2890 N. Main Street, Suite 206 • Walnut Creek, CA 94597

Walnut Creek Trusts & Estates Attorney

Establishing a revocable Family Trust will accomplish at least three fundamental estate planning objectives.  A well-constructed family trust will do the following:

  • Avoid costs of court-supervised probate proceeding.
  • Protect the estate from unnecessary estate taxes.
  • Preserve trust assets for the benefit of children or selected beneficiaries.

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This information will briefly explain how your family trust works and how your Family Trust will achieve these objectives.

1.  Generally.

A Family Trust is a legal entity.  However, since you will have full control over the trust, the entity is ignored by the Internal Revenue Service (IRS).  Therefore, during your lifetime, the taxpayer identification number (TIN) of the trust will be your social security number (SSN).  No separate tax returns are needed for the trust during your joint lifetimes.  (The terms “Revocable Trust”, “Living Trust” and “Revocable Inter-Vivos Trust” all mean the same as Family Trust.)

2.  Parties to a Family Trust.

The mechanics of a Family Trust are fairly straightforward.  The persons who establish the trust are called the “settlors” of the trust.  The settlors transfer property to the Family Trust (i.e., the titles to assets are changed to reflect the trustee of the Family Trust as the owner).  While both settlors are living, the Family Trust is revocable, which means that the settlors are always free to change the terms of the trust (even after the trust is signed) and can even decide to terminate the trust.  Changes are done by amending the trust.  If significant changes are made, the trust is “restated”.  If the trust is terminated, all of the assets which were previously transferred to the trust, are re-titled into the names of the settlors.

Typically, the settlors are also the “trustees” of the trust.  The trustees of the trust manage the trust assets, so are free to invest, spend or deal with the trust assets as they wish (i.e., as if the trust were not in existence).  The settlors also name successor trustees in the event that both of them are unable to continue to act as trustees (due to incapacity or death).

In naming successor trustees, you should select persons who will be able to handle financial matters and manage assets (i.e., obtain the proper money managers, tax return preparers and other advisers), who can say “no” to beneficiaries’ requests for distributions, and organize clean records of trust transactions.  You should also ask your selected trustees if they are willing to serve, so as to avoid surprise when they are called upon to act.  If you do not have an individual you wish to name as trustee, you may name a bank or other financial institution to serve.  An institutional trustee is especially appropriate if you anticipate some family discord during the administration of your trust.  (The office of trustee does place an individual “in the middle” of any family conflicts.)

During their joint lifetimes, the settlors are also the “beneficiaries” of the trust.  So the settlors can use the income and principal of the trust for themselves as they may choose.  The settlors also designate other beneficiaries to receive their trust assets after the death of both of them (and after the death of the first of them, if they choose).  These other beneficiaries are normally the settlors’ children and grandchildren (i.e., the settlors’ issue), but can also be other individuals and charities.

3.  Probate Avoidance Purpose.

The Family Trust, when properly maintained by you, will serve the purpose of avoiding a court-supervised, public probate.  It is desirable to avoid a probate proceeding because in addition to being a public process, it is very expensive and time-consuming.  A typical probate proceeding can cost 4% to 6% of the gross value of the probate estate (i.e., the full fair market value of the probate assets without offset for any debts or expenses) and a “simple” estate may take upwards of 18 months to complete.  In contrast, administering a family trust may cost 1% of the gross estate assets and a “simple” estate may take less than one year to complete.  As you can see, establishing a Family Trust does present an “up-front” expense, but without it, a person’s estate will be expensive to administer, and also costly in terms of time and inconvenience.

A Family Trust can avoid the need for probate because it continues to exist even after the settlors are deceased.  A court-supervised probate is required to distribute assets from a deceased person to the deceased person’s proper heirs.  A properly maintained Family Trust will own all of settlors’ assets.  Since the Family Trust continues to “live on” when both settlors have passed away, it can continue to own the deceased settlors’ assets (much like a corporation would).  The court does not need to step in to distribute the assets.  If trust assets need to be distributed, the successor trustee(s) of the trust will carry out this task.

Additionally, if you own real property in another state, establishing a Family Trust will eliminate the need to open another probate proceeding in the state where the property is located.  Your Family Trust will also provide a vehicle for management of assets in the event that both settlors become incapacitated during their lifetimes.

Please note that an estate attorney should be contacted in the event of either settlor’s death.  The Family Trust avoids a public probate, but there are still matters that need addressing in the event of either settlor’s death.

4.  Estate Tax Savings Purpose – Married Couples.

For married couples, your Family Trust can save estate taxes by taking advantage of two estate tax laws. The first estate tax law is the estate tax exemption.  The estate tax exemption allows an individual to pass a certain amount of assets without incurring estate taxes .  For 2006, this amount is $2,000,000.  Every individual is allowed this exemption amount, but it must be used by that individual or else it is lost .

The second estate tax law is the unlimited marital deduction.  The unlimited marital deduction allows a person to pass an unlimited amount of assets to his or her spouse upon death.  To reduce estate taxes, an individual should try to take advantage of both of these estate tax laws.

To illustrate how your family trust can save estate taxes, let’s consider the following examples.

Example 1:  A married couple, Harry (H) and Wanda (W), have Wills that state that when one spouse passes away, all assets are to be distributed to the surviving spouse.  For simplicity purposes, we will assume the following:

  • All of the couple’s assets are community property (CP), i.e., owned in 50/50 by each spouse.
  • The estate tax exemption amount will remain at $2,000,000 at each death.
  • Harry (H) and Wanda (W) have combined estates of $4,000,000 and that value does not change.

Let’s say that W is the first spouse to pass away.  Her one-half of the CP assets, or $2,000,000, will pass to the husband.  No estate taxes are due upon her death because of the unlimited marital deduction.  She can pass an unlimited amount of property to her husband free of estate taxes upon her passing.  However, shortly thereafter, H passes away, and his estate is now $4,000,000 (H’s original $2,000,000, plus W’s $2,000,000 which she bequeathed to him).  H’s estate tax exemption amount will allow him to pass $2,000,000 free of tax, but the remaining $2,000,000 will be subject to estate tax.  The estate tax rate for 2006 is 46%.  So at 2006 rates, H’s estate will need to pay $920,000 in estate taxes.

Example 2:  Let’s assume that the couple has a Family Trust in addition to their Wills.  The Family Trust saves estate taxes by creating an irrevocable trust, called the Bypass Trust, upon the death of the first spouse.  So now, when W passes away first, her share of the CP assets are funded into the Bypass Trust, up to the estate tax exemption amount of $2,000,000.  H is the trustee of the Bypass Trust, and receives all income (i.e., interest, dividends and rents) from it.  H also can take the principal from the Bypass Trust, but for certain purposes only, i.e., to pay for H’s health and support costs.  Upon H’s passing, the remaining assets of the Bypass Trust are distributed free of estate tax to the trust’s remainder beneficiaries (i.e., H and W’s children).  The assets are not subject to the estate tax because they were protected by the wife’s estate tax exemption amount when she died.  The assets are not included in H’s estate because H did not fully control the trust assets.  H’s estate is now only $2,000,000.  H’s estate is not subject to estate tax because of H’s estate tax exemption.  Because of the Bypass Trust, H’s estate saves $920,000 in estate taxes and this amount is now available for H and W’s children, and not the IRS.

In Example 1, more estate taxes were incurred because W’s estate tax exemption was wasted.  Instead, W used only her unlimited marital deduction.  The assets she passed to H were added to H’s estate and taxed on H’s passing.  The unlimited marital deduction only postponed the estate tax on wife’s assets until H’s passing.  In Example 2, less estate taxes were due because the Bypass Trust was established to utilize the wife’s estate tax exemption amount.  As you can see, the Bypass Trust is so-called because it bypasses the estate tax.

In Example 2 above, the Bypass Trust is established automatically, i.e., it is required to be created upon the death of the first spouse.  Another version of the Bypass Trust is a Disclaimer Trust.  A Disclaimer Trust functions much in the same way as a Bypass Trust, but the Disclaimer Trust is elected to be created by the surviving spouse at the time of the first spouse’s death. The Disclaimer Trust provides flexibility in estate planning.

Please note that for estates larger than $4,000,000, additional estate planning may be required.  Also, if a spouse is not a U.S. citizen, the Family Trust will contain a QDOT Trust.

5.   Preservation of Assets for Children.

As illustrated above, a Family Trust can preserve your assets by saving probate costs and fees and by minimizing the effect of estate taxes.  In addition, it can provide a transition for management of your assets in the event that one or both of you are living, but are unable to manage your assets due to incapacity.  In this event, your Family Trust will allow a trusted family member, friend or advisor to manage your trust property.  Furthermore, although the Family Trust does not provide asset protection during your lifetimes, it will be more difficult to contest than a Will.

Additionally, after the death of second settlor, if the trust property is to be distributed to minor children, the funds will be held in trust for their benefit.  The trusts for the children will exist until the children reach ages specified by you in the trust document.  Until that time, the trustee may disburse funds for the children’s health, education, support and maintenance.  Usually, the trust will then terminate upon an age where the child is mature enough to manage his or her funds in a responsible fashion.  The terms of the child’s trust can provide that the trust assets be distributed in stages, for example, one-half at age 25 and the balance when t child reaches age 30.

6.  Responsibilities of Maintenance in Establishing a Family Trust.

Family Trusts do have three drawbacks:  (1) they do present an “up-front” cost to the settlors; (2) they must be funded; and (3)  new assets must be properly titled in the name of the family trust.  None of these issues should dissuade a person from creating a Family Trust if establishing a trust otherwise makes sense. Although Family Trusts do cost more to set up initially than a Will, the savings you pass on to your children and heirs make it a good investment.  Funding the trust requires your obtaining paperwork from your financial institutions and transferring title of those assets to your Family Trust.  It is not difficult, but it can be somewhat time-consuming.  I will teach you how to make the transfers and assist you if you run into problems.

In comparison to funding the trust, keeping the trust up-to-date is a simple process.  At the end of each Family Trust I prepare, you will find a Schedule of Assets, which describes what is initially funded into the trust.  I will teach you how to update the schedule, so you do not have to consult with an attorney each time the schedule changes.  You need only review your trust periodically to make sure that the schedule and your Family Trust distribution provisions are up-to-date.

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Generally, Family Trusts are a wise investment for those whose estates would otherwise pass through probate.  Because California real property values are significant, those needing Family Trusts will typically include all those owning any real estate in California (regardless of the amount of the loan on the property), since any real property will likely exceed the $20,000 threshold for probate.  If no real property is owned, individuals without a Family Trust and with a gross estate of $100,000 (i.e., without offset for debts) will need to probate their assets when they pass away.

It is important to understand how your Family Trust accomplishes your estate planning goals.  If you have any questions, please do not hesitate to contact me.

1 The exemption amount is $2,000,000 for 2006, 2007, and 2008.  In 2009, it will increase to $3,500,000.  In 2010, the exemption amount will be repealed, i.e., no estate taxes will be imposed.  However, in 2011, the exemption amount will return to $1,000,000, unless new legislation is passed.

2 This amount may be used up by gifts during life, or via will or trust at death.  However, only $1,000,000 may be given free of gift taxes during life.  For example, if Harry gives away $500,000 to his only child during his lifetime, and then dies leaving that child an additional $1,500,000, there would be no estate taxes due on his passing.  However, if he gave the $500,000 gift and then died leaving his child $2,000,000, his estate would owe taxes on the $500,000 above the $2,000,000 limit.  An advantage of making gifts during life is that all appreciation on the gifted assets escape inclusion in the donor’s estate upon the donor’s death.

3 The surviving spouse has nine months after the death of the first spouse to create this Disclaimer Trust.   The net income of the Disclaimer Trust will be paid annually to the surviving spouse, and the principal of the Disclaimer Trust can be distributed to the surviving spouse at the trustee’s discretion.  The surviving spouse will be the trustee of the Disclaimer Trust.  However, the Disclaimer Trust is irrevocable, and cannot be amended or revoked by anyone once it has been established.  The purposes of the Disclaimer Trust are to (1) exclude its assets from estate tax in both of your estates; (2) provide income distributions, and the principal if necessary, to the surviving spouse; and (3) then pass its assets on to your children when both of you are gone.

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