Author: Mercy Kurian

Revocable Living Trusts – Common Misconceptions

Posted on | by Mercy Kurian

A few days ago, I was explaining the concept of “funding” of trusts to some clients who were new to the world of estate planning and I was struck by the fact that what I had always thought were easy concepts to understand caused a lot of confusion to my clients and their understanding of how trusts operate. The two main areas of confusion appear to be in (1) figuring out exactly how trusts differ from wills and (2) the mechanics of how accounts are transferred into trusts causing trusts to become the new “owner” of those accounts. This article hopes to shed light on these two seemingly simple (or so I thought!) concepts – revocable living trusts and trust funding.

We’ve heard people use the word trusts in different settings and under different circumstances. Many people mistakenly believe that all trusts offer asset protection. However, not all trusts are made equal – trusts can either be living (i.e. inter-vivos trusts) or testamentary (i.e. those that become effective upon the death of an individual). All testamentary trusts are automatically irrevocable but living trusts can be either revocable or irrevocable. The person(s) setting up these trusts are interchangeably called Grantor(s), Trustor(s) or Settlor(s) of trusts.

Living trusts are typically stand-alone entities that become effective immediately upon the signing of the trust agreement. Those that are revocable are called Revocable Living Trusts or RLTs or Will substitutes. These RLTs allow a Grantor to set up the trust and retain full control of the trust assets by also being appointed as Trustee of the trusts. The Grantor can also enjoy the full benefits of the trust assets as a beneficiary. There are several benefits for setting up a RLT the most important one of which is that they are meant to avoid probate (i.e. court supervised process) upon death which is often considered to be ridden with hassle in some states. In contrast, Irrevocable Living Trusts are more difficult to be changed once set up. In this case, the Grantor transfers assets into an irrevocable trust by assignment, sale, gift or loan, then typically gives up control over the assets. The primary benefits of irrevocable trusts are that assets are removed from the Grantor’s estate upon his or her death thereby avoiding estate taxes; and these assets are protected from both the Grantor’s creditors as well as the creditors & predators of the beneficiaries. Properly designed trusts may even escape Medicaid recovery and preserve assets for the Grantor’s ultimate beneficiaries should the Grantor be receiving public benefits. Regardless of which irrevocable trust is used, these trusts are typically sophisticated planning techniques established as part of an individual or married couple’s advanced planning. They should always accompany a robust foundational plan complete with a Will and/or a RLT, a General Durable Power of Attorney and Advanced Healthcare Directive. For more information on the benefits of a RLT, check out our earlier posts on this subject1.

When it comes to “funding” trusts though, it is important to note that this term of art has to do with the act of transferring accounts into the trust or retitling assets into the name of the trusts and has nothing to do with refinancing or getting loans to trusts. The following visual imagery may help provide a better understanding how RLTs2 actually “receive” assets.

If you think of your trust as a cookie jar, then our firm would work with you to take your cookie jar from concept to design to set-up. Once you sign the trust agreement, your cookie jar is now ready to be filled with assets or ‘cookies’. And because your trust is like your alter-ego, it can do almost anything you can do. This means that if you have 5 bank accounts each at a different bank and you want to continue to bank at these 5 banks, then you can open 5 trust accounts at these banks. Our office would then provide you with the necessary documentation you need to present to your bank representative who will then open a new trust account and more often than not, it will have a new account number. Depending on the type of trust you are setting up (revocable or irrevocable), the account will either be associated to your social security number or have its own separate tax identification number or EIN# for income tax reporting going forward. This process of funding may involve several back and forth communications with institutions and can sometimes be challenging especially when a representative may be unfamiliar with trusts. This is when your choice of law firm become important so the firm can work with you and the representatives to see this process through to the end.

This article would not be considered complete if we did not address funding in connection with real property, businesses, and accounts with beneficiary designations. Here is a quick synopsis of how these assets are funded:

  • Real property must undergo a title change (i.e. the deed needs to reflect the new owner as the trust) in order for this to properly avoid probate. This deed must be recorded at the county clerk’s office just like any other deed. So long as the property is being transferred into a RLT, and the Grantor continues to reside in the property, a lender holding mortgage to the property cannot trigger the due on sale clause as the Grantor is protected by statute

  • Depending on how a business is structured (LLC, S Corp., C Corp.), a Grantor-owner’s interest could be assigned to the RLT

  • Accounts passing by beneficiary designations, typically retirement accounts, life insurance policies and/or brokerage and investment accounts with beneficiaries, must be amended to ensure the RLT (or its subtrusts for the various beneficiaries) is the primary beneficiary of these accounts.

While funding is a relatively straightforward process and may be handled the Grantor on his or her own, it is always better to do so under the guidance and counsel of the drafting attorney or let the drafting attorney’s office handle the funding process for an extra fee to ensure things get done correctly and time efficiently. Once all of the assets are either moved into the trust or named as a beneficiary of asset, then going forward, it becomes very easy to administer and manage these trusts because any new account that is opened or property purchased can be made directly by the trust.

2 Our focus in this article is mainly on addressing funding challenges with Revocable Living Trusts and only briefly discussed Irrevocable Living Trusts in passing.

Inheritance Taxes and How They Can Affect Your Planning

Posted on | by Mercy Kurian

 

New Jersey is one of the six states that has an inheritance tax.[1] This means that if you live in New Jersey (or if you own property in New Jersey), the beneficiaries of your estate may need to pay a tax depending on how much they inherit, what type of asset they inherit, and their relationship to you.

Who is exempt and who has to pay?

Class A beneficiaries are exempt from the inheritance tax. Class A beneficiaries are your spouse, children, stepchildren, grandchildren, parents, or grandparents. They do not have to pay an inheritance tax in New Jersey. This means that not all of your relatives are Class A beneficiaries. You may love your niece as a daughter, but she could be subject to an inheritance tax if you leave her a part of your estate in your Last Will & Testament or Revocable Living Trust.

Class C[2] includes your siblings and your son in law (or daughter in law). The first $25,000 is exempt, but anything more than that is subject to a tax that starts at 11% and is based on a graduated scale.

Class D beneficiaries include everyone else who is not in A, C, or E. Your nieces, nephews, friends, or significant other are Class D. There is a $500 exemption after which they have to pay at least 15% on any inheritance which is subject to the tax.

Class E beneficiaries are tax exempt entities such as charities. They do not have to pay an inheritance tax.

What Assets are Subject to the Inheritance Tax?
Most assets are subject to the inheritance tax including bank accounts, IRAs, real property, personal property. Life Insurance, however, is not subject to inheritance tax in New Jersey.

Notable Exceptions

Interestingly, Life Insurance is not subject to Inheritance Tax.  Payments from certain pension plans such as the New Jersey Public Employees Retirement System, the New Jersey Teachers’ Pension and Annuity Fund, and the New Jersey Police and Firemen’s Retirement System are not subject to Inheritance Tax. Also, in New Jersey, there is no inheritance tax on gifts made during lifetime so long as the gifts were made 3 years before death

How Does this Impact Your Planning?

Since not everyone is subject to an inheritance tax and among those who are, not everyone is subject to the same rate, it would be wise to consult with a specialized estate planning attorney when creating your estate plan so that you can maximize the amount of money going to your beneficiaries and minimize the amount going to taxes.  Additionally, it would be important for your beneficiaries to know who has to pay the inheritance tax – by making the estate pay the taxes out of the residue, it would make it  easier for the Executor to administer the estate as he or she can avoid chasing after the various non-Class A beneficiaries to pay up, but it also would mean that less money would go to the residuary beneficiaries.

Example:

Bob is a widower. He and his late wife never had children, but he has two siblings, two nephews, and three close friends who he would like to include in his Will. He would like to give his seven beneficiaries 1/7 of his total $500k estate.

Half of Bob’s estate comes from his life insurance policy; in which Bob had named his wife as the beneficiary but never updated it when she died, nor had he named any contingent beneficiaries. This means Bob’s estate became the beneficiary upon his death and his seven beneficiaries now have to pay inheritance taxes on their respective shares

Result: Each beneficiary inherits $71,428, but the siblings would only have $66,321 after taxes and the other beneficiaries would have $60,714 after taxes. Out of the $500,000 estate, $63,784 or 12.7% will go to the State.

What could Bob do differently?

If Bob goes to an estate planning attorney, the attorney can advise Bob that his beneficiaries are subject to an inheritance tax, and that his nephews and friends are subject to a greater tax than his siblings.

With this awareness, Bob can be more strategic in how he distributes his estate, can reduce the total amount paid in taxes, and can allow for each beneficiary to inherit more money.

Instead of splitting the estate in 7 equal parts, Bob can split his life insurance amongst his five class D beneficiaries, giving each one 20% of the policy. To make it up to his siblings, Bob can give each sibling 30% of his estate and divide the remaining 40% amongst the class D beneficiaries, giving each one 8% of the estate.

By doing this, each sibling will receive $69,500 instead of $66,321, and the nephews and friends will receive $67,000 each instead of $60,714. Out of the $500,000 estate, only $26,000 or 5.2% goes to taxes.

Conclusion

An estate planning attorney can help you achieve the best results for your beneficiaries. Not only would the attorney have advised Bob on proper titling of all probate and non-probate assets but could have helped ensure which beneficiaries inherit what amount and from where. Just splitting the estate equally might sound fair, but as you saw with Bob, it created a not so great outcome for all of his beneficiaries.

[1] Iowa is phasing its out and is set to be gone by 2025.

[2] Class B no longer exists.

 

When Your Estate Plan Does Not Match Your Assets

Posted on | by Mercy Kurian

Henry is a widower with three children. He wants his children to inherit in equal shares, and he hires a lawyer to create his Will.

The lawyer creates the Will using Henry’s instructions, and six weeks later, Henry signs in front of two witnesses and a notary.

The Will is valid, and as far as Henry is concerned, his work is over. When he dies, his children will inherit equally. Unfortunately, Henry did not understand that the Will applies only to probate assets, i.e those assets that go into the estate upon death. The will does not apply to his non-probate assets, assets that  bypass the Will because they automatically belong to someone else upon the owner’s death.

Henry did not discuss with his lawyer what arrangements he needs to make to ensure that all his assets flow the way he wants once he dies. He thought the Will was all that he needed.

What happens to Henry?

Five years later, Henry is having health issues and is struggling with his bills. He has the money, but he is tired, sleeps a lot, and does not always remember which bill is due when. Henry’s son Kevin creates a joint account with Henry, so that Kevin can pay his father’s bills for him.

Kevin does so, dutifully, until his father dies two years later.

Henry named his good friend Mark to be the executor of the estate. Mark knew that Henry had wanted his assets to be equally divided amongst his children. Unfortunately, Henry’s assets were not set up to allow for this.

While trying to administer the estate, Mark ran into three different problems.

Problem #1: The Joint Account

The joint account that Henry and Kevin both had access to had $50,000 in it when Henry died – money that Henry had put into the bank. Kevin’s siblings want him to share the money, as Henry’s Will states everything is to be split evenly.

Kevin refuses, stating that the money is legally his, as that is what the bank has told him. He is angry that his siblings did not do more to help him when their father was struggling, and he does not think they deserve the money.

The siblings go to Mark for help, but there is nothing Mark can do. The joint account is a non-probate asset, which means that the Will does not apply to it. as The account automatically belongs to Kevin once Henry has passed away.

Problem #2: The Life Insurance

When Henry was younger, he purchased  a life insurance policy for $100,000, and named his brother, Cory, as the beneficiary. When Henry got married and had children, he forgot to update  the beneficiary on the policy.   Therefore, when Henry died, the money went straight to Cory. Mark asks Cory to give the money to Henry’s children voluntarily, but Cory cannot because he owes a lot of back child support, and the government took takes the money as soon as it reaches his account.

Problem #3 The IRA

Henry also had an IRA (Individual Retirement Account) when he died. He had made his wife the beneficiary, but he never updated the policy when she died, nor did he name contingent beneficiaries. Mark was able to get the IRA into the Estate, so it could be shared amongst the three children, but this led to a poor tax consequence. When an estate inherits an IRA, it must be cashed out within five years.

If Henry had named his children as the beneficiaries, they could have stretched the payout over ten years, which would have allowed them to pay less in income taxes.

What could Henry have done differently?

If Henry had aligned his non-probate assets with his estate plan, his children would have inherited all his money equally in a tax efficient manner, as he intended when he created a will. Henry could have done several things differently to have a better outcome for his children.

Instead of having a joint account with Kevin, Henry could have appointed  Kevin his power of attorney, which would have allowed Kevin to help Henry with the bills without making Kevin an owner of the account.

Then, Henry could have made each of his children equal  beneficiaries of the joint account. The bank account would still have bypassed the Will, but it would have been allocated the way Henry wanted.

Additionally, Henry could have updated his life insurance policy and IRA , naming his wife as the primary beneficiary of each policy and his children as contingent beneficiaries, inheriting equally. Therefore, when Henry’s wife passed before him and there was no longer a primary beneficiary, the contingent beneficiaries were still in place to automatically inherit the policies upon Henry’s death.

When you are creating an estate plan, it is important to understand how that plan will treat your probate assets, and what you need to do with your non-probate assets to make sure they pass on the way you intend. It is essential  to review your estate plan each time you have a life event, and make sure that the designations on your accounts reflect how you want them to be distributed. It is also important to name contingent beneficiaries in case your primary beneficiary pre-deceases you. When working with an estate planning attorney, always be sure to discuss how to make changes to all your assets to ensure they align with your overall estate planning goals. Life is full of changes – make sure your estate plan and accounts don’t get left behind.