Estates, Trusts & Tax FAQ
June 30, 2016
The answer is an emphatic “Yes” if you have heirs or charities that you care to protect. Should you die intestate (without a will) the Commonwealth of Pennsylvania will determine how to distribute your assets, which may or may not be in accordance with your wishes. To ensure your estate is distributed the way you prefer, you should make your wishes known via a will.
Generally, a will is a part of an estate plan. A good estate plan will also include a Durable Power of Attorney and a Health Care Power of Attorney/Living Will. Additionally, it will assist with the coordination of the designation of beneficiaries for life insurance, 401(k)s, IRAs, and other retirement plans and investment vehicles. Depending on the value of your estate and your personal circumstances, you may want to consider various trust vehicles to compliment your will. While an attorney is not required to write a will, Power of Attorney or Health Care Power of Attorney/Living Will in Pennsylvania, consulting an attorney may be advantageous if you 1) are interested in exploring strategies that may reduce or eliminate death taxes, or 2) have complicated circumstances regarding how to divide your estate (i.e. children from different marriages, young children, heirs with special needs, or multiple business holdings). If you are young, it may be wise to develop a relationship with an estate attorney presently so that as your assets grow he/she can advise you on changes to suit your new circumstances.
Probate is the process by which your will is determined to be your final wishes, and is filed of record with the Register of Wills or probate court. An administrator or executor/executrix is then appointed. During probate, your assets will be tallied, any outstanding debts, expenses and taxes will be paid, and the remainder will be distributed to your heirs as instructed by your Will. Probate is a matter of public record.
Probate Assets are assets that you own in your individual name at the time of your death (e.g., bank accounts, stocks, bonds, mutual funds, real estate, etc., titled solely in your name). Probate Assets pass to the beneficiaries named in your will. Certain Non-Probate Assets pass outside of your will by beneficiary designation or by operation of law. Non-Probate Assets that pass by beneficiary designation are generally retirement assets (401k’s, IRA’s, etc.), annuities, and life insurance proceeds. When you complete a beneficiary designation form, the individual(s) that you name will receive these benefits without even looking at your will. In addition, Non-Probate Assets include assets owned jointly by husband and wife and assets owned as joint tenants with the right of survivorship (not tenants in common) with other individuals.
Many people think that probate is cumbersome and costly and will seek to avoid the process altogether by setting up revocable (living) trusts. In all honesty, probate in the Commonwealth of Pennsylvania is not overly burdensome and may not be worth the cost of establishing a living trust to avoid the process. Even if you set up a trust, you will still need a pourover will to pass title to assets that were not re-titled into the name of your trust during lifetime. You should consult an attorney who can advise and make recommendations on your particular circumstances.
In general, a trust is contract made between the grantor (the creator of the trust) and the trustee (the caretaker of the trust). The grantor decides which assets will be placed in the trust and the terms of the trust. Once they are transferred to the trust, the trust is the legal title owner of the assets, not the grantor.
Under a living trust, the grantor is usually the trustee (or a co-trustee) and typically retains all rights to manage the trust as he/she sees fit. Upon the grantor’s death or incapacity, the trustee (or a successor trustee) manages the trust.
If the living trust is utilized, all (or the vast majority) of the grantor’s assets should be re-titled into the name of the trust. Upon the grantor’s death, the assets that are owned by the trust avoid probate since they are not owned in the decedent’s individual name.
Both a will and a living trust accomplish the same goal – they pass your assets in compliance with your wishes after you die. Which choice is right for you depends on your circumstances. An experienced estates and trusts attorney can help you decide. Here are some considerations:
|All proceedings are a matter of public record.||Usually private (unless there is court intervention).|
|You can name a guardian of the person and estate for minor children||Although a trust can manage assets for minor children, a will is usually necessary to appoint a guardian of the person for the minor children.|
|You can control how assets are given to heirs. This is especially useful if you have minor children or heirs with special needs.||You can control how assets are given to heirs. This is especially useful if you have minor children or heirs with special needs.|
|Assets remain in your name.||Assets are transferred to the trust during your lifetime (but the trust is revocable, so assets can easily be returned to the grantor).|
|Creditors have set time frame to make any claims. If they miss the time frame, the claim is barred.||Creditors have set time frame to make any claims. If they miss the time frame, the claim is barred.|
|Generally lower cost to set up, but more administrative duties and filings for your recipients after death.||More effort and cost up front but usually less administrative duties and filings for your recipients after death.|
|Good for those who do not own real property in multiple states.||Good for those who own multiple pieces of real property in multiple states.|
As you can see from the list below, there are numerous trust vehicles which offer advantages and disadvantages. You should consult with your attorney and financial planner to determine which best suit your particular circumstances and will best achieve your goals.
Also called a “bypass trust,” a CST is normally established to take advantage of the applicable federal exclusion amount (formerly the unified credit). This is the amount you can pass free from tax for federal estate tax purposes. The CST is normally established upon the death of the first spouse to die and the estate is divided into two parts: one part is placed in the CST to benefit the surviving spouse and/or other family members without being subject to tax at his or her death or at the death of the surviving spouse. The other part is passed outright to the surviving spouse or is placed into a marital deduction trust.
Established solely to benefit the surviving spouse, it is structured to qualify for the unlimited federal estate or gift tax marital deduction.
A CRAT is a charitable trust arrangement whereby the donor or other non-charitable beneficiary is annually paid a fixed annuity of at least 5% (but not more than 50%) of the initial fair market value of the property in the trust, either for life or a period up to 20 years. Upon the death of the donor or income beneficiary, a qualified charitable organization is named to receive the remainder of the trust. The actuarial value of the charitable remainder interest must be at least 10% of the net fair market value of all property transferred to the trust, determined at the time of transfer. This is similar to a commercial annuity that pays a fixed sum.
Since the remainder interest passes to charity, at the time of the creation of the CRAT, the donor is entitled to a charitable income tax deduction for the actuarial value of the remainder interest.
A CRUT is a charitable trust arrangement whereby the donor or other non-charitable beneficiary is annually paid a fixed percentage of at least 5% (but not more than 50%) of the annually revalued trust assets, either for life or a period up to 20 years. Upon the death of the donor or income beneficiary, a qualified charitable organization is named to receive the remainder of the trust. The actuarial value of the charitable remainder interest must be at least 10% of the net fair market value of all property transferred to the trust, determined at the time of transfer. Very similar to a CRAT, the main difference is the CRUT is a fixed percentage of the trust assets, which are revalued annually, rather than a fixed payment based on the initial fair market value. Under the CRUT, the income beneficiary shares in the appreciation or depreciation of the trust.
Since the remainder interest passes to charity, at the time of the creation of the CRUT, the donor is entitled to a charitable income tax deduction for the actuarial value of the remainder interest.
In a Charitable Lead Trust, an annuity is paid to a charity for a specified period of years. At the end of the designated timeframe, the remainder is paid to non-charitable beneficiaries, which are normally the donor’s heirs/family members.
At the time of the creation of the CLAT, the donor may be entitled to a charitable income tax deduction for the actuarial value of the annuity interest that is paid to charity.
A GRAT is a post-1990 trust that pays the grantor a fixed annual payment (an annuity) for a specified number of years. Since the value of the grantor’s retained interest reduces the value of the gift to the remaindermen (usually succeeding generations), it is an excellent vehicle to pass wealth to younger generations at a discounted gift tax value. Upon the expiration of such time period, the assets pass to heirs/family members.
A GRUT is a post-1990 trust that pays the grantor a percentage based on annually revalued trust assets. Since the value of the grantor’s retained interest reduces the value of the gift to the remaindermen (usually succeeding generations), it is an excellent vehicle to pass wealth to younger generations at a discounted gift tax value. Upon the expiration of such time period, the assets pass to heirs/family members.
An RLT is created during the grantor’s lifetime and enables him/her to alter, amend or revoke the terms. At the grantor’s death, the trust can either terminate or become irrevocable and continue for the beneficiaries. An RLT is typically used to avoid probate.
A QTIP trust is a creature of federal estate and gift tax laws. It is used to provide lifetime income to a surviving spouse and allows the grantor to designate who receives the principal after the surviving spouse dies. This makes it useful for providing for children from a first marriage. Although the surviving spouse’s interest is subject to some restrictions, a QTIP trust still qualifies for the estate and gift tax marital deductions.
An irrevocable Life Insurance Trust holds a life insurance policy in which the grantor gives up all rights to the property transferred to the trust and retains no rights to revoke, terminate, or modify the trust. An ILIT allows the grantor to remove the death benefit of the life insurance policy from his/her taxable estate.
An irrevocable trust cannot be altered, amended, or revoked once it has been established, thus the grantor gives up all control over the trust and it becomes solely governed by the terms of the trust. While most times people opt for a revocable trust, there are instances when an irrevocable trust is useful, such as when the grantor does not want the assets to be taxed in his/her estate; in some instances of divorce when a court mandates a trust for a spouse or children; or when the court mandates a trust for minor children who receive a settlement for injuries from an accident.
A testamentary trust is created in your will or otherwise takes effect (and becomes irrevocable) upon your death.
A DAPT is created to protect assets from a beneficiary’s creditors. It is an effective tool for business owners, doctors and other professionals who run a high risk of being sued. Currently, several states allow for DAPTs, including Alaska, Delaware, Rhode Island, Nevada, Utah, Oklahoma, Missouri and South Dakota.
A 2503(c) Trust is set up for minors to comply with Section 2503 (C) of the Internal Revenue Code so that any gift placed in the trust for the benefit of a minor will qualify for the annual gift tax exclusion.
A “Crummey” Trust is set up so that all or a portion of any gift placed in the trust will qualify for the annual gift tax exclusion.