Estate Planning Basics
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Estate Planning is an important, ongoing process that affects everyone. This process includes anticipating and planning for the distribution and management of your assets during your lifetime, but more importantly at your incapacitation or death. The plan should be carefully crafted so your loved ones can be taken care of, and your wishes carried out.
A basic estate plan is created through a set of legal documents and strategies, which we will address one-by-one below. Please keep in mind that this article focuses on CA based estate planning and, as each state may differ slightly, we recommend contacting a local estate planning attorney.
Revocable Trust
A revocable trust or living trust (you might also see this abbreviated as RLT), is a legal document holding title/ownership of your assets during your lifetime. Due to the legal nature of estate planning documents, and specifically the living trust, there are some common terms that first need to be defined.
Revocable Trust Keywords
1. Grantor/Settlor/Trustor – This is the person who sets up and funds the trust.
2. Trustee – This is the person who manages the assets of the trust.
3. Beneficiary – This is the person(s) who have enjoyment or use of the trust assets.
a. When discussing a revocable living trust in particular, the above three people are usually the same. For other types of trusts, it is important to name an independent third party as the trustee or beneficiary, but in this case, it will be you.
4. Revocable – The trust agreement can be amended or revoked at any time during the grantor’s lifetime. The term “living” is used to distinguish the trust as one that is created during the grantor’s life, as opposed to a “testamentary” trust, which is created at a grantor’s death.
5. Successor Trustee – This is the person who becomes the trustee when the current trustee is no longer able. For a revocable living trust, this is usually due to your (as initial trustee) incapacitation or death.
6. Decedent – This refers to a deceased person.
7. Estate – This refers to all of the assets owned by a particular person, especially at their death.
Revocable Trust Benefits
Now that we have some of the vocabulary defined, we can talk about the benefits of executing a living trust. The primary benefit is that the assets held within the trust can avoid probate court. Probate is a lengthy and expensive court process in which a judge decides what happens to your assets when you pass away. The process can take 12-18 months or longer and can cost up to roughly 5-7% of the gross estate value. For those with large estates, this cost adds up quickly. In the state of California, the asset threshold for needing to go through probate court is only $208,850. This amount is adjusted periodically for inflation, but is relatively low, given the amount of wealth held by many in the state. An additional benefit of the trust is that it keeps the distribution of your assets private. Once assets go through probate court, they become part of the public record.
A living trust agreement outlines your wishes for the distribution of your assets to your heirs, without the need for the courts to get involved. This streamlines the distribution process and is less costly for your heirs, at the same time keeping details private and free from the public record. These trusts are flexible and can be amended anytime to account for life’s changes (i.e. getting married, having kids, renaming any non-family beneficiaries, etc.). While it is common for most assets to be passed on directly to kids or grandkids, it may be the case that you would like your assets to be distributed to friends or a specific charity. The trust agreement outlines all of these decisions and leaves your heirs with no question of your intentions.
For tax purposes, a living trust is what is called a “disregarded entity”, meaning a separate tax return is not required for the trust. There is no separate tax identification number (EIN) needed, and the grantor will simply use their social security number for tax purposes. Any income earned from assets within the trust will be taxed on the grantor’s individual income tax return, as though it did not exist (hence the “disregarded” name for tax purposes).
The titling of the assets in the name of the trust is strictly for legal purposes. The re-titling of existing assets into the name of the trust is an important step once the trust agreement has been executed. Certain assets will not be titled in the trust and will instead have separate beneficiary designations. Assets such as retirement accounts and life insurance are not titled in the trust and will pass to the beneficiary without the need for probate. A review of these beneficiary designations together with the living trust, is important in order to ensure that they align with your interests.
Last Will and Testament
Similar to a living trust, a last will and testament (or just “will”) is a document outlining where you would like your assets to go at your death. It is very similar in operation to a living trust and takes effect at death. The key difference is that unlike assets in a living trust, the assets in a will are subject to the probate process. A will by itself does not allow the decedent’s assets to avoid probate. This means that the time it takes for your heirs to receive their inheritance may be longer. In addition, the distribution of those assets will become a part of the public record.
The majority of wills in the state of California are what is called a pour-over will. In the case that someone’s assets are not titled or owned by the living trust at the time of passing, the will states that this was the intention of the deceased and works in conjunction with the living trust. Therefore, estate planning attorneys will generally create a will in addition to the living trust.
The will also names the executor of your estate. This is the person named in your will who will carry out its instructions, similar to the trustee of the living trust. In some cases, the successor trustee to your living trust and the executor named in your will, will be the same person. Additionally, one of the most important functions of a will, particularly for those with minor children, is the naming of a guardian. This decision cannot be made in a living trust, and without a will, the decision would be left to the courts.
Durable Power of Attorney
The next document generally included in a basic estate plan is a durable power of attorney. A durable power of attorney is a document allowing a designated individual to make decisions on your behalf if you were to become mentally or physically incapacitated. The word durable in this case means that the power of attorney continues to stand and be effective even if you yourself become incapacitated.
The primary function of this power of attorney is for the appointed individual to have the ability to make financial decisions on your behalf in case something were to happen to you. When choosing someone for this responsibility, it is important to choose someone who is trusted and will make the best decisions for you. This power of attorney will end at your death, at which point the successor trustee of your living trust or the executor named in your will, will follow your trust agreement or will in the disposition of your assets.
Advanced Healthcare Directive
The final document included in a basic estate plan is the advanced healthcare directive. This document works similarly to the durable power of attorney by outlining, in advance, your wishes regarding your medical decisions. The enforceability of the healthcare directive depends on your jurisdiction, but if you were to become incapacitated or unable to express your medical wishes (e.g., DNR, organ donation, burial preferences), this document allows your proxy to make those decisions for you. In some cases (for obvious reasons), it may make sense to name someone other than the person named as your financial power of attorney.
This directive provides guidance as to your wishes, but may be left vague if you do not have specific thoughts or opinions on these matters. However, if you do have strong opinions about specific medical decisions, it is important that they are documented in the healthcare directive and that your loved ones understand your wishes.
Summary
In the state of California, these four documents constitute the basics of an estate plan and most estate planning attorneys will prepare all of these together when engaging you to create one. The most important of these documents is the living trust. It should be carefully written and as specific and thoughtful as possible. A benefit of the revocable trust is that it can be amended or restated in its entirety at any time during your life, and can be seen as constantly evolving as your life.
It is advisable to have these documents drafted and executed (at least) once you have reached the asset threshold for probate court ($208,850) so that your estate can avoid this lengthy and expensive court process. Although many people think that they need to wait to start this process until they are married with children or purchase their first home, we think creating an estate plan is necessary for anyone who has specific wishes for their assets after they are gone.
For those who already have a basic estate plan in order, or who may have a large enough estate to trigger the estate tax, we will be covering more advanced estate planning and gifting techniques in future articles.
