Why People Set Up Revocable or “Family” Trusts

A quick perusal of county records reveals a large number of homes are owned in trusts. Typically these trusts are creatively named something like the “John and Jane Doe Family Trust.” Almost everyone who is even the slightest bit affluent, including just about anyone who owns real property in Silicon Valley, has heard that they should have a trust, but many can’t really articulate why. This article will touch upon the what and delve into the why.

What Is a Living Trust? A trust is a written legal document that performs many of the same functions as a Will. In other words, it spells out the rules set by the maker of the trust for assets held in the trust for the beneficiaries. However, a trust does much more than a Will. Conceptually, a trust is also similar to a corporation in that its existence is separate from the person who created it (the “trustor”), and it outlives the trustor. There are different types of trusts (e.g., revocable trust, irrevocable trust, testamentary trust, and charitable trust), and their existence depends upon the trustor’s purpose.

One of the most common and flexible types of trusts is a “revocable living trust” or “family trust” as it enables the trustor to retain the power to change or revoke the trust during the trustor’s lifetime. Following the creation of a living trust, the trustor transfers all assets into the trust. The trust property is managed and administered by the trustees, who also carry out the terms of the revocable trust and hold legal title to the trust property. Most individuals who establish living trusts name themselves as the trustees.

Oftentimes, a married couple serves as the initial co-trustees of the trust, and they retain virtually unfettered control over the trust assets as long as they both live. They can change the trust, move assets into and out of the trust and even terminate the trust as they see fit. When one of the spouses dies, then there are often substantial limitations on what the surviving spouse can do with the decedent spouse’s share of the assets.

Why Do People Set Up a Living Trust?

Generally, many people set up living trusts to avoid probate costs and to manage and control the distribution of assets. While trusts can be used to reduce estate taxes in some circumstances (e.g., people with combined gross assets above $5 million), nowadays this is rarely the driving force for most families.

1. To Avoid Probate Costs

California probate costs remain a significant reason for people to establish trusts. Probate costs are related to the cost of administering the transfer of the decedent’s assets to their heirs, whether those transfers are pursuant to a will or according to a statutory distribution that applies to people who die without a will (i.e., intestate). It is important to note that probate costs are calculated on the gross value of assets that the decedent owned on the date of death, which is very unfortunate for people who own expensive real estate that is subject to a large loan (like most of us). Put another way, to determine the amount that is subject to probate costs, the gross value of all assets is added up with no deduction for debt. For an estate with a gross value of $3 million, the probate costs would be in excess of $40,000.

A living trust avoids probate costs because property that was transferred into a living trust before the trustor’s death is no longer deemed owned by the trustor. The successor trustee – the person appointed to handle the trust after the trustor’s death – immediately steps in to handle the trust property in accordance with the instructions set forth in the trust (e.g., transfers the trust property to the beneficiaries and pays the estate’s debts). Unlike a Will, the trust property can be transferred within days or weeks (not months or years) with no court intervention or probate costs.

2. To Manage Asset Distribution

Another key benefit to a trust is the flexibility of distribution of assets that it affords. Many people would like to provide for their surviving spouses for the remainder of their lives and then have the assets go to their children. However, if assets are left outright to a surviving spouse, there is no guarantee that the surviving spouse will leave all of the assets to the kids upon the surviving spouse’s subsequent passing. Remarriages complicate things further!

With a family trust, the spouse can provide that the surviving spouse can use the decedent spouse’s portion of the assets as long as the spouse is alive, but whatever is left over at the survivor spouse’s death goes to the children. Additionally, distributions to the children can be delayed until they reach certain ages.

3. Estate Tax

Estate tax is invoked upon the transfer of property of a deceased person. “Property” includes everything the deceased owns or has certain interest in at the date of death. The fair market value of these items is used in calculating estate taxes, not what the decedent paid for them. Federal estate taxes are expensive, with the top federal tax rate currently 40 percent, must be paid in cash, and are usually due within nine months after the decedent passes away. Because few estates have sufficient ready cash, some of the assets within these estates must be liquidated to pay the estate taxes.

While every U.S. citizen is subject to the federal estate tax system, not every estate has to pay the tax. The federal government gives each citizen a certain exemption amount that can be applied against the value of the net estate. This exempt amount has varied over the years. For example, estate tax is due for estates with combined gross assets and prior taxable gifts exceeding $5.34 million in 2014, $5.43 million in 2015, and $5.45 million in 2016.

Further, beginning January 1, 2011, the concept of “portability” was introduced, allowing a surviving spouse to use a decedent spouse’s unused estate tax exclusion, which effectively doubles the exemption amount to almost $11 million for the couple. With the high estate tax exemption amount and the portability rule, many families may not be exposed to the estate tax unless their total assets exceed $10.86 million (i.e., $5.43 million per spouse in 2015). For more affluent families, there are ways to mitigate the estate tax exposure with efficient planning, but such discussion goes beyond the scope of this article.


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