Level 1 Planning - The Living Trust
Situation
No estate planning in place, or present planning is outdated or inadequate.
Objectives
- Defer all estate taxes until the death of the surviving spouse.
- For married persons, take advantage of each spouse's Estate Tax Applicable Exclusion Amount of $1,000,000.
- Avoid the delays, publicity and cost (approximately 2% – 5%) of probate in the event of death or disability.
- Make certain that what you have goes to who you want, when you want and how you want.
- Prevent intentional or unintentional disinheritance of children and grandchildren by surviving spouse.
- Protect heirs from their possible inability to plan, their potential disability, their creditors and their potential predators.
- Decide who will manage the estate (i.e. personal representatives, trustees, attorneys-in-fact, etc.) and be responsible for the distribution of the assets.
- Designate a patient advocate and state intent regarding artificial life support.
- Designate on a separate list who is to receive items of personal property such as jewelry.
Tools & Techniques
- Revocable Living Trust.
- Pour Over Will.
- General Power of Attorney for Financial Matters.
- Durable Power of Attorney for Health Care/Living Wills.
Disadvantages
None, since grantor maintains total control over his/her assets and all documents are amendable and revocable.
The Transfer Tax System
Every U.S. taxpayer is given a tax credit, known as the applicable credit amount which protects a portion of his/her assets from estate taxes, referred to as the estate tax applicable exclusion amount (the "exemption"). Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "Act"), the exemption for estate taxes increased to $1 Million in 2002 and then will gradually increase to $3.5 Million by 2009. The Act repeals the estate tax and generation skipping tax for only one year in 2010. In 2011, the estate and generation skipping taxes are reinstated, generally as they existed before the Act.
Gifting during lifetime is treated differently than bequests at death. The gift tax applicable exclusion amount (the "gift tax exemption") increased to $1 Million in 2002 and remains indefinitely at that amount.
In 2010, the top gift tax rate will be the top income tax rate. The exemption available at death is reduced by the exemption used to make lifetime gifts. The phase in of the rates and exemption is detailed in the table below.
In addition, the law provides an unlimited marital deduction which allows married persons to leave any amount of property to their spouse (if a U.S. citizen) free from Federal estate and gift taxes. The unlimited marital deduction was not affected by the new Act.
In 2010, the estate tax is repealed. The present rules, providing for a step-up to fair market value basis for property acquired from a decedent, are also repealed. For 2010, a carryover basis generally replaces the stepup basis for property acquired from a decedent. However, each decedent's estate generally is permitted to retain the step-up in basis for up to $1.3 million of assets transferred. In addition, the step-up in basis may be retained for an additional $3 million of property transferred to a surviving spouse.
For simplicity's sake, the examples and illustrations in this brochure assume that both spouses die after December 31, 2010 and, therefore, the $1,000,000 exemption applies.
| Estate Tax | Gift Tax | |||
| Calendar Year | Exemption | Highest Estate Tax Rate | Exemption | Highest Estate Tax Rate |
| 2001 | $675,000 | 55% | $675,000 | 55% |
| 2002 | $1 Million | 50% | $1 Million | 50% |
| 2003 | $1 Million | 49% | $1 Million | 49% |
| 2004 | $1.5 Million | 48% | $1 Million | 48% |
| 2005 | $1.5 Million | 47% | $1 Million | 47% |
| 2006 | $2 Million | 46% | $1 Million | 46% |
| 2007 | $2 Million | 45% | $1 Million | 45% |
| 2008 | $2 Million | 45% | $1 Million | 45% |
| 2009 | $3.5 Million | 45% | $1 Million | 45% |
| 2010 | - 0 - | - 0 - | $1 Million | 35% |
| 2011 | $1 Million | 55% | $1 Million | 55% |
Because of the Congressional Budget Act of 1974, all provisions of the Act "sunset" (i.e., expire) on December 31, 2010, and the estate and gift tax rules in effect in 2001 are reinstated, with a $1 Million exemption. In other words, unless Congress acts before 2011 to extend the provisions of the Act, the estate and gift tax structure in effect prior to the Act will return.
It is important to remember that the size of the estate is increased by the death proceeds of all life insurance owned by the decedent on his/her life. However, no estate or gift taxes are due on transfers to a spouse (who is a U.S. citizen) because of the unlimited marital deduction.
A revocable Living Trust becomes irrevocable at death. Often, a married person will establish a revocable living trust so that the trust property is divided into two parts at the first death. The exemption amount (i.e. $1,000,000) is placed in a Family Trust (Trust B in the chart on Page 4). The balance of the trust property is placed in a Marital Trust (Trust A in the chart on Page 4). No taxes are due at the first death because the $1,000,000 exemption applies to the Family Trust, and the unlimited marital deduction applies to the Marital Trust.
Upon the second death, the assets in the Family Trust pass estate tax free to the children under the terms established in the trust. The assets in the Marital Trust are taxable as part of their estate, but only to the extent they exceed the surviving spouse's exemption. Thus, a married couple can leave $2,000,000 to the surviving spouse's children federal estate tax free!
The Advantages of a Living Trust
A Revocable Living Trust is one created during lifetime in which the grantor retains the right to revoke the trust, change its terms, and regain possession of the property in the trust. The grantor is typically the trustee of the trust during his/her lifetime.
With proper coordination, a married couple can leave up to $2,000,000 estate tax free to their heirs.
A Living Trust will minimize administration and probate costs arising at the grantor's death, since property titled in the name of the trust avoids probate.
Placing property in a Living Trust also avoids the necessity of a court supervised conservatorship in the event of the grantor's mental incompetence.
Upon death, the trust sets forth the dispositive terms for the grantor's spouse, children and grandchildren. The trust can also protect the grantor's heirs from potential creditors, including divorced spouses.
Common Mistakes in Designing
Living Trusts
People often execute revocable Living Trusts without really understanding their trust's provisions. For example, is the Marital Trust a so-called QTIP TrustIf not, then the surviving spouse can intentionally or unintentionally disinherit the children. Does the Family Trust allow income to be "sprinkled" to children and grandchildrenIf not, the opportunity to shift income to lower tax brackets is lost. Does the trust agreement permit the trustee to postpone distributions to beneficiaries (beyond their required distribution dates) for good causeIf not, it may be impossible to protect trust assets from the beneficiaries' creditors, including divorced spouses. Do the marital and family trusts give the surviving spouse a testamentary limited power to appoint trust property among children and grandchildrenIf not, considerable flexibility to reduce the income and estate taxes of the children is lost. For these and many other issues too numerous to cover here, it is advisable to have one's estate planning documents reviewed by an estate planning specialist.
Living Trust Diagram
The Marital - Family type of Trust is designed to make certain that the $1,000,000 exemption of each spouse is used, while allowing the surviving spouse to have use of all of the deceased spouse's assets during the remainder of his or her lifetime. The Family Trust (Trust B) is generally not taxed at either death. The Marital Trust (Trust A) is generally taxed at the surviving spouse's death.
Click on the image below for a larger view of the living trust diagram.
