MATERIALS FOR ACTIVE CLIENTS
Frequently Asked Questions
Revocable trusts do not offer asset protection, since there are no restrictions on the trustmaker’s to access the trust assets. If an individual would like to protect their assets, the use of a different estate planning tool would be suggested including various forms of irrevocable trusts. Irrevocable trusts provide asset protection since the trustmaker usually may not serve as the trustee and usually is also not the beneficiary and due to this lack of control, creditors have difficulty in reaching those assets. Life Insurance Trusts (“ILITs”) are an effective way to protect life insurance benefits and reduce your overall estate value to reduce estate taxes. For clients who have rental properties or business assets they want to protect, LLC’s can be created to protect the client assets from claims made by creditors stemming from the assets owned by the LLC.
Yes! Whether the RLT owns the asset or the RLT is the POD Beneficiary, the asset avoids passing through probate at death. However, an RLT-based plan often includes planning goals beyond just probate avoidance. Of course it should be noted that funding recommendations are specific to the client, the client’s goals, and her specific estate plan. In general, however, for certain accounts (e.g. brokerage accounts, investment accounts, savings accounts) there are further benefits beyond probate avoidance that are triggered when such account is owned by your RLT. A properly drafted RLT has benefits above a power of attorney, in that it gives specific guidance to the Trustee on how to use assets during periods of incapacity (versus a fiduciary/best interest standard applied to the Power of Attorney). In addition, in our experience, we have found that the transition of the account to a disability Trustee is usually smoother than the use of a power of attorney.
In addition to the disability benefit, for married clients with estate tax planning incorporated into their joint plan, the joint RLT as owner versus a POD beneficiary is crucial. For example, if the investment account remains a jointly owned account by the spouses with their RLT as POD Beneficiary (for after they are both deceased), then the account will simply pass automatically to the surviving spouse, outright, at the first spouse’s death (regardless of what the RLT says). The asset then becomes part of the survivor’s estate and taxable at the survivor’s death. If the couple has incorporated estate tax planning under their joint RLT (to capture the $1m Massachusetts estate tax exemption amount for example), then the joint RLT is effectively pointless for this purpose in that scenario because there is no way to capture the $1m at the first spouse’s death if the assets go directly to the surviving spouse as joint owner. The only way to effectively capture the $1m at the first spouse’s death is if the asset is already owned by the trust during both parties’ lives. Even if this scenario does not apply to your specific plan, the disability benefits should not be discounted.
Life and Death: Understanding Your Various Retirement Accounts
A Standalone Retirement Trust (SRT), also know as an IRA Beneficiary Trust, is a trust that acts as a qualified designated beneficiary for retirement accounts. Typically the SRT does not own any assets during your life, but will receive retirement accounts (or part of the retirement account), at your death, through beneficiary designation. By having the trust qualify as a designated beneficiary, the beneficiary you name under the SRT receives the benefit of tax-deferred growth of the retirement account, creditor and/or divorce protection, or delaying certain distributions due to the beneficiary being a minor or having certain needs or limitations that would likely result in poor management or spending of the retirement accounts, if he/she were named outright as a beneficiary.
Our typical clients who create an SRT often have some or all of the following:
- have retirement accounts that make up more than 50% of their total wealth
- have saved a large amount of retirement assets
- want to provide generation-skipping transfer tax planning
- want to protect their beneficiaries from the retirement accounts being subject to their creditors or divided in the event of divorce
- want to ensure that their beneficiaries take advantage of the tax-deferred savings structure of an inherited retirement account
- have beneficiaries with special needs (financial or education), who may not be savvy with money, or may need guidance in preserving their inheritance
No! Retirement accounts, like a 401(k), 403(b), or Individual Retirement Account (IRA), must stay in your individual name and an RLT cannot be the owner of such account. If you were to change the ownership to a Trust, the retirement account would have to be cashed out, and a trust-owned non-retirement investment account would have to be opened. This would result in early withdrawal penalties (if you were under 59 1/2 at the time), income taxes (for non-ROTH accounts), and the loss of opportunity for tax-free growth during your life – so all in all a complete disaster! You may name a Trust as a beneficiary of a retirement account, but this should be carefully considered to ensure the Trust qualifies as a designated beneficiary.
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The Basics of Life Insurance
An ILIT is an irrevocable trust created to own certain life insurance policies outside of your estate. You, as the grantor, create the ILIT, which owns your policy. You do not maintain control over the policy and your selected Trustee is effectively the owner.
As you are no longer the owner of the policy the death benefit is outside of your estate for tax purposes. You (grantor) remain the insured, which means your death triggers the death benefit being paid to the trust.
The Trustee(s) of your ILIT must:
- maintain the policy
- manage an ILIT checking account
- accept gifts from you for the premium payments
- provide notice to the lifetime beneficiaries of the gift and their right to withdrawal the gift
- timely pay the premium each year
- at your death, collect the life insurance proceeds and distributes the proceeds in accordance with the ILIT’s terms.
ILITs are used to solve for the goal of reducing estate taxes and providing liquidity, to ensure the most amount of money passes to your beneficiaries. The amount of insurance that may motivate someone to create an ILIT can vary depending on the circumstances. But typically the death benefit amount is either: large enough to create a Massachusetts estate tax ($1m+), large enough to further increase an already Massachusetts taxable estate ($1+m), and/or large enough to further increase a federally taxable estate ($11.2m for an individual or $22.4m for a married couple) where beneficiaries are at risk of losing up to 56% of the death benefit proceeds to federal (40%) and MA (16%) estate taxes.
If you are not concerned with tax planning and already have liquidity in your estate, then you may not benefit from an ILIT.
Drafting Considerations for Separation Agreements with Life Insurance
Successful Business Succession Planning
The most straightforward reason to update an outdated estate plan is to include any desired changes in an individual’s family or to change any beneficiaries. An estate plan created some 20 years ago is likely to need updating for people who have both come and gone that the client would like to include or remove from the old plan. Estate Planning lawyers often find that their clients are surprised to review an old plan and see who it was they assigned for what. It could be worth it to review the plan and update it simply to include a new beneficiary or assign a new beneficiary if a prior one has passed away.
In 2012, Massachusetts adopted the Uniform Probate Code, which was the first true overhaul of state probate laws (some of the laws dated back to the inception of the Commonwealth). Therefore, it is clear that many of the laws governing an estate plan created 20+ years ago would be outdated and a revision could/should be made in order to comply with the updated laws. Here is a link summarizing many of the changes that would be of interest to the general public: http://www.lexology.com/library/detail.aspx?g=e9e5f56b-0915-4aef-829c-a760b835acdc. For example, the adopted Model Uniform Probate Code increased the size of the surviving spouse’s intestacy share by a considerable amount – from the article: If the decedent is not survived by any descendant or parent, the surviving spouse now takes the entire probate estate. This is a huge change from previous probate law. Furthermore, if the plan was created 20+ years ago, modern tax laws are likely to be entirely different from the ones in place when the plan was created. For example, current Federal Estate Taxes and Exemptions are 40% tax and up to $5,450,000 in exemptions, whereas 20 year ago in 1997, those numbers were 55% tax and only $600,000 in exemptions. https://www.thebalance.com/exemption-from-federal-estate-taxes-3505630. These numbers can be important for structuring a plan, so having an updated estate plan to account for tax laws is very important. In 2003, Massachusetts adopted its own estate tax, separate from the federal estate tax; so, any 14+ year old estate plan would want to be updated to adjust for this change in law.
Another important consideration when deciding whether to update an estate is the client’s current financial situation. Often times when an estate plan is out of date, the client may now be in a very different financial situation. It would be important to update the estate plan to include any financial changes that may have occurred in order to avoid any new assets being sent through the probate process. Also, some financial institutions do not accept power of attorney documents that are “stale” or of a certain age. While the document is still technically legally binding, some institutions have internal policies that outline how old a power of attorney can be for them to accept it. Additionally, some healthcare providers are reluctant to accept old health care proxies because they want to make sure that the person being cared for is receiving the care they intended to receive. Updating these documents is important for clients with estate plans that are outdated.
You hear it time and time again…you have probably even said it at some point in your life, “I want to avoid probate!” I find that few people understand exactly what that phrase means. And fewer understand the true impact of probate avoidance, or why they want to avoid probate.
As you learned in Series 1 of this installment, probate is the court process of administering someone’s probate estate at death – either under the direction of a decedent’s Will or the intestacy laws. Probate can be avoided or reduced through restructuring one’s assets. For example, naming beneficiaries on bank accounts, investment accounts, retirement accounts, stocks, and life insurance; adding a joint owner to an asset with rights of survivorship; or, creating a revocable living trust and transferring title of your house or other assets into the trust during your life. These are easy ways to restructure your assets from ‘probate’ assets to ‘non-probate’ assets. These ‘non-probate’ assets will pass immediately at your death to the beneficiary or joint owner outright, or to the then-serving trustee of your revocable trust to be distributed and administered in accordance with the terms of the trust.
I will admit it – I am a huge proponent of avoiding probate for most circumstances. In many situations, using beneficiary designations or creating a revocable trust is the easiest way to distribute assets at death, without getting the court involved in the administration. Probating an estate can be expensive, time-consuming, and frustrating. It requires court involvement and your assets and Will are made public. I think there are many compelling reasons to avoid probate. However, this is not a ‘one size fits all’ analysis.
For those without a revocable trust, probate avoidance is nearly impossible if you have assets like a house or a car – where there is no ability to designate a beneficiary. In addition, if you have minor children then you would absolutely not want to name a minor child as beneficiary on your investment account or life insurance policy (a greater discussion outside the scope of this series – but trust me!), since that minor child is unable to own property directly under the age of 18. If you do not have a revocable trust, and are relying on your Will to distribute your assets to your loved-ones in the percentages you desire, then you want a probate at your death to make sure that your intent is carried out.
Imagine you create a Will and decide you want to leave all of your assets to your four children, equally. Your oldest son asks you to add him as joint owner on all of your bank accounts, “To make things easier for you; to help pay the bills, cash checks, etc.” Little did you realize that adding your son as a joint owner overrides the terms you outlined in your Will. During your life, if your son files bankruptcy or has a credit claim against him or gets divorced, it will bring that account – your account – into your son’s litigation. When you die, those bank accounts become your son’s accounts – he owns them and can immediately access them. Your other children could sue their brother for their ‘rightful share’ but how much will litigation cost? What if your son spends the money before his siblings even realize it was there? Or maybe you did intend for those assets to pass directly to your son, but there was no evidence indicating this and you never had this discussion with your other children. It all gets very messy, very quickly.
Another issue is the payment of expenses and taxes. If you name direct beneficiaries or add someone as a joint owner, it is going to be very hard for your Personal Representative to get money back from that beneficiary to help pay taxes, funeral expenses, credit card debt, etc., after you die. Once someone gets an asset, they are very reluctant to give it up. It can put the estate at unnecessary risk of being insolvent and create an administration nightmare.
Before deciding if you want to avoid probate, or even should avoid probate, you need to be very clear on what you have (assets and debts), how you own your property, and how you want it to pass to your loved ones. In some situations, probate avoidance is ideal. In other situations, it can completely be counter to your goals and your existing estate plan. And when in doubt, contact me or your estate planning attorney to discuss your specific circumstances.
The court process of “probate” that we will discuss in this article only deals with a person’s “probate” property and the Massachusetts Probate Courts do not have authority over or even care to know about “non-probate” property in most circumstances. So, in order to fully understand probate, I think it is imperative we first understand “probate” versus “non-probate” property.
Generally, probate property is 1) individually owned, and 2) has no designated beneficiary. Probate property is often the surviving spouse’s real estate, or someone’s individual checking account, or a car (all individually owned). Retirement assets often have a named beneficiary, or the beneficiary is determined under the plan, and is therefore generally not probate property (because although it is individually owned, it has a designated beneficiary). A joint checking account between spouses or a parent and child is also not probate property (because the asset is not individually owned and immediately passes to the surviving account owner at death). Assets owned by someone’s revocable living trust are also not probate property (because the asset is not ‘individually’ owned).
At death, your loved ones will need to determine what “probate” property you own, if any. This will be pretty apparent as jointly owned property will be accessible by the surviving owner, assets with beneficiary designations will be distributed directly to the named beneficiary, and trust assets will be accessible by the successor Trustee. With probate property, your loved ones will, in a sense, hit a wall and be refused access to the asset. Someone (a bank teller, financial advisor, the registry of deeds) will hold up a stop sign and say – “STOP! You cannot proceed without court appointment or approval.” Once your loved one hits this ‘wall,’ they will immediately realize the need for court involvement (in other words – probate!).
The need for court involvement or probate does not have anything to do with whether or not someone has a Will. I repeat, the need for court involvement when someone dies with probate assets has nothing to do with whether or not she has a Will! I am a huge fan of the Wizard of Oz and I often think of probate as the yellow brick road. Who is traveling on the yellow brick road? Your loved ones – whoever would help administer your probate property at your death (maybe a spouse, child, close friend, or attorney). Where does the yellow brick road lead? Why to the Emerald City of course! And who is at the Emerald City? Oz…I mean, the probate judge. While traveling on the yellow brick road towards the Emerald City, which is the only route when dealing with probate assets, your loved one may encounter friends, allies, apple-throwing trees, maybe even a flying monkey or two. Who she encounters while traveling on the yellow brick road is dependent on many factors, such as whether or not you had a properly drafted Will, whether your family is contesting the Will, or whether you had no Will at all. So, although in any case your loved one is traveling on the yellow brick road to get to the Emerald City, how easy the path (how many flying monkeys swoop in to cause havoc), will be entirely dependent on your Will and your family (not to say that Oz never blows some smoke and fire into the mix).
So, what will your loved ones encounter on the yellow brick road? Well, if you have a Will, your nominated Personal Representative will need to file the Will with the probate court and request appointment through the court as the Personal Representative. If you have no Will, then someone with priority as determined under the law (such as a spouse or child), will request appointment as the Personal Representative. If there is little probate property (under $25,000 in cash, and/or a car), then your Personal Representative will travel on the yellow brick road at turbo speed and get to the Emerald City in no time! If there are more assets, or more complexities, then your Personal Representative will need to proceed with either an informal or formal probate. There are many factors that are involved when deciding which option (formal or informal) to choose. Personal Representatives often hire attorneys to assist in this process and ensure the yellow brick road is as bump-free as possible.
Once appointed, your Personal Representative will be given the authority to access your probate assets, and is tasked with administering them – paying your last bills, creditors, and then ultimately distributing the balance of your probate assets, if any, to those you have named in your Will (i.e. the devisees), or your heirs as determined by Massachusetts laws (if you have no Will). The yellow brick road is long, windy, riddled with unexpected turns, but your Personal Representative will eventually get to the Emerald City. It takes at least a year, but the road is often smooth and calm during that time. If you die without a Will, the probate path (the yellow brick road) may be more difficult for your Personal Representative, and who ultimately receives your property is determined by the laws of Massachusetts (i.e. your heirs). Your Will acts to override certain defaults in the law, but it does not avoid probate!
Over the next installments in this newsletter series on probate, we will go into further detail about whether we really want to avoid probate, how probate fits into your current estate plan, and what happens if you have no Will.
Please do not hesitate to contact me should you need assistance with probate or your estate plan. Because although the yellow brick road may be great at times….there’s no place like home.
Maybe. Just because you do not have a Will, does not mean you are going to have probate assets at death. For example, if your assets are comprised of a bank account, investment account, retirement account, and stocks, you may have added beneficiary designations on each of these assets. As a reminder, probate property generally is individually owned with no beneficiary designation. Therefore, you can still avoid probate, even if you do not have a Will, by naming direct beneficiaries. If you have a car or real estate, where you cannot name a beneficiary, then yes, those assets would have to pass through probate at your death. Since there is no Will, the law will dictate where those assets go (to your heirs-at-law) and who can administer those assets. It is extremely important to have a Will. This will ensure that if you do have probate assets, the administration is as easy as possible, and your assets are going to the right person(s).
Okay, by now you are certainly sensing a theme…the answer again is “Maybe.” What is an often ENORMOUS hole in someone’s estate plan is the proper ‘funding’ of one’s trust. The concept of funding is retitling assets during your life into the name of your trust or naming the trust as a beneficiary. You can have the most impressive set of trust documents ever created, but that does not mean your assets have been properly funded or tied into that trust. If your assets remain in your individual name, with no beneficiary designation, then your assets will still have to pass through probate at your death. Typically, a trust plan will include a “Pour Over Will.” A Pour Over Will directs that the assets passing through probate and your estate be paid over to the trustee of your trust, and then distributed in accordance with the terms of your trust. Although the estate administration for this may be easier, it does not mean the estate or probate piece is eliminated. In order to avoid probate entirely, your assets must be retitled into the name of the trust or have proper beneficiary designations. If your trust is fully funded, then yes, you can avoid probate. I find that cars are often the one ‘hiccup’ when it comes to probate assets – as they are generally not recommended to be retitled into the trust and there is no ability to name a beneficiary. So, if the car is the only probate asset, then a probate will be necessary (but in Massachusetts, it is a very simple, quick, and inexpensive probate.)
Maybe. If all marital assets are jointly owned by the spouses or have beneficiary designations, then usually there is no probate at the first spouse’s death. But, if any of the assets are individually owned, without a beneficiary designation, then there will be a probate at your death, even if your spouse is living. Keep in mind, how Massachusetts law distributes property at your death and to whom is often surprising! For example, if you are married, have no children, but have living parents, then your parents may be partial beneficiaries of your estate (M.G.L. c. 190B, s. 2-102). If this is not your intention, then you must have a Will to override this default under the law and ensure all assets pass to your spouse.