A living trust conveys money and/or property to the recipients of your choice after your death, usually free of court supervision. Many homeowners can save their heirs money by having a living trust prepared. To understand the potential benefits of trusts, it helps to start by reviewing the functions of wills and their interpretation in the probate process.
Functions and limits of wills
A will is the traditional U.S. way to distribute property after death. While a trust gives instructions to a trustee, a will expresses the deceased person's wishes to both the court and the executor. You can use a will to name beneficiaries to receive your assets, nominate executors, nominate a guardian to take care of your children, and give instructions about your burial or cremation and other memorial observances.
Documents and forms of ownership to consider
A will remains a suitable estate planning tool for many people, especially if there is no real estate to consider, or if real estate can be passed forward by joint tenancy or community property language on the deed (though see "Advantages of living trusts for homeowners" below), and if any other large assets take the form of bank or investment accounts that can be transferred with beneficiary or "pay on death" provisions. In such circumstances, an estate plan can consist of just a few documents: a will, a durable power of attorney for finances and an advance health care directive. For more information about these possibilities, see “Additional Estate Planning Documents.” Each of the documents mentioned above must meet precise requirements to be valid under California law. Improperly executed documents can defeat the purpose of estate planning, so it can be important to consult an attorney to get these papers right.
Disadvantages of wills without trusts
The main disadvantage of a will alone is that an individual’s estate may need to be settled through a court probate procedure, which takes significant time and money. Probate is described in detail below. Another disadvantage of a will is that a married couple with substantial assets may have to pay federal estate taxes if they had wills but not a trust. For more information about federal estate taxes for married couples, see “Trusts for Married People.” Another disadvantage of wills without trusts is that they do not as easily enable parents to give specific directions about financial care for their minor children.
Probate is a Superior Court proceeding used to clear the titles of estates. It was originally designed to ensure that creditors got their money before the estate passed to the heirs. In California, estates containing real property (for example, a house) worth more than $50,000, or other assets worth more than $150,000 such as cash, stocks, bonds, etc. will eventually have to go through probate unless enough of the assets pass to the heirs through pay-on-death (P.O.D.) accounts. However, for probate purposes an individual's estate is not considered to contain the assets that have been placed into a living trust. Therefore, if transfers into a trust leave less than $150,000 in the estate, a probate is generally not necessary. A probate proceeding typically takes between nine months and two years to complete.
The cost of probate
California Probate Code Sections 10800 and 10810 authorize executors and attorneys to charge probate fees on a sliding scale keyed to the overall value of the estate involved. Where a house is part of the estate, the fee is calculated from its full market value at the time of the deceased person's death, regardless of whether it is mortgaged. For example, if your home is worth $600,000 and you have a $200,000 mortgage, the statutory probate fees would be based on the full $600,000 value. The statutory probate fee for a $600,000 estate would be $15,000 to the attorney. The executor would also be entitled to claim a further fee of $15,000, though executors often choose not to claim their fees if they are also heirs or beneficiaries.
The chart below lists examples of minimum fees that attorneys and executors may each charge under state law. These are not necessarily what would be charged in all cases. The figures below represent only attorneys' fees; executors who claimed their fees could charge the same again. Attorneys handling probate matters sometimes do agree to fees below the statutory level when the estate administration is relatively simple. On the other hand, attorneys or executors who provide "extraordinary services" involving complex assets, inheritance disputes, or tasks such as selling assets, may receive court permission to take higher fees than the statutory minimum levels. The amounts below do not include court fees or court-granted “extraordinary fees,” preparation of tax returns, or other miscellaneous expenses.
Statutory attorneys' fees by total estate assets:
See: California Probate Code Secs. 10800 and 10810.
What is a living trust?
Like a will, a living trust is an estate planning document enabling you to give your money and/or property to your loved ones after you pass away. Unlike a will, a living trust can frequently operate free of court supervision. Living trusts have been used in the U.S. since the Constitution was drafted. Living trusts are revocable, which means they can be changed or revoked at any time. (In the case of a married couple, part of a trust may become irrevocable – that is, unchangeable – after the first spouse passes away.)
How a living trust works
Four main types of parties are involved in a living trust. First is the “settlor,” who creates the trust and owns the property to be transferred into it. Second is the “trustee,” or the person who manages the trust. The settlor is usually the initial trustee. If you create a trust in this manner, you will have complete control of your money and other assets so long as you are both the settlor and the trustee. The third party is the “successor trustee.” If you die or are incapacitated, the successor trustee takes over as the manager of the estate. The fourth party is the “beneficiary,” the person who will receive your estate when you pass away. There may be more than one settlor, trustee, successor trustee, or beneficiary. The trust document defines the roles of each of these four parties. It outlines how your property, which you placed into the trust as its "settlor", shall be managed by the initial trustee (probably yourself) and later how management of the property shall be transferred to the successor trustee (a trusted party, usually a loved one but sometimes an institutional trustee such as a bank's trust department) to be distributed or managed for the benefit of your beneficiaries.
General advantages of living trusts
1) A probate proceeding will probably not be necessary for your estate if you have a trust.
2) At upper asset levels, a living trust is designed to reduce
the federal estate taxes your estate will owe. (As we'll discuss below, the current asset level that triggers federal estate tax is $5,490,000. The asset lever that triggers federal estate tax in 2016 was $5,450,000).
3) If you become incapacitated, a court-imposed conservatorship is unlikely to be necessary to manage your affairs, because your successor trustee can manage your
property without court supervision.
4) Parents can decide how soon their children will receive income and principal from the trust. Parents can also give specific instructions about financial management for their
Advantages of living trusts for small estates
If you own a home or any other real property (land or a home), or if you own more than $150,000 in assets, you should definitely consider the advantages of living trusts. If you do not have a living trust, your estate will eventually be subject to probate, unless enough of your property is held in joint tenancy or “pay on death” (P.O.D.) accounts at the time of your death. The cost of probate can be particularly devastating to small estates.
Advantages of living trusts for homeowners
It is possible for homeowners to hold real property in joint tenancy or "community property with right of survivorship" form in order to avoid probate proceedings, but there are major disadvantages to this type of ownership. Under a joint tenancy, if one joint tenant (co-owner) dies, the other holds a right of survivorship. That is, upon the death of one joint tenant, the entire property automatically passes to the surviving joint tenant. However, the property still needs to go through probate after the death of the surviving joint tenant. There may be problems with holding property in joint tenancy with your child. For example, if your child incurs liability through an event such as a car accident, your house may be at risk to creditors because the child is part owner of the property. Moreover, there may be adverse tax consequences for a child who receives a home in the form of a gift through joint tenancy ownership, rather than as an inheritance. If a home is given through joint tenancy, the child will not receive a full basis step-up for capital gains tax purposes if the home is sold.
Federal Estate Taxes
Tax issues important for estate planning include the federal estate and gift tax exemption levels and the unlimited marital deduction.
Under the federal estate and gift tax exemptions, each individual is entitled to lifetime federal estate and gift tax exemptions. The “estate tax applicable exclusion amount” – the asset level where the estate tax kicks in – is $5,450,000 for the estates of people who die in 2016. It is $5,490,000 for the estate of people who die in 2017. This means each person is able to give away $5,450,000 free of tax in 2016 and $5,490,000 free of tax in 2017 in the form of an inheritance.
A living trust can substantially reduce estate taxes for couples whose estates do reach the current federal asset threshold.
The unlimited marital deduction allows U.S. citizen spouses to pass unlimited assets to each other upon death, without federal estate taxation. Unfortunately, if one spouse dies before both spouses have executed proper estate planning documents, that spouse’s estate may fail to use its estate tax exemption, creating possible tax disadvantages for the surviving spouse or his/her heirs.
For further discussion of estate taxes for married couples, see “Trusts for Married People.”