"Put not your trust in money, but put your money in trust," counseled Oliver Wendell Holmes more than 100 ago. The advice remains sound today -- depending, of course, upon whether you know how to choose the appropriate trust for your circumstances. The selection process depends upon whether you seek to reduce the estate tax bite for your children (if so, the clock is ticking), protect assets in the event long-term care is needed, or merely wish to avoid probate for your heirs. The three basic trust types that can help one to achieve these goals are discussed below.
1. Revocable Trust: If you've ever attended a Living Trust seminar, you may wonder why everyone doesn't have one. The concept of this trust is very appealing. The creator (also called the settlor) can serve as his or her own trustee. Therefore, full control over the assets in the trust is retained. There is no need to go to a third-party in order to access the trust. The primary purpose of this type of trust is that it will avoid probate at death. Probate is the court-supervised process whereby an individual's will is authenticated. It is usually a good idea to avoid probate because of the attendant delays and costs involved. This is especially true when there are any difficulties within a family. If, for example, an individual is in a second marriage, it may be best to avoid requiring the surviving spouse to endure several months in a court proceeding with the decedent's surviving children. It is also advisable to avoid probate if one of the estate beneficiaries has a developmental disability, cognitive impairment, long-term illness, or is estranged from the family. Any of these complications will likely result in a probate process that can last over one year. Assets in a revocable trust, on the other hand, will pass automatically to one's beneficiaries. The transfer is private, without court oversight, and will enable the assets to avoid capital gains taxes because the revocable trust preserves the so-called step-up in (tax) basis afforded to assets passing at death.
So far, so good -- right? What, if any, are the downsides to a revocable trust? There is only one that I can think of. That is, when an individual with a revocable trust mistakenly believes that this document, in and of itself, will protect a family's assets from the potential ravages of estate taxes and/or long term care costs. Common sense (as well as federal law) tells us otherwise. Think about it. If I have total access to and control over my assets in the revocable trust, how can I then turn around and expect a nursing home to agree that the assets are not available for my care? The same goes for the Internal Revenue Service. Any asset that I have retained access to (even if it is only an income interest) will be included in my gross taxable estate at death. It is very important to remember that assets do not avoid estate tax just because they may avoid probate.
Who should consider a revocable trust? An individual or family with assets below the current state and federal estate tax thresholds (currently $1 million for New York and $1 million federal as of January 1, 2013). It may also be advisable for someone who is not concerned about potential liabilities such as long term care needs.
2. Estate Tax Trust: This is a type of Irrevocable Trust designed to remove assets from an individual's gross taxable estate. This trust is not for the faint of heart. One may not retain access to or control over the assets transferred into an estate tax trust. A common misconception is that a retained income interest is permissible. This is not the case. The Internal Revenue Code provides that a retained income interest in an asset will cause the entire value of the asset to be included in one's gross taxable estate at death. Therefore, it would never be advisable to transfer all of one's assets into an estate tax trust.
The Estate Tax Trust may be a good idea for an individual who wishes to shield some portion of his or her assets that are in excess of the current estate tax threshold. Federal law through the end of 2012 provides us with a unique opportunity to "gift" up to $5 million into such a trust. As of January 1, 2013, the lifetime federal gift tax exemption is scheduled to revert to $1 million.
3. Asset Protection Trust: This type of trust is designed to protect one's assets in the event that long term care is later needed. There is currently a five-year "look-back" period on transfers to any individual or entity other than a spouse. In order to commence the running of this clock (after which the assets are exempt for Medicaid purposes) the trust must be irrevocable. It is not, however, as restrictive as the estate tax trust. If, for example, this type of trust owns a home, the Grantor may retain lifetime use of the property. One's property tax exemptions, step-up in tax basis at death and the $250,000 ($500,000 for a couple) capital gains exclusion for sales during the settlor's life will be all be preserved with a properly drafted asset protection trust.
This type of trust avoids probate but does result in the assets being included in the gross taxable estate at death. This is not a problem, however, provided that the assets it owns are valued in an amount below the estate tax threshold. It is a common planning technique to have this trust own the primary residence and let an estate tax trust own some of the other assets.
With some careful forethought and planning, it is possible to avoid probate, protect one's assets during life and achieve a tax-efficient transmission to the next generation at death.
Ann Margaret Carrozza is a renowned Elder Law and Estate Planning Attorney who served as a New York State Assemblywoman. During her fourteen years in the legislature, she authored dozens of bills designed to streamline the estate planning process, protect seniors against consumer fraud and expand access to quality long-term care.
She is an executive member of the N.Y.S. Bar Association, Elder Law section and the National Academy of Elder Law Attorneys. She also serves as a member of the Surrogate's Court Advisory Committee to the Chief Administrative Judge.
Her practice focuses on Elder Law, Trusts and Estates, Asset Protection, Estate Administration and Long Term Care Planning. A frequent lecturer, Ann Margaret Carrozza has been the keynote speaker for the NYS Bar Association, and the Surrogate's Association and has been interviewed by FOX News, FOX & Friends, Geraldo, NBC News 4, CBS2, NY1, The Wall Street Journal, USA Today and Money Magazine. www.myelderlawattroney.com