unnecessary capital gains and estate taxes, and court control of your assets at your death or in the event of incapacity. Other than procrastinating until it’s too late and, therefore, not having a living trust at all, the following is a list of some common estate planning mistakes.
Failing to Keep Your Trust Up to Date
Many living trusts created before 2008 contain a mandatory requirement to divide the trust into two or more sub-trusts upon the death of the first spouse. These trusts were commonly utilized to reduce or eliminate estate taxes by taking advantage of the then current estate tax exemption laws. However, many have become obsolete for families whose assets are under the current (2021) estate tax exemption of $23.4 million. For example, upon the death of the first spouse in an outdated married couple trust, a rental property had to be placed into an irrevocable sub-trust. This property appreciated to a $1.15M fair market value gain, between the death of the first spouse and the passing of the surviving spouse. This gain was great for the heirs, but due to the outdated trust and changes in the tax laws, the rental did not receive the appropriate step-up in basis. Therefore, the heirs had to pay capital gains tax on the entire $1.15M, which could have been completely avoided had the trust been appropriately amended.
Inaccurate Assumptions
Misconceptions may lead some people to wrongly believe that a living trust is not necessary. For example, erroneously believing that outright gifts during one’s lifetime (such as placing your adult child on the deed to your home as a Joint Tenant) is a good way to avoid probate. The fallacy with this approach is that once your child becomes a co-owner of the house, your child could force a sale against your wishes. Additionally, your child’s creditors (from lawsuits, bankruptcy, or divorce) could take the home from you to satisfy your child’s debts. Furthermore, assets gifted while you are alive loses the benefit of receiving a stepped-up basis at your death, leading to unnecessary capital gains taxes. Another common misconception is believing that a Will functions as a living trust. However, unlike a living trust which entirely avoids probate, a Will must go through probate which is expensive and takes two or more years in probate court. Furthermore, a Will is of no use in the event of temporary or permanent incapacity. Durable powers of attorney are needed to handle property, finances, and medical decisions during incapacity. Otherwise, the expense and hassle of a court ordered conservatorship may be necessary.
Trying to do it Without an Attorney
Relying on the advice of non-attorneys for estate planning and trust drafting is a serious mistake. Omissions or technical errors may go unnoticed, until after you die. You are taking great risk not having your living trust prepared by an experienced trust attorney. If the trust is not drafted and properly funded, it will likely be worthless or create unintended negative consequences when you die. Furthermore, online software and legal document services have no legal duty to make sure the necessary provisions are included and properly tailored to your circumstances. Also, they may not be California specific, nor up-to-date, and often fall into the category of “one-size-fits-all” estate planning. These omissions fail to address your specific needs, goals, assets, family dynamics, or taxes. For example, special considerations apply for owning a business or vacation home, blended families, children with special needs, or marriage to a non-citizen.
Improper Funding of the Trust
It is a mistake to believe your estate plan is complete as soon as your estate planning documents have been signed. To avoid probate, most assets must be transferred to the trust. Leaving out assets can defeat the purpose of your estate plan. This includes ensuring that financial accounts are owned by the trust. Funding your living trust with bank/investment accounts, business interests, and real estate is critical, as is designating the correct named beneficiaries of your life insurance and retirement accounts.
Another funding mistake can arise if a lender bank asks you to temporarily transfer your home out of the trust in order to help the bank facilitate a refinance. In many instances, I have seen where owners have failed to transfer the property back into the trust. This can result in the property having to go through the entire probate process. Additionally, if you own an LLC, it is important not to overlook the transfer of your LLC interests into your living trust.
Drafting Issues/Wrong Type of Trust
When preparing a living trust, a failure to make a careful distinction between percentage allocations versus specific gifts, can lead to beneficiary distribution problems. For example, if leaving specific dollar amounts to a specific beneficiary, the funds may not later exist or there may not be enough funds to distribute the desired amount to the beneficiaries. Or, a specific real property bequeathed in the trust may have been sold, or be worth far more or less than when the trust was created. Percentage allocations often alleviate these potential problems.
Another mistake can be made by not designating whether inherited assets should go to the children of a predeceased beneficiary, or to other named beneficiaries who do survive. Another may be failing to regulate over time the distribution of assets to heirs who are prone to mismanagement or may quickly squander their inheritance. Most trusts should specifically contain provisions to allow a successor trustee to use the trust assets for young children’s health, education, maintenance, and support, until such children have reached the appropriate age. Also, once your children have become responsible adults, your trust should be amended if someone other than your child is named as successor trustee.
Selection of the right provisions in your trust is critical. In some cases, a mandatory A-B trust split, after the death of a spouse, may be beneficial for reducing the estate tax. However, as illustrated in the scenario earlier in this article, smaller estates could suffer from a loss of step-up in tax basis after the death of the surviving spouse if there had been an unnecessary mandatory split. A flexible option is to utilize an A-B Disclaimer trust, which allows the surviving spouse to delay the decision of whether or not to split the trust, until nine months after the death of the first spouse. This provides time to ascertain estate tax rates, exemptions, values, and goals.
Preventing Miscellaneous Problems
Once you have created a good living trust estate plan, care should be exercised to ensure your heirs have access to the documents. Although not mandatory, it’s a good idea to mention to some of your beneficiaries or your successor trustee that you have a trust and where it can be located. It’s recommended to create a backup copy in case the original is ever misplaced, lost, or destroyed. An electronic PDF copy is fine and facilitates easy delivery to any desired recipient.
Michael K. Elson is a prominent Trusts & Estates 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 nearly 20 years. He may be reached at www.living-trust-attorney.com or by calling (818) 763-8831 or emailing [email protected]. 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.