You may think you don’t need to make any estate planning moves because of the generous federal estate tax exemption of $12.92 million for 2023 (effectively $25.84 million if you’re married). The exemption amount is scheduled to go down significantly in 2026 unless Congress extends it.
However, if you have significant assets, you should consider establishing a living trust to avoid probate. Probate is a court-supervised legal process intended to make sure a deceased person’s assets are properly distributed. However, going through probate typically means red tape, legal fees and your financial affairs becoming public information. You can avoid this with a living trust (also commonly called a family trust, grantor trust and revocable trust).
HOW THEY WORK
You establish the living trust and transfer legal ownership of assets for which you wish to avoid probate to it (such as your main home, a vacation property, antique furniture, etc.).
In the trust document, you name a trustee to be in charge of the trust’s assets after you die and specify which beneficiaries inherit which assets.
You remain the trustee while you’re alive. After that, you can designate your spouse, adult child, sibling, faithful friend, attorney, CPA or financial institution to be the trustee.
Because a living trust is revocable, you can change its terms at any time, or even unwind it completely, while you’re alive and legally competent. That’s why it’s called a living trust.
For federal income tax purposes, the existence of the living trust is ignored while you’re alive. As far as the IRS is concerned, you still personally own the assets in the trust. You continue to report on your tax return any income generated by trust assets and any deductions related to those assets, such as mortgage interest.
For state-law purposes, however, the living trust isn’t ignored. Done properly, it avoids probate. And that’s the goal.
When you die, the living trust assets are included in your estate for federal estate tax purposes. However, assets that go to your surviving spouse aren’t included in your estate, assuming your spouse is a U.S. citizen due to marital deduction.
SOME CAVEATS
A living trust has several benefits, but you must title assets in the trust to get probate avoidance:
- When you fill out forms to designate beneficiaries for life insurance policies, retirement accounts and brokerage firm accounts, the named beneficiaries can automatically cash in upon your death without going through probate. If the distribution provisions of your living trust are different from your beneficiary designations, the latter will take precedence. Keep beneficiary designations current because your living trust’s provisions won’t override them.
- If you co-own real estate jointly with right of survivorship, the other co-owner(s) will automatically inherit your share upon your death. It makes no difference what your living trust says.
- You must transfer legal ownership of assets to the living trust for probate-avoidance. Many people set up living trusts and then fail to follow through by transferring ownership.
MORE PLANNING MAY BE NEEDED
Living trusts do nothing to avoid or minimize the federal estate tax or state death taxes. If you have enough wealth to be exposed to these taxes, additional planning is required to reduce or eliminate them. Contact us for more information.
