Co-Counsel Bulletins

SETTING THE RECORD STRAIGHT ON LIVING TRUSTS

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BY NEIL COGHILL, Board Certified Specialist in Estate Planning and Probate Law
[Reprinted by permission from North Carolina Lawyer, Nov./Dec. 1993, a publication of the N.C. Bar Association. Copyright 1993, N.C. Bar Association.]

          Living trust schemes, mostly aimed at the elderly, have been called "the new fraud of the 1990s."  These trust documents are being widely marketed as the simple solution to every estate planning problem.  They are not.  Living trusts are also being advertised as a guaranteed means of protecting your assets from taxes and the claims of creditors. They are not. 

          In the fall of 1992 the N.C. Attorney General's office stopped an out-of-state company from selling living trusts in Hendersonville and Asheville.  Also, a Wake County judge has barred a Greenville, S.C. company from selling living trusts and other estate planning documents to North Carolina residents.

          A living trust (also called a lifetime trust) is nothing more than a trust agreement created by a person (called the "grantor") by transferring property to another person (called the "trustee") to hold for the benefit of another person or group of persons (the "beneficiaries").  Grantors can serve as trustees of their own living trusts and also be beneficiaries of their own trusts during their lifetime.

          In some situations, a living trust can be an effective estate planning tool.  However, current marketing information about the benefits of such trusts is often incomplete, deceptive or misleading.  As a result, many individuals are buying living trust "plans" that they do not understand, do not need and, in many cases, cannot afford.

          An important feature of a living trust is that it is can be amended or completely revoked during the grantor's lifetime.  Many estate plans include irrevocable lifetime trusts, principally to accomplish tax planning, which cannot be changed or revoked once they have been executed. However, we are talking here about revocable living trusts.

                      Living trusts have been used to accomplish tax and estate planning goals for many years.  However, in the past several years a growing number of insurance agents, financial planners, stockbrokers and for‑profit companies have been selling "prepackaged" living trust plans.

          "Prepackaged" means that the trust agreement and related documents have already been printed and require only the signatures of the grantor and the trustee and the transfer of property to the trust to be effective.  The terms of the trust, including how the trust property will be distributed to the beneficiaries, have already been set and the grantor has few, if any, options.

          Marketing techniques for these living trust plans include free seminars or workshops, mass market advertising and direct telephone solicitation. Typically the marketing is targeted at elderly individuals and focuses upon their concerns about probate, taxes, health care costs and attorneys' fees.

          Some of these living trust plans are well‑intentioned, well‑prepared, and sold by knowledgeable professionals. Unfortunately most of them are not.  Let's take a look at the typical representations of what a living trust can accomplish and separate myth from fact.

           Myth #1.  A LIVING TRUST CAN AVOID PROBATE.  The first question is why you would want to avoid probate in North Carolina. It is true that in some states (such as California) probate administration can be lengthy and expensive. North Carolina is not one of those states.

          The maximum court cost that can be saved in North Carolina by using a funded living trust is $3,000, and those costs are generally much less in most estates. However, even with the use of a funded living trust, some form of probate proceeding will be necessary in virtually every estate.

          Probate administration in North Carolina is nothing to be feared. Although every estate is different, most estates can be closed within nine months to a year from a person's death, and many estates can be closed in as little as three months.

          In North Carolina, the "probate court" is the Clerk of the Superior Court of the county in which the person dies.  It is not necessary that an attorney assist the executor in administering the estate, although in many instances that may be advisable.

           Myth #2.  A LIVING TRUST WILL SAVE ESTATE TAXES.  A properly prepared trust agreement can reduce or defer federal estate taxes in appropriate cases. However, the same estate tax planning can just as easily be accomplished under a person's will without the use of a living trust. There is no unique estate tax advantage to the use of a living trust.

          More importantly, however, unless a person's estate is greater than $600,000, under present federal estate tax law the use of any trusts will not be necessary to save federal estate taxes. That means for a husband and wife with combined estates of less than $1.2 million, proper planning will result in no federal estate tax liability.

          Myth #3.  A HUSBAND AND WIFE CAN SIGN ONE LIVING TRUST FOR BOTH OF THEM.  Many of the one‑size‑fits‑all living trust plans being marketed are a form of living trust called a "joint revocable trust." Simply put, a joint revocable trust is one where both a husband and wife create a single trust and transfer all or substantially all of their assets to that one trust.

                      There is wide disagreement among estate planning professionals as to whether or not such a trust will have any estate or income tax advantages at all, and whether the tax consequences of such a trust will be recognized by the Internal Revenue Service. It is clear, however, that a joint revocable trust is a sophisticated estate planning technique that should be used only in special circumstances and only after full disclosure of the tax risks.

           Myth #4.  A LIVING TRUST WILL PROTECT YOUR ASSETS FROM CREDITORS AND HEALTH CARE COSTS.  Because a living trust can be revoked by the grantors at any time during their lifetimes, the assets of the trust are subject to the claims of their creditors and are available to pay their health care expenses. Any representations that the assets held in a living trust will be safe from the claims of creditors or exempt from health care costs are simply incorrect.

          Furthermore, the assets and the income of a living trust will be counted in determining whether the grantor is eligible for Medicaid benefits. Any representations that the use of a living trust will assist the grantor in qualifying for Medicaid benefits are also incorrect.

          Upon the death of the person creating the living trust, the assets held in the trust are generally available to pay the costs of administering the estate, any debts or other claims against the estate, and any taxes payable by the estate. In other words, in most cases, the assets of the living trust are not shielded from the claims of the creditors of a person's estate.

           Myth #5.  A LIVING TRUST WILL PASS YOUR ASSETS IMMEDIATELY TO YOUR BENEFICIARIES.  The assets of a living trust do not pass through probate and may be distributed to the beneficiaries by the trustee without the intervention of any court. However, because the assets of a living trust are subject to estate and inheritance taxes and, typically, the debts, expenses, and other claims against the estate, in most cases those assets will not be distributed to the beneficiaries until the person's estate has been closed.

          In addition, assets such as stocks and bonds cannot be sold by the trustee until the North Carolina Department of Revenue has issued a "tax waiver" indicating that the inheritance tax liability for the estate has been satisfied, or that other assets are available to pay the taxes.

           Myth #6.  BUYING A LIVING TRUST KIT CAN SAVE SUBSTANTIAL ATTORNEYS' FEES.  The services of an experienced estate planning attorney can be expensive. However, transferring your assets to a living trust will have immediate and long‑term legal and tax consequences. That is a step no one should take without fully understanding the real risks and benefits involved. For that reason, buying a living trust plan is not like buying an automobile where getting the best "deal" on the product is the best result for the consumer.

          A trust agreement should be designed for the particular needs and goals of the individual, taking into account the nature and extent of assets, the size of the estate, and how the grantor wishes those assets to be distributed to family members and other beneficiaries at death. In other words, the real benefit of consulting an attorney is the benefit of counsel and advice.

          Many of the living trusts and other estate planning documents being marketed by non‑attorneys are very poorly drafted and will create significant legal and tax problems upon the death of the grantor. Many of these documents are prepared outside of North Carolina and do not meet the requirements of North Carolina law. A will, trust, power of attorney, or living will prepared in California or South Carolina or any other state may not be legally valid in North Carolina.

          The sad irony of the "hook" of avoiding attorney fees by buying a prepackaged set of documents is that, in many cases, it will be necessary for the family to pay an attorney to "unravel" the unnecessary legal and tax problems at the death of the grantor, at a much greater cost.

           Myth #7.  A LIVING TRUST MUST BE FUNDED WITH INSURANCE.  It is possible and sometimes advisable to make a revocable trust the beneficiary of a life insurance policy on the grantor's life. However, it is not necessary to purchase additional insurance on the life of the grantor to make the estate plan effective.

          The decision whether to purchase life insurance and how much coverage is necessary should be made independently of the decision whether to establish a living trust. The former is an investment decision, and the latter is a tax and estate planning decision. Any representation that the living trust plan will not "work" without purchasing additional life insurance is incorrect.

           Myth #8.  SOME LIVING TRUST PLANS ARE "APPROVED" BY THE NORTH CAROLINA STATE BAR.  Wrong. The State Bar requires that any business offering prepaid legal services be registered as a prepaid legal plan. Such registration does not mean approval of the value or quality of the product or services offered. No company offering living trust plans in North Carolina has been "approved" by the State Bar.

          A number of state bar organizations have successfully sued non‑attorneys selling these services and products for the unauthorized practice of law. In fact, the N.C State Bar is currently investigating several complaints against companies doing business in North Carolina for the unauthorized practice of law.

          Taking all of this into account, then, when should you consider a living trust? Generally, if your estate is worth less than $600,000, you do not need a living trust for tax reasons. If your estate is worth more than $600,000, a living trust may be appropriate, but the same planning can be done under your will.

          If you are concerned that you would not be able to manage your own property during your lifetime (for example, if you were facing long‑term illness or were concerned about senility), then a living trust may be useful regardless of the size of your estate. In that case, it would be especially important that the trust agreement be properly drafted to ensure that your personal needs during your lifetime are appropriately addressed.

          If you are concerned about the confidentially of your estate plan, a living trust may be appropriate. Your will is a matter of public record and is available to be reviewed by anyone once it has been probated. A living trust is a private agreement which is not subject to public perusal.

          If you want professional management of your assets during your lifetime, a living trust may be appropriate. In North Carolina, only banks empowered to conduct trust business and trust companies are authorized to serve as a corporate trustee and solicit trust business.

          Any company or organization purporting to provide trust services other than a bank or trust company should be questioned carefully about its legal authority to do so in North Carolina.  The problem of living trust scams is not unique to North Carolina. A growing number of state attorneys general are bringing similar lawsuits against companies selling living trusts and other estate planning documents.  Recently, the N.C. Attorney General's office has joined with 15 other state Attorneys General in an action against an Oklahoma company to attempt to recoup citizens' funds on the basis of fraudulent and deceptive sales practices.

          A properly prepared revocable trust agreement can be a valuable part of an estate plan in the right circumstances.  Unfortunately, many people are paying a lot of money for living trusts that do not fit their individual needs, that will not accomplish the tax and other purposes for which they have been sold, and which will make administering their estates more complicated, more time-consuming and more expensive than if the trusts had never been used in the first place. 

[rev. 6/28/99]

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