Revocable Living Trusts Often Fail to Avoid Probate, Protect Family Members, or Make Sure the Right People Inherit the Right Property.
Ever think you had taken care of something, checked it off your infinitely expandable
“to do” list, only to find you had failed to really solve the problem?
• You sent your tax return to the IRS, but had to resend it because the IRS lost the original return.
• You shoveled the snow off the walk, but the walk was reburied an hour later.
• You got a heart checkup, passed with flying colors and had a heart attack the next week.
• You had a sensitive sharing with your spouse about socks on the floor and there was a new pair straddling the hallway ten minutes later. No, don’t blame the dog!
Sound familiar? These irritating but inevitable problems happen to all of us. As irritating as they are, these incidences generally don’t cost us cold, hard cash.
Unfortunately, when it comes to estate planning, even a small glitch can be disastrous.
Like landing on the moon, you’ve got one—and only one—chance to do it right or you’ll crash and burn.
Houston, we have a problem!
Sadly, many revocable living trusts do not accomplish what they are supposed to do: avoid probate, protect family members, ensure the right people inherit the property, and save taxes.
Why do they fail in the very areas they were supposed to protect? Because no one changed the ownership of property from the individual owner to the living trust.
You may be in shock that I—the big proponent of living trusts as the center piece of estate planning—am saying that there is a huge problem with living trusts. But that is a simplification and misunderstanding. I am saying that there can be a huge problem if the living trusts are not conceived well and executed properly.
And there is the problem.
But to start at the beginning…Living trusts are hard for most normal people to understand. By normal, I mean people who are not lawyers. Basically, a trust is a legal “fiction” (pretenses) fabricated by English lawyers and recognized only in England and former English colonies (that’s US, folks). The rest of the world—and many of us who live here—think that living trusts are crazy. One of my clients, struggling to understand her trust document, said, while pointing to her trust portfolio: “I finally get it—it’s that crazy thing.”
You sign a trust document that says you or someone else owns the property as trustee of the trust for yourself and others. But the trustee only has naked legal title—pretenses title—and someone behind the curtain is the real person who gets to use and benefit from the property. That man behind the curtain is called the beneficiary.
With me so far? Good! Now it gets complicated.
The trust is an artificial legal person similar to a Corporation. When it is a revocable grantor trust, it exists under state property law, but does not exist under federal and state income tax. It can own property (but in the name of the trustee, not the trust), has new pretenses owners when you die, quit or have a stroke; can avoid estate taxes; protect spouses, children, the disabled, and keep out son-in-laws who are rotten husbands. It can exist forever but can easily be shut down; it does not pay any taxes now, but may pay lots of taxes later; it can subdivide like cells or gobble up other trusts like pacman; and in some cases, it can give you income even though you don’t own the income-producing assets.
But to make it all work, you have to transfer the title to most of your property to your trustee. The one exception is retirement accounts which cannot be payable to your trust during your lifetime, but can after you pass on.
Here’s how it works. If Sam’s house is titled to Sam Smith, it is not owned by the Sam Smith Trust. But if the house is titled to Sam Smith, Trustee for the Sam Smith Trust, then the house is owned by the Trustee for the trust. It’s a small difference with huge consequences. No transfer to trust equals disaster on the way.
Here’s how it works most of the time:
Alice, Betty, and Clara Luckless. Allan Luckless married wife A and they had Alice as their only daughter. Allan divorced his first wife and married wife B with whom he had daughter Betty. Allan divorced wife B and then married Monique, his trophy wife, 25 years younger and very beautiful. Monique sold pharmaceuticals to doctors, including Doctor Allan Luckless.
Allan and Monique signed a valid prenuptial agreement in which they agreed that most of Allan’s property would be inherited by his daughters and not by Monique. With Monique, he had daughter Clara.
Every time they went out partying, which was frequently, Allan was frustrated that Monique took almost two hours on her hair and make-up, and changed dresses and jewelry several times before they got out the door. Allan forgot that it was her looks that perked his interest in her in the first place and she sure did look stunning in that diamond necklace he bought her for their first anniversary. They were quite the couple.
Then Allan died.
Alice, Betty, and Clara consult me. Allan’s three daughters came in to consult with me as to why they were getting virtually no inheritance from their father. They showed me his will, living trust, and powers of attorney—all done by a highly competent and well respected attorney in another law firm. Allan’s trust indeed left all of his property to his three daughters.
Monique did not file a claim for her marital share against the will or trust. She didn’t have to. Allan had not put any of his property in the name of his trust. He had put his property in his and Monique’s names, with right of survivorship.
When Allan died, Monique survived him and automatically got everything—the houses, the bank accounts, the brokerage accounts, and the retirement accounts where she was the primary beneficiary. Legal title and beneficiary designations take precedence over what the will and trust says.
The only inheritance that Alice, Betty, and Clara got was an interest in a limited partnership that Allan had owned in his own name. He hadn’t gotten any income from the partnership yet and had forgotten to add Monique as a co-owner. After probate of the partnership interest, in five or ten years, Alice, Betty and Clara might get $100,000 each. But most of the $3,000,000 in Allen’s estate went to Monique. For Monique, it was like winning the lottery, except with 100-to-one odds in her favor. No dumb blonde here.
The failure to transfer properties to (ie, fund) living trusts is rampant. The few lawyers who offer funding services usually spend more time transferring assets than they do putting together the trusts and other papers. As a result, many financial advisers have jumped in to oversee the funding process. We find doing funding together with our clients works best to make sure the trust delivers on its promises.
In the end, getting your trust funded is something you have to monitor if don’t want to only have the illusion—but not the reality—of having an estate plan that actually does what you thought it would do.
Consult us for an estate plan that accomplishes your goals. Contact us at firstname.lastname@example.org or call us.