Q&A: More solutions for avoiding probate

Dear Liz: I’m wondering why, in your answer about whether to use a will or a living trust, you didn’t mention that probate can be avoided by using beneficiaries for assets such as mutual funds and brokerage accounts and now, in many states, homes. This seems quite relevant to the question and the gist of your answer.

Answer: Space limitations, and reader attention spans, prohibit exhaustive answers to many personal finance questions. Nowhere is that more true than in estate planning, which can get complicated quickly.

It’s hard to avoid probate entirely without a living trust. So-called transfer on death designations can indeed work for small estates, providing that the rest of the estate — the “tangible personal property” such as furniture and jewelry — is small enough to qualify for simplified probate proceedings. (In California, that limit is $150,000.)

Even with small estates, though, transfer on death designations aren’t necessarily the right solution for everyone. Beneficiary designations are easy to forget, for one thing, which can mean accounts going to the wrong people after life changes. In other words, your ex-wife or your mother may wind up with an account that should have gone to your spouse. People who choose to use transfer on death designations instead of a living trust need to remain vigilant about keeping those designations up to date.

They also need to explore other potential ramifications, especially if they’re taking a do-it-yourself approach. For example, if a beneficiary dies first, or simultaneously, the asset may wind up having to go through probate.

Also, as this column discussed a few months ago, real estate transfers in certain circumstances can cause the property to be reassessed, leading to much higher tax bills for heirs. That’s something an attorney would be able to explain to a client while preparing a will or living trust, but it’s something a DIYer might miss.

Q&A: When a living trust can save money

Dear Liz: Here’s another advantage to a living trust. If the person owns real estate in more than one jurisdiction and just uses a will, there will be a probate in the resident jurisdiction and ancillary probates the other location or locations, with the attendant time, costs and delays — all of which could be avoided with a living trust. All properties would have to be transferred into the trust, of course, and it’s always wise to have a pour-over will to make sure that anything inadvertently left out of the trust is included and protected from probate.

Answer: Good points. Living trusts are more expensive to set up than wills but can save money in the long run in such situations.

Q&A: Which is better: Will or living trust?

Dear Liz: I am 48 and my wife is 45. Should we set up a will or a living trust? Which is better?

Answer: One of the major differences between wills and living trusts is whether the estate has to go through probate, which is the court process that typically follows death. Living trusts avoid probate while wills do not.

Probate isn’t a big problem in many states, but in some — including California — it can be protracted, expensive and often worth avoiding. Another advantage of living trusts is privacy. While wills are entered into the public record, living trusts aren’t.

Living trusts can help you avoid another court-supervised process called conservancy. If you’re incapacitated, the person you’ve named as your “successor trustee” can take over management of your finances without going to court. To avoid the court process without a living trust, you’d need separate documents called powers of attorney. If you have minor children, your living trust trustee can manage their money for them. If you have a will, you would need to include language setting up a trust and naming a trustee.

One big disadvantage of living trusts is the cost. Although price tags vary, a lawyer typically charges a few hundred dollars for a will, while a living trust may cost a few thousand. Also, there’s some hassle involved, since property has to be transferred into the trust to avoid probate.

There are do-it-yourself options, including Nolo software and LegalZoom, that can save you money if your situation isn’t complicated and you’re willing to invest some time in learning about estate planning. If your situation is at all complicated, though — if you’re wealthy or have contentious relatives who are likely to challenge your documents — an experienced attorney’s help can be invaluable.

Whichever you decide, make sure that you have one or the other before too much longer. Otherwise, when you die, state law will determine who gets your stuff and who gets your kids.

Q&A: Avoiding estate taxes

Dear Liz: You recently answered a question about what a wealthy couple could do to reduce future estate taxes, and you mentioned the annual exclusion. They also could pay education and medical expenses for anyone, and there’s no annual limit.

Answer: Absolutely — and the couple’s estate planning attorney almost certainly would have informed them of this option.

The original letter came from one of the couple’s children, asking what their parents could do to reduce future estate taxes, in addition to the irrevocable trust that already had been set up. The reader lamented that the estate was bigger than the current exemption limits (now $10.98 million for a married couple) and so could incur estate taxes.

My answer was that the couple’s attorney would have told them of other options. One of those options is to use the annual exclusion of $14,000 per recipient to gift tens if not hundreds of thousands of dollars out of their estate. If the couple chooses not to use available options, and instead lets the estate incur the taxes, there’s not much the heirs can do about it.

Q&A: Federal estate tax exemption

Dear Liz: You mentioned that the federal estate tax exemption limit this year is $5.49 million per person. Can I double that if married?

Answer: Essentially, yes. Married couples can double the amount that can be given or bequeathed to heirs tax free. If one spouse doesn’t use up his or her exemption, the surviving spouse can use the remaining amount in addition to the surviving spouse’s own exemption.

You also should know that you can leave an unlimited amount of money to a spouse who is a U.S. citizen. (The rules for non-citizen spouses are different and could fill a whole column on their own.) This is known as the unlimited marital deduction.

Q&A: These heirs worry their parents aren’t doing enough to minimize estate taxes

Dear Liz: My parents, ages 75 and 76, have established an irrevocable gift trust for my five siblings and me. Wonderful! With the single trust, they have maxed out their lifetime gifting exemption. What else can they do with their other investments to minimize the inevitable estate taxes that will come with their deaths? They have lived a frugal life of caution and reserve, but before their nest egg can be distributed to their heirs, the government will extract millions of dollars.

Answer: If your parents maxed out their lifetime gift exemption, that means they contributed more than $10 million to the trust. It also probably means they employed an estate-planning attorney, since such trusts aren’t typically do-it-yourself projects. If that’s the case, the attorney probably has reviewed with them their other options for minimizing taxes.

They could, for example, give each sibling $28,000 ($14,000 from each parent) each year — and make similar gifts to each sibling’s spouse and children, if they were so inclined. This annual exemption limit is separate from the lifetime gifting exemption they’ve already used. If each of you is married with two kids, that would move $672,000 out of their combined estates each year.

Another way to move money out of their taxable estate, either now or at their deaths, is to donate to charities.

If they opt not to take further steps, you can take comfort in the fact that the top estate tax rate is 40%, which means the bulk of their estate will still reach their heirs. Also keep in mind that you’re in rare company — only about two estates out of 1,000 are large enough to trigger an estate tax return, now that exemption limits have been raised to $5.49 million a person.

Q&A: Don’t bequeath trouble to your descendants

Dear Liz: I have two grown children, neither of whom owns a home, and three grandchildren. I would very much like to keep my house in the family for all to use, if and when needed. It is not large, and it would be somewhat difficult for two families to live here at the same time. I have a trust that splits everything between the two children. I also have handwritten a note and had it notarized explaining I would like the house kept in the family and not sold or mortgaged. Can you advise me?

Answer: Please think long and hard before you try to restrict what the next generation does with a bequest, particularly when it’s real estate. Is your desire to keep the house in the family worth causing rifts in that family?

It would be hard for two families to share even a large home. You could be setting up epic battles, not only over who gets to live there but how much is spent to maintain, repair and update the home. It’s difficult enough for married couples to own property together; siblings are almost certain to disagree about how much to spend and the differences may be even greater if only one family is actually using the house.

If your house is sold, on the other hand, it could provide nice down payments for each family to buy its own home. Alternatively, one family could get a mortgage to buy out the other and live in the house. Or the home could be mortgaged to provide two down payments and then rented out. Your notarized note wouldn’t prevent your children from doing any of these things, but it may cause them unnecessary guilt and disagreements about honoring those wishes.

Q&A: Proposition 13 considerations

Dear Liz: I read your column with some interest since I just had a client who received a life estate from his long-term partner. They neither married nor formed a registered domestic partnership, either of which might have saved my client some bucks.

The Los Angeles County assessor reassessed the property at its full value even though the remainder will go to my client’s partner’s children on my client’s death. The property was originally purchased in the 1970s. I’d like to think that I or any other estate planning lawyer could fashion a satisfactory work-around for this potential problem faced by folks who wish to give a life estate to someone without Proposition 13 protection and the remainder to someone with that protection.

Of course, one must always bear in mind that the tax tail should not wag the business dog, so a weighing of burdens and benefits is always in order in any plan.

Answer: Here’s another case where stinting on an estate planning attorney’s fee probably cost the heirs vastly more.

For those of you who don’t live in California, Proposition 13 limits property taxes to 1% of the assessed value, and assessments typically can’t increase more than 2% a year until the home changes hands. The lower “Prop. 13” value of a home can be inherited by the children, which means their tax bill would be a fraction of that owed by someone who purchased a similar property more recently.

Instead, the property in question lost its Proposition 13 protection and its tax bill more than tripled.

Q&A: Transferring property after death

Dear Liz: Just a quick comment on the woman who contemplated transferring her house to her partner and daughter as joint tenants. One must always consider the property tax impact on such transfers. In Los Angeles, real property that is transferred to a transferor’s significant other who is not the spouse or domestic partner will ultimately be reassessed by the county assessor. There are a number of property tax reassessment exclusions on transfers, such as from a parent to a child, from a person to his or her revocable trust and between spouses. This is why all factors must be considered before such a transfer is made.

Answer: A revocable transfer on death deed allows real estate to avoid probate in many states, but this option shouldn’t be used before thoroughly researching the consequences and consulting an estate planning attorney. Read on for an actual case where an ill-considered transfer had big financial consequences.

Q&A: Does moving to a new state necessitate a new living trust?

Dear Liz: My husband and I have a revocable trust that was drawn up in Florida. We live in California now. We are renting and don’t own a house. Do we still need a trust if we don’t own property and have just one adult child to leave our financial funds to? One tax planner wants to charge us $1,800 to revise our trust to comply with California laws. That sounds high to me. What do you recommend?

Answer: Any time you move across state lines, you should have your estate documents reviewed and — probably — revised. State laws differ, and in this case you moved from a common law state to a community property state, where the rules differ a lot. Property acquired during marriage in a common law state isn’t automatically owned by both spouses, while in community property states, it typically is.

“Property,” by the way, doesn’t just refer to real estate. It refers to pretty much all your assets, including financial funds.

A relatively simple revocable living trust typically costs $2,000 and up, so the price you were quoted does not seem high, but you can check with one or two other estate planning attorneys if you want to compare costs.