Time to Revisit Your Trust

by Michael Repka, Esq.

Historically, there have always been three important reasons why affluent California residents should establish a family trust. First, probate costs in California are extremely high and, if properly executed, a trust can eliminate the need to go through the time-consuming and expensive probate process.

Second, trusts provide a way to distribute assets to younger generations without an immediate and unconditioned distribution.

Third, estate taxes can be extremely costly and the old estate tax rules resulted in the loss of a significant deduction upon the death of the first spouse.

However, the estate tax system was changed significantly in 2010 and the estate tax now hits a far smaller portion of the population.

Probate Costs

There are a number of reasons why dying is disadvantageous. The California probate system is quite costly and time-consuming, which is yet another reason why dying is unattractive.

When someone dies without a trust, their assets have to go through the probate system, which involves the court, lawyers, and a lot of frustration. This is true irrespective of whether the decedent died intestate or with a will.

In California, probate costs are calculated based on the gross value of the assets with no deduction whatsoever for any debt. In other words, if someone owns a house that is worth $4 million, but that house is encumbered by a $3 million mortgage, then that asset would be valued at the full $4 million for California probate purposes. Thus, it is easy to understand how probate costs can take a large bite out of a decedent’s estate. The good news is that assets owned by a person’s trust are generally not included when calculating probate costs.

Inter-Family Considerations

As a former estate planning attorney, I used to have couples come to my office with a pretty firm idea of how they wanted their assets distributed in the event of their death. For many young couples, their approach was fairly straight forward: When the first person passed away, all of the assets would go to the surviving spouse until their death, at which time, all of the assets would go to their children.

The problem with that structure is that it does not consider the possibility of the surviving spouse remarrying.

By way of example, Jim and Sally are married and they have a son, Johnny. Jim and Sally have a combined net worth of $4 million, which is comprised of $2 million each. Under the traditional plan, Jim would die and leave his $2 million to Sally. Many years later, when Sally dies, she is supposed to leave the $4 million to Johnny.

Unfortunately, five years after Jim dies, Sally meets Alejandro and they get married. Alejandro has two children from his prior marriage.

It is easy to imagine how this situation can become very complicated very quickly, however, a family trust can be drafted to ensure that the decedent’s desires are followed.

Estate Tax Concerns

When I started practicing law back in 1999, each taxpayer could leave $650,000 to their heirs without any estate tax. Additionally, there was an unlimited exemption between husband and wife.

Unfortunately, when a spouse died leaving all of their assets to their surviving spouse, then their $650,000 exemption would die with them.

As a result, estate plans were typically drafted such that at least $650,000 would go to other heirs, even if those assets remained in a trust that the surviving spouse could use, with some restrictions, for the rest of their life. This very common structure would result in the functional doubling of the $650,000 exemption.

However, in 2010, Congress enacted significant changes to the estate tax laws. These included a provision, commonly known as “portability,” which gave the surviving spouse the exemption amount from the decedent spouse. Additionally, over the years, the amount that someone can leave to their heirs’ estate tax has skyrocketed to over $11 million for each spouse.

Time to Review your Trust

Given that many people drafted their trusts prior to 2011, they should consider whether the trust is overly restrictive now that the estate tax laws have been made much more favorable.

As part of our service, I am happy to review my clients’ trusts to see whether they should have them revised. In the alternative, it may be a good idea for anyone with a trust drafted prior to 2010 to meet with a qualified estate planning attorney to determine whether the trust adequately addresses their needs.