Ten Serious Mistakes to Avoid in Estate Planning

2. Improper Use of a Failure to Fund "Lifetime" Trusts".

In some states, such as Florida or California, probate is known as a difficult process, so people often set up what are called “lifetime trusts” to avoid probate. In those states, and states with similar laws, establishing lifetime trusts is often desirable. However, in states such as New York, where probate in a common family situation is not onerous, establishing lifetime trusts to avoid probate is not only costly, but as will be discussed, is often self-defeating. 

A brief discussion of terminology is necessary. Trusts can be set up either by agreement between a Trustee and a person who contributes property (known as a “Grantor” or “Settlor”) or in someone’s will. Trusts established by will only become effective when the person dies and the will is admitted to probate. Lawyers refer to such trusts as “testamentary trusts.” Trusts established by agreements (sometimes also called Trust Indentures) are known as “inter vivos trusts” (Latin for trusts established during lifetime).  

“Lifetime trusts” is the terminology sometimes used for what Trusts & Estates professionals know as “revocable trusts” (as opposed to irrevocable trusts). They are “inter vivos trusts.” (revocable trusts). Revocable trusts act as will substitutes: the person who sets it up is the Grantor and usually is also the Trustee. The Grantor can use the property in any way that he or she wishes, including taking the property out of the trust altogether, and when the Grantor dies, the property passes under the terms of the revocable trust. The revocable trust does not have to be brought to a court to be admitted to probate, and unless a disgruntled potential beneficiary challenges it in court, there will not be the need to probate a will (at least in theory). Like a will, a revocable trust can be amended during a person’s lifetime. Also like a will, a revocable trust can establish one or more trusts to carry on after the person’s death.  

A revocable trust, like a will, can be structured to minimize Federal and State Estate Taxes. However, avoiding probate DOES NOT avoid or eliminate Federal or State Estate Taxes. The taxation is identical, whether property passes by will or outside of probate, such as through a revocable trust.  

So, if a will and revocable trust can both be used to pass assets at death, have the same tax consequences, and a revocable trust at least avoids the necessity of having a court admit the instrument to probate, why shouldn’t everyone use it?  

The first, and probably most important, reason why revocable trusts are not appropriate in every situation (at least in states like New York) is that in the majority of cases where people have attempted to avoid probate by establishing revocable trusts, some or all of the person’s assets were not properly transferred into the trust. In other words, the mere signing of a trust agreement alone is not sufficient. Nor is it sufficient for the assets that are to be contributed to the trust to merely be listed on a schedule at the end of the trust. If real estate is being contributed to the trust, a new deed must be prepared to transfer it into the trust. If bank accounts, or securities accounts are being transferred, the old accounts must be closed and new ones in the name of the trust must be established. If valuable artwork, jewelry, or other personal property is to be contributed, deeds of trust in conformity with the requirements of state law must be executed. Indeed, ALL of the person’s property (with the exception of retirement accounts and any accounts that otherwise pass by a beneficiary designation) must be re-titled into the name of the trust (and see the discussion below regarding retirement accounts).  

What happens in those cases where none of the Grantor’s assets had been transferred into the trust! ? A will has to be probated! And if there is no will, the property passes by intestacy –meaning that state law will determine who gets the person’s property (see #8, below). 

Even the most meticulously planned revocable trust where the Grantor and the Grantor’s advisers worked hard to make sure every asset had been transferred into the trust usually requires that a will be probated, because some asset fails to find its way into the trust. Aside from these difficulties, revocable trusts typically cost significantly more than does a will.

In a state like New York, there are limited situations where using a revocable trust to pass assets is preferable to doing so through a will. The first case is where a person owns property in a number of states. So if you own your main house in New York, a vacation home in Cape Cod and, a condominium in Florida, your will would first have to be admitted to probate in one state, and then submitted for what is known as an “ancillary probate” in the other two states. In effect, three probates instead of one. So in that case, deeding all property into a revocable trust during lifetime to avoid multiple probates makes sense.  

Another time that passing property via revocable trust rather than by will may make sense is if your only living relatives are distant relatives, such as cousins, nephews and nieces. This is especially true when your family is large, and you may have lost contact with some members of the family. In cases such as this (as opposed to the more typical case where a person dies leaving a spouse and/or children), the probate process in New York is far more difficult, costly and time consuming.

If a will contest is anticipated, a revocable trust rather than a will may be preferable. Suppose you want to leave a child out of your will. In New York, when the will is submitted for probate, that child will receive notice (called a “Citation”), and have the opportunity to object to the will being admitted to probate. While upsetting a will is exceedingly difficult, the disgruntled child could still cause a lot of trouble, including delays and significant additional costs for the estate. While a good estates litigator knows how to get his hands on a revocable trust and challenge it in court, it is more difficult to do so, and if the disgruntled child is not put on notice about the existence of the instrument that leaves him or her out of the estate, then it may discourage that child from challenging your estate plan. It is not a guarantee, but it may help. 

Sometimes a client prefers a revocable trust because a revocable trust, unlike a will, is not a public document. A will is filed in court, and is accessible to the public. Sometimes, as a matter of planning for long-term care, a home that would otherwise be subject to “estate recovery” for Medicaid benefits provided to a senior citizen might be transferred to a revocable trust. Such planning should only be done with the advice of a competent Elder Law attorney who is fully knowledgeable of the Medicaid laws of your state. 

Absent these circumstances, though, a will functions just as well as a revocable trust. But at the very least, if your circumstances make a revocable trust desirable (or you’re just plain stubborn and HAVE to have a revocable trust), make sure that you actually fund it! Make sure that you (or your attorney) deed your real estate into the trust, transfer your co-op apartment into the trust (if your co-op board will even permit this), and the name of your bank accounts, brokerage accounts, stocks and bonds (except for retirement accounts, which are discussed in #6, below), from your name to the Trust. 

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