The State of Our Estates
Revocable Living Trusts are Effective but not Omnipotent
When it comes to life and estate planning for domestic partners, a prime component in the overall plan is a revocable living trust. As mentioned in past articles, the revocable living trust provides tremendous benefits to domestic partners by avoiding complicated and costly court processes when partners either fall ill or pass on.
The benefits of avoiding government bureaucracies (and that is what the court system is) can be tremendous. Overall costs for probating an estate can average between 4% and 10%, and assets inside a revocable living trust avoid that. Delays in settling an estate can average six months to a year and a half or more, and assets inside a revocable living trust avoid that. A deceased person’s financial information and the names, addresses and ages of the beneficiaries are open to the public, but a revocable living trust avoids that as well. For many domestic partners, probate costs, delays, and the release of financial and personal information to the public can quickly move from being annoyances to huge life problems, especially if one partner is more financially dependent on the other.
While it is fortunate that the public is becoming more aware of alternatives to the Last Will and Testament to avoid probate, there is a large revocable trust industry developed by life insurance companies, and life insurance salespeople are using seminars on revocable living trusts simply to sell expensive life insurance policies and annuities. It is extremely unfortunate that a lot of these presentations are not given by (or even reviewed by) estate planning attorneys, and the primary goal is to make a sale.
It is here that half-truths and patently false statements about trusts are made, and while properly drafted and executed revocable living trusts can do much for domestic partners and others, these documents are not omnipotent fortresses of life and estate planning designed to protect people from every evil that may befall them. Previously, I wrote about the myths of probate. Here are the biggest three myths about revocable living trusts.
MYTH 1: A Revocable Living Trust Avoids All Estate Taxes.
While it would be nice to have a single trust where someone could simply put all of their assets into it, keep complete control of the trust, and it would be completely exempt from any estate taxes at all, ever. However, such a trust simply does not exist. This misconception probably stems from the mistaken belief that avoiding probate means avoiding taxes, and therefore if you avoid one you must automatically avoid the other, also.
Not true.
The distinction between avoiding probate and avoiding taxes is most easily seen when looking at “title” to assets versus “control” of assets. If a person passes on and something is titled in an individual’s name, then it must go through the probate court process before getting to the end beneficiaries. This is true even if a person has a Last Will and Testament. In order for the title, or “ownership papers,” to go from the deceased person to their beneficiaries, the probate court has to officially transfer title. Again, this can be a costly, time-consuming process. If the deceased person had all of their assets titled in the name of their revocable living trust, then there is no “title” for the probate court to pass along… everything is handled outside of court through the terms and conditions of the trust.
As complicated, time-consuming, and frustrating as the probate court process can be, it has nothing to do with another of life’s great tragedies—taxes. Estate taxation is based on “control” over an asset rather than “title.” If a person has control over an asset when they pass on, then it is counted as part of their taxable estate, regardless of how the actual title is held. Therefore, if a person holds title to their house, checking account and mutual fund in the name of their revocable living trust and they maintain complete control over the trust, then their house, checking account and mutual fund will avoid the probate process when it is transferred to their partner. However, the value of their house, checking account and mutual fund will be counted as part of their taxable estate.
There are some potential estate tax breaks partners can take advantage of in the revocable living trusts our firm has developed specifically for domestic partners. While in the example above the first partner’s house, checking account and mutual fund will be part of the first partner’s taxable estate, our firm’s Partner AB-SECURE Trust can make sure that these assets are not taxed again when the second partner passes on. To read a special report about this trust, which is also available nationally through a company called The Estate Plan, please go to www.partnerabsecuretrust.com. While this report is usually $9.97 plus tax, readers of Out in Asheville can receive the report for free by entering coupon code “ASH88”.
MYTH 2: Assets in a Revocable Living Trust are exempt from lawsuits.
While this would be fantastic for domestic partners and other individuals, particularly those who are business owners, a revocable living trust does not exempt assets from lawsuits. Again, this comes down to title versus control, and since the partners setting up their revocable living trust maintain complete control over their trust assets, those assets are not exempt from being taken in a lawsuit.
Again, this misconception probably comes from intentionally or unintentionally vague seminars conducted by non-attorneys. The kernel of truth about assets being exempt from lawsuits refers not to the partners who create the trust and run it as trustees, but instead applies to the beneficiaries who would receive the trust assets when the second partner passes on. Well-drafted trusts will protect assets from being distributed to beneficiaries involved in lawsuits or a bankruptcy.
While partners may not be able to use a revocable living trust to protect their personal assets from business lawsuits, there is actually a simpler, more common solution, which is to incorporate the business. By establishing a corporation or limited liability company and keeping business operations and funds separate from personal matters and finances, partners can protect their personal assets.
MYTH 3: Revocable living trust assets are protected from Medicaid spend down rules.
While the first two myths are probably derived from confusing issues of title and control, this myth is probably perpetuated more by confusing the revocable living trust with another trust specifically designed to shelter assets if someone needs to go to a nursing home and wishes for Medicaid to pay for the expenses. (Without going too much into the complexities of the Medicaid program, let me give the short and incomplete summary that Medicaid will handle nursing home bills provided you have little or no assets of value.) The revocable living trust helps partners with the management and distribution of assets if one or both become incapacitated or pass on. A catastrophic illness trust can preserve assets for the benefit of a person in case they become ill and need the long-term care contemplated by the federal Medicaid program.
The differences between these two kinds of trusts are stark. With a revocable living trust, partners can maintain complete control over their trust assets throughout their lifetimes. With a catastrophic illness trust, a person would have to give up complete control when the assets go into the trust. With a revocable living trust, the partners can amend or revoke the trust at any time. With a catastrophic illness trust, the trust is permanent and unchangeable once established. With a revocable living trust, the partners can be the trustees of the trust. With a catastrophic illness trust, someone else must be the trustee. Finally, for the catastrophic illness trust to even work, the assets going into the trust must be transferred five years before Medicaid is even applied for.
“I don’t like that,” is what I usually hear from clients when I describe the terms of a catastrophic illness trust. The fact is that the rules for a person to qualify for Medicaid care have become so strict in making sure a person has very little in assets that it is almost not worth trying. Almost. There are some potential solutions for Medicaid qualification depending on your specific situation, but they do not usually fit into a simple solution. And the solution is definitely not a revocable living trust.
There are some extremely important benefits available for domestic partners in life and estate planning with the right kind of revocable living trust, but it is not a solution to all potential problems. Whether or not a revocable living trust is right for your situation is something you should discuss with an attorney experienced in estate planning with domestic partners, but be definitely beware of the false information out there.
Jeffrey G. Marsocci is a Raleigh-based life and estate planning attorney who frequently lectures and works in Asheville. He is also the author of Estate Planning for Domestic Partners, and focuses on helping domestic partners achieve many of the same rights married couples have. He can be reached through his main Raleigh office at 919-844-7993, and his book providing valuable information on revocable living trusts for LGBT couples can purchased at www.estateplanningfordomesticpartners.com. For more information on domestic partner estate planning issues, please check out the Podcasts at www.rainbowlegaltalk.com.
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