Before You Trust In A Living Trust

Living trusts are quite the fashion these days, and little wonder, with America's by-now-ingrained fear of probate. But beware: They are hardly a cure-all for estate planning, as some promoters suggest.

With a revocable living trust, the most popular kind, title to your assets is taken out of your name, so you technically own nothing. Then, at death, your estate neatly bypasses probate. Despite the legal transfer, you retain control of the assets and the right to use them any way you choose. As the name implies, a revocable trust can be dissolved at any time.

STARTUP COSTS. But for most people, a will, properly drawn, can provide most of the advantages of a living trust with far less bother. For one thing, trusts can be expensive to set up, especially since you might well choose to retain a lawyer. Upfront expenses typically start at $1,000 just to prepare the trust documents, and some financial planners have been known to charge fees approaching $10,000. And the costs don't stop there. Hundreds more must be spent on changing title of all your assets--house, bank accounts, and such--to the trust.

Trusts must also be administered. If you do it yourself, it can mean lots of extra paperwork. You may be required to make tax and other filings, and you must keep any business or investment activities for the trust separate from other transactions in your name. If you use an outside administrator, such as a bank, you'll pay a percentage of your assets each year for that luxury.

A trust is not necessarily a substitute for a will. Since it's not uncommon for assets to get inadvertently left out of the trust, you'll at least need a so-called pour-over will that transfers all assets to the trust. Otherwise, any unassigned assets will go to probate anyway. If the estate is complicated, requiring a bevy of lawyers and accountants, it can take just as long to settle as a will in probate.

Trusts do make sense in states where probate can be costly and time-consuming. But that's only in about a third of the states, including New York and much of New England, says John Langbein, a law professor at Yale University. Probate elsewhere is often inexpensive and largely hassle-free. That's because about 15 states have adopted the Uniform Probate Code, which so simplifies the process that it can often be done informally, without a lawyer or court appearances. And the remaining states use comparable procedures, having abolished at least the more onerous requirements of the past, such as automatically granting probate lawyers a percentage of the estate as their fee. "Where lawyers are involved in probating an estate, the amount at stake really increases," observes Theresa Meehan Rudy, research director at HALT, a legal-reform group based in Washington.

A little forethought can further reduce the pain of probate. As the law works, only those possessions left in a will are subject to probate; all assets that are jointly held with right of survivorship, such as houses and bank accounts, or have designated heirs at death, such as individual retirement accounts, bypass probate entirely. And some states--New Mexico and North Dakota among seven so far--are adopting laws that allow securities to be transferred directly to beneficiaries on death. Conceivably, then, a well-structured will would leave only odds and ends, such as clothing and household effects, for probate.

Contrary to popular belief, and to what many promoters would have us believe, a living trust does not avoid inheritance taxes, federal or local. "You're not getting out of taxes at all," says John Donaldson, law professor at the College of William and Mary. "The revocable trust is not a tax-savings device. Nothing can be done to save taxes that can't be done with a will."

PLAN AHEAD. Rather, tax-saving comes from smart planning. And all but the wealthiest should be able to avoid federal taxes entirely, using either a will or a trust. Under a series of reforms that began in the 1970s, no federal tax is paid on estates under $600,000, and there are unlimited marital and charitable deductions. With an estate of, say, $1.5 million, you could leave $600,000 to your children, taking advantage of the standard exemption, and the remainder either to your spouse in entirety or divided among the spouse and charitable causes. The effect of the marital deduction is to forgo any tax payment until the spouse's death, presuming he or she is single and has no spouse to pass the estate to.

Couples may also take advantage of an annual exclusion during life, which enables them to give each child up to $20,000 a year ($10,000 per spouse). The effect is to remove this money from the estate and the risk of taxation.

There has been talk in Washington of slashing the $600,000 estate tax exemption, but a bill lowering it to $200,000 died last year, and President-elect Clinton has said he would be against a reduction. More likely are efforts to cap the lifetime gift allowance. In the meantime, as a result of such exclusions, fewer than 1% pay federal inheritance taxes today, says William and Mary's Donaldson, compared with 8% in 1976, when the basic deduction was just $60,000.

Whether you pay state taxes depends on where you live. Many states levy none; others may charge either a tax against the entire estate or an inheritance tax against each heir's share. Again, it doesn't matter whether there is a will or a trust.

Despite all the drawbacks, sometimes good reasons exist for setting up a trust. They are practical devices when property is held in several states. In such cases, without a trust, a will must be filed and probated in each state. Trusts also have the advantage of being secret, unlike wills, which must be filed with the court for public view. And trusts are harder to challenge, so they might make sense for someone who fears a squabble among heirs. Trusts also make sense for anybody who becomes incapacitated. Management of the estate can then be handed over smoothly to a designated trustee.

A slew of books and computer programs are on the market advising consumers how to draw up their own will or living trust. Nolo Press based in Berkeley, Calif., is a leader in this area. One of its most popular self-help books, Plan Your Estate with a Living Trust ($19.95), provides all the information and forms you need to create a living trust or a will. Or, you can get the same material from two separate software programs: WillMaker 4.0 ($69.95) and Nolo's Living Trust ($79.95).

But even critics of the probate system, such as HALT, recommend that a lawyer at least look over what you prepare. If the estate is of any size or complexity, leave the work entirely to a lawyer. A good practitioner uill ensure that the estate isn't suddenly thrown into disorder as a result of an unforeseen event, such as the death of a child. "Probate avoidance is not lawyer avoidance," says Yale's Langbein.

FAIRER SHARES. A well-crafted estate plan reduces the chance of a grantor's intentions not getting carried out. For example, a father who wants all his children treated equally may name each of them as heirs to specific assets of seemingly equal value. But with the passage of time, their values can change, with, say, the house skyrocketing in price and various financial accounts tumbling.

Unless the estate plan accounts for such possibilities, someone may be shortchanged.

Whether you pick a will or a trust may ultimately depend on where you live. Your lawyer can advise you on probate in your state, or you can send away to HALT (1319 F St. NW, Suite 300, Washington, D.C., 20004), which offers guides on probate and trusts that detail each state's laws, including their taxes. One HALT title: Probate: Settling an Estate: A Step-by-Step Guide (Random House; $8.95).

Whatever instrument you choose, keep it simple. Too-fancy an estate scheme could haunt your heirs long after you're gone. E.S. Ely

      A will makes sense in two-thirds of the states that have adopted the uniform 
      probate code or similar legislation making probate a simple and relatively 
      inexpensive process. A living trust may be a good idea:
      -- In the remaining third of the states where probate can be costly and 
      --  When property is held in several states
      --  When the person who owns the assets is at risk of becoming incapacitated
      --  When you want to keep the terms secret 
      --  When you're worried about a will being contested 
      DATA: BW
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE