Saturday, March 13, 2010

How to use a trust to avoid probate?

You have heard horrible things about probate. It will be long. It will be expensive. The government will get all your money?

Before you buy into all the hype, review my post explaining probate in Oregon. You may not want to avoid it at all. For a lot of people probate has advantages, the most important of which is that it forces your family to administer your estate in the way it ought be done. With the help of modern technology, lawyers can get you through probate fairly cheaply, and the time it takes is reasonable for the amount of work that has to be done. Before you run off avoiding probate be sure you know what you are running from.

Let's assume you have read my post about probate and no matter what anybody says, you hate the whole idea of it. You can avoid it by being poor.  You can avoid it with an estate plan that relies on joint ownership and beneficiary designations. Most people, however, when trying to avoid probate, look to a trust.

Those of you who have read my post on trusts know a trust is a legal agreement between three people: a person called a settlor who puts up the money, a trustee who takes care of the money, and a beneficiary who gets the stuff that the money buys.  So how does this three-way legal relationship let a person avoid probate?

The answer is  . . . . drum roll . . . by letting one person serve as three. Instead of three people, we clever lawyers create a trust controlled by one person wearing three different hats. You, the settlor--because you settled on creating a trust rather than going through probate--transfer all of your  property to your trustee. And who serves as trustee? You do. It is your job to hold and invest your property and use it for the benefit of the beneficiary. And who is the beneficiary? You are, of course. You give all your property to yourself to be held for the benefit of yourself for as long as you shall live. And just in case anything goes wrong, you reserve the right to revoke the trust and take back your property any time you want.

You might well think that this is far to clever too work in real life. Who would believe in such a thing? A lot of people agree with you. The Internal Revenue Service is one of those people. As far as the IRS is concerned this is a sham and it will call your trust a "disregarded entity."  Money earned by this kind of trust is taxed as if it came directly to you. If you owe money, the people you owe can sue you and get at the money in the trust as if the trust did not exist. The only people willing to buy into this scheme are people who live in the world of probate and estate planning.

Here is how it works. Your trustee--who is you--owns all your property. Your trust says that if you die, your trusted son, Harold, will take over as  trustee. It says that since you can no longer be the benefiiciary--you being dead--Harold and his sister, Maude, are to be the new beneficiaries. The trust tells Harold to sell all your property, pay your bills, and divide the money between himself and Maude. So when you die, the trust lives on. While you were alive the purpose of the trust was to keep you happy. Now that you are gone, the purpose of the trust is to pass your property on to your children.

Let's compare the workings at death between a will and a trust using your biggest asset, your house, as an example.

Let's assume that you wrote a will naming Harold and Maude to receive your house. After you die, Harold wants to sell your house and split the money from the sale with Maude. He goes down to Infidelity National Title Company and they explain to him that the only way he can sign the deed necessary to sell the house is to be appointed personal representative of your estate. This means he has to take the will to the courthouse, pay a filing fee, and open a probate. He will not be able to sell the house until he does.  After he starts the probate he will have the court looking over his shoulder from then on to make sure he pays your old bills, does your taxes, and distributes the money exactly as the will says.

Next let's assume you wrote a revocable trust, transferred your house and your other property to the trust, and named Harold to be the trustee when you die. Once again, you are gone, and Harold wants to sell your house and split the money with Maude. He goes down to Infidelity National Title and says my father's trust owns the house and I am now the trustee. The title company will make sure what Harold says is true and then will allow him to sell the house. He can split the money with Maude and the courthouse is out of the loop. You have avoided probate.

That is how it works. You know the downside to probate: higher costs, public filings and the supervision of the court. What are the down sides to a trust?

Trusts cost you more money today. Trusts are harder for your lawyer to write than wills and he has to makes sure that all your property is transferred into the name of the trust. Deeds have to be written and your investment accounts all have to be changed. I explain to clients, "I am going to get your money. You can pay me now by doing a trust or you can do a will and let your children pay me later." Some folks want to make it as cheap as possible for the kids. Others think that because the kids are getting all that money for nothing, the least they can do is pay the costs involved. I don't care. I get paid either way.

One upside to trusts--freedom from court oversight--is a downside if you don't have a trustworthy, competent, and diligent person to take over the trust when you die. If the personal representative named in a will isn't doing the job, the court will replace him or her with someone who will get it done. When you have a trust there is no one to make sure your bills get paid and your property distributed. If Harold, in our example, happens to be living in your house when you die and has no inclination to sell his rent-free home and split the money with his sister, the only way Maude can get her inheritance is to hire a lawyer and sue Harold. In a lot of families, a little court oversight is a good thing.

At the end of the day the choice is yours. Think about what you own, who you can nominate to take charge when you die, and how much you want to pay for estate planning right now. Then collect your questions and talk to a lawyer.