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Funding Your Living Trust
by: Richard H. Hallstrom, Esq.
Funding Your Living Trust
Once you have signed your living trust document, the next step is
to change titles and beneficiary designations to your trust. This is
called "funding" your living trust.
This is probably the most important part of getting a living
trust. If you have signed your living trust document but haven't
changed titles and beneficiary designations, you've simply wasted
your money. You may have a great trust, but until you fund it, it
doesn't control anything - because your living trust can only control
the assets you put into it.
Remember, when you put assets in your living trust, you do not
lose control of them. You can continue to buy and sell assets just as
you did before. And anything you put into your living trust can
always be taken out later.
In this section, we'll discuss who is responsible for funding your
trust, how difficult this process is, and then explain the general
procedures for changing titles and beneficiary designations for the
most common types of assets people own. We suggest that you look for
the ones you own and skip over the others. If you own something that
is not included here, call us so that we can tell you how to put it into
your trust.
WHO WILL FUND YOUR TRUST?
You should know, before your trust is set up, how much of the
funding process the attorney will do. In order for your trust to be as effective as possible, we will assist you in making sure that everything is put into the trust properly.
Usually, trust funding is a combination of us doing some
and you doing some. Ideally, we would like to review each asset
with you, explain the procedure to you, and together decide who will be responsible for each asset. We will
put your home in your trust for you at no additional cost.
We have some pre-written letters you can send to your bank,
investment broker, insurance company, etc. that tell them how your
assets should now be titled. Also, we can provide you very specific instructions and the exact wording to use for
titles and beneficiary designations. The wording will include the
name(s) of the trustee(s), the name of your trust, and the date you
sign the trust document. So it will be something like this: " John
Doe and Mary Doe, Trustees of the Doe Family Trust, dated
month/day/year."
HOW DIFFICULT IS THE FUNDING
PROCESS?
As you will see in the next few pages, most titles and beneficiary
designations are not difficult to change. Some are done by using an
assignment, a short (usually one-page) document your attorney will
prepare that identifies the asset and states that you are
transferring its ownership to your living trust.
Others will require written instructions from you, giving the
institutions the exact wording to use on the titles and beneficiary
designations (usually the pre-written letters from your attorney will
be all you need). Some institutions have their own forms that you
will need to complete (for example, life insurance companies have
standard forms to change the beneficiary on policies).
Most changes can be handled through the mail and by telephone.
Some will require your signature to be notarized or guaranteed (we'll
explain who can do this for you).
Even though the process itself is not really difficult, it will
take some time. How much time will depend on how many titles and
beneficiary designations you have to change and how quickly the
institutions respond. Most will be cooperative. However, you may encounter a few people who are still unfamiliar with
living trusts. (Since living trusts have become so popular, this
doesn't happen as often as it used to.) If you do have any
difficulties, usually a quick call from your attorney will clear
things up.
If you decide to do most of the funding yourself, we suggest that
you make it a priority and keep going until you're finished. Start
with your assets that have the largest values, then work down to the
smaller ones. Remind yourself why you are doing this - and look forward to the peace of mind
you'll have when your living trust is complete.
Now let's look at how titles and beneficiary designations are
changed.
HOW TO CHANGE TITLES AND BENEFICIARY
DESIGNATIONS
If You Live In a Community
Property State
If you live in one of the eight community property states, like California,
your attorney may suggest that jointly-owned assets - especially real
estate - be retitled as community property before they are put in your
trust.
When one spouse dies, community property assets receive a full step-up in basis. This reduces the capital gains tax that
would be due when the assets are eventually sold. With joint
ownership, only the deceased's share would receive a step-up in basis - so you would have a
bigger gain (profit) when the assets are sold, and would pay more in
capital gains tax.
Community property status can be retained when the assets are put
in your living trust. So, by retitling jointly owned assets as
community property first, you
will get the full step-up in basis when one spouse dies.
If You Live in a
Noncommunity Property State
If you live in a noncommunity property state and have owned an asset
jointly with your spouse since before 1976, the asset may be entitled
to a full step-up in basis when one spouse dies. If you change the
title on it now (even to your living trust), you could lose the full
step-up - the deceased spouse's share would still get a step-up, but
the surviving spouse's share would not. This could cause your
surviving spouse to pay more in capital gains tax if he/she decides
to sell the asset after you die.
If the asset is your personal residence, losing the full step-up
will not be a problem unless the gain is more than $500,000. (If you
are married, up to $500,000 of the gain on the sale of your personal
residence is now exempt from capital gains tax. See page 167.) But it
could be a problem for other assets like farmland, commercial real
estate or stocks.
If this sounds like it could apply to your situation, check with
your tax advisor before you
change the title. (For more information, see
Gallenstein v. United States, a
1992 Sixth Circuit Court of Appeals case. Other circuit courts have
followed this ruling in similar cases.)
Your Home, Real Estate, Land, Condominium,
Etc.
Depending on the state in which the property is located, a
correction deed, grant deed, warranty deed, assignment, or quitclaim
deed will be used to change the titles of real estate to your living
trust.
The new deed will include how the property is titled now (before
you put it into the trust), what the new title should be (to put it
into your trust) and the legal description of the property. The deed
for each property will be signed by you, witnessed, notarized, and
recorded in the county where the property is located.
Again, your attorney will probably put your home in your living
trust for you at no extra cost. This is usually a good idea since the
home is the most valuable asset most people own, and the legal
description and titles must be exact.
Out of State
Property
If you own property in another state, you will want to transfer it to
your living trust to prevent a conservatorship and/or probate there.
Your attorney can contact a title company or an attorney in that
state to handle the transfer for you.
You may also be able to do part (or all) of it yourself. First
find out what is involved - check with an attorney or escrow office
in that state to find out the proper form to use, to verify the
process, and to get the name and address of the recording office. In
some states, your trust may have to be recorded - if so, a
certificate of trust should be all that is needed. However, it may be
more convenient (and wise) to have the local attorney or escrow
office handle the transfer for you.
Current
Mortgage
Putting real estate - especially your home - into your living trust
should not disturb your current mortgage in any way. Even if the
mortgage contains a "due on sale or transfer" clause, retitling your
home in the name of your living trust should not activate the clause.
(It would still be a good idea to contact the lender
before you transfer the property
so you don't inadvertently activate the clause, especially if you own
rental property or commercial real estate. The lender may charge a
small fee to approve the transfer.)
In the past, some people who wanted to put their homes into their
living trusts were met with resistance. Many banks, savings and
loans, and mortgage companies (called primary lenders) who write home
mortgages simply did not understand living trusts. Many were also
afraid the secondary lenders -
institutions who buy home mortgages from these primary lenders,
providing them with more money to loan out - would not buy mortgages
if the borrower was a living trust instead of an individual.
But things have changed as living trusts have become so popular.
Fannie Mae, Freddie Mac and Ginnie Mae (which buys FHA home
mortgages) - the major secondary lenders - all now consider a
revocable living trust to be an "eligible borrower" as long as normal
guidelines are met (for example, the property must be owner-occupied,
they want to make sure the trustee is authorized to borrow against
the property, and they usually want the owner to be a trustee, which
most people are anyway).
These recently published guidelines will make it much easier to
transfer your home into your living trust, to refinance your home
after it is in your living trust (without having to temporarily
remove it from the trust), and even to purchase new real estate in
the name of your living trust.
If you do run into resistance, it will probably be from a lender
who has not informed its loan officers about living trusts or simply
doesn't want to change the way it does business. If this happens to
you, you can always take out the mortgage in your personal name and
then transfer the property to your living trust after the closing -
or you may want to find another lender.
Homeowner's, Liability, and
Title Insurance
Your homeowner's and liability insurance should be changed to reflect
your living trust on the title and the trustees as additional
insureds. (If you are your own trustee, it will show you as trustee
instead of you as an individual.) Your agent will be able to make
this change for you (probably at no charge). Usually all the
insurance company will need is a letter of instruction from you and a
copy of the new deed.
Title insurance should also be changed. Check to make sure your
title insurance company will still insure title when your living
trust is the owner of the property. Most will. In fact, one of the
largest title insurance companies routinely issues title insurance
when the property is in a living trust. (And they do not require a
separate title search.)
Property
Taxes
Most owners of real estate pay a property tax every year based on the
appraised value of the property. Transferring real estate to a living
trust should not cause your property to be reappraised because the
underlying ownership is the same (remember, it's
your trust) and because the trust
is revocable (remember, you can take the property out of your trust
and put it back into your individual name at any time).
Even so, you may need to notify the tax assessor's office. In
California, for example, a "Preliminary Change of Ownership Report"
must be filed. This is a simple form (with check boxes) that the
attorney usually completes at the same time the new deed is prepared.
Transfer
Tax
Generally, a transfer tax is charged whenever property is sold.
Putting real estate into a living trust does not constitute a sale,
because you can take the property out of the trust at any time. So,
in most states, there will be no transfer tax when you transfer
property to your living trust.
However, a few states and counties are looking for creative ways
to raise revenue and they may charge a transfer tax anyway. For
example, Pennsylvania used to
charge a transfer tax when real estate was transferred into a living
trust and any beneficiary was
someone other than a spouse, grandparent, parent, child, grandchild
(and spouse) or sibling (and spouse). So if you named a friend or a
charity as a beneficiary of your living trust (even as an Alternate
beneficiary), you had to pay a transfer tax on real estate you put
into your living trust. This tax was recently repealed, specifically
for living trusts.
Exemption From Capital Gains
Tax When Residence Sold
Previously, if you were over age 55, you were allowed a one-time
$125,000 exemption of the gain (profit) on the sale of your home.
Also, if you sold your home and bought a new one for at least the
same price within two years, the profit from the sale of your
previous residence was exempt from capital gains tax, providing you
had owned and made this house your principal residence for at least
three of the previous five years. Putting your home in a living trust
had no effect on either of these exemptions.
Thanks to The Taxpayer Relief Act of
1997, we have a new capital gains tax exemption that
replaces these two previous ones. Now, under current tax law, if you
sell your home and you are single, up to $250,000 of your gain
(profit) will be exempt from capital gains tax - providing you have
owned and made the house your principal residence for at least two of
the past five years. (If you are married, up to $500,000 will be
exempt.) You can use this exemption only once every two years. Having
your home in a living trust will have no effect on you getting this
new capital gains tax exemption.
Homestead Exemption From
Creditors
As we explained in Part Two, part or all of the value of your home
may be protected from creditors' claims under your state's homestead
laws. Putting your home in a living trust should not cause you to
lose this protection.
Rental Real
Estate
Under current tax law, the expenses you have from rental real estate
(including mortgage interest, property taxes, insurance, repairs,
depreciation and other operating expenses) can usually be deducted
only from rental income.
If you don't have enough rental income (called "passive income")
to offset your expenses (called "passive losses") in the year they
are incurred, you can carry the excess losses ("net losses") forward
and deduct them from rental income in subsequent tax years. If you
have not been able to deduct all of your losses by the time you sell
the property, you can write them off then.
As usual, there are exceptions:
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1.
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If you earn your living mainly in the real estate
business (for example, you are a contractor, builder or
broker), you may not be affected by these "passive loss"
rules.
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2.
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If your Adjusted Gross Income (as defined on IRS Form
1040) is less than $150,000 and you actively participate in
the management of the property (approve repairs and new
tenants, write checks, make management decisions, etc.), you
can deduct up to $25,000 ($12,500 if married filing
separately) in net losses each year from your ordinary
income (wages, tips, etc. as defined by the IRS on Form
1040). (If your AGI is more than $100,000, the $25,000 is
gradually phased out so that, by the time the AGI is
$150,000, the amount of passive net losses that can be
deducted from ordinary income is reduced to "0.")
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Transferring rental real estate to your living trust does not
affect the way you handle these losses while you are living. However,
if you are currently allowed to deduct up to $25,000 in net losses
from your ordinary income, these losses may be handled differently
after you (and your spouse) die.
For a full explanation, see Part Eight.
If You Suspect the Property
is Contaminated
You can still put contaminated property in your living trust but the
trustee can personally be responsible for any clean up. As we
explained in Part Two, if you are your own trustee, this won't affect
you because you are already
responsible. But, remember, if the clean up is not complete by the
time your successor trustee steps in, he/she (and, ultimately, your
beneficiaries) can also be liable. If you suspect that property you
own may be contaminated, be sure to read the discussion of this in
Part Two. And make sure you tell your attorney
before you transfer the property
to your trust.
Credit Cards, Notes You Owe
Setting up a living trust should not affect any credit cards,
loans or notes you owe. These are not assets, so you don't need to do
anything with them. You just continue making your required payments
as usual.
Mortgages, Loans, And Notes Owed To
You
If you have "owner-financed" any assets (for example, you "took
back" a note on a house you sold), loaned someone money or have any
other notes payable to you, you will need to assign these
mortgages/loans to your living trust. This is done by an assignment
(as we explained earlier). It is signed by you only (not the other
party), notarized and attached to the original document. If the
original mortgage was recorded, some attorneys will also record the
assignment.
If you have loaned someone money without documenting the loan,
this would be a good time to put it in writing to prevent disputes
over the terms and nature of the loan. Write up the terms of the loan
and have it signed by the other party. An assignment can then be
prepared to transfer the loan to the trust.
Checking, Saving, And Pay-on-Death
Accounts
You will need to change the ownership of your checking and saving
accounts to your living trust. New signature cards will then need to
be signed by the trustee(s). If you are your own trustee, you can
sign the signature cards with just your usual signature.
You may need to sign new account agreements. Some institutions
will require a new account, with a new account number and new checks.
If you are your own trustee, the information on your checks does not
need to change - they can still be printed with just your name,
address, and telephone number on them - and you continue to sign
checks the same way you always have.
If you have named beneficiaries on any accounts, you'll want to
change them to your living trust. For example, you may have
established an account and named your spouse, child or grandchild as
the beneficiary. These are called "Totten trusts." The account title
probably includes the words "in trust for" (or "ITF"), "as trustee
for" (or "ATF"), "payable-on-death" (or "POD"), or "transfer on
death" (or "TOD").
Remember, by changing the beneficiary on these to your living
trust, you prevent the possibility of the court taking control of the
funds if your beneficiary is a minor or incapacitated when you die,
or dies before (or at the same time as) you. The institution will
probably have its own form to change the beneficiary.
To change the ownership or beneficiary of an account, the
institution will probably ask to see a copy of your trust document.
Remember, this is for your protection and, as we explained in Part
Five, a certificate of trust should satisfy their requirements.
Certificates Of Deposit
These should be retitled in the name of your trust. Some let you
name a beneficiary - if yours does, the beneficiary should also be
your trust. You do not need to cash these in to do this.
Some institutions will retitle the certificates immediately with
no penalties. If yours requires you to wait until the certificate
matures, you can go ahead and change the beneficiary and use an
assignment to transfer your ownership interest to your trust. Then,
when the certificate matures, you can change the title to your trust
before you renew it.
Note: This process does not apply to
IRAs that are invested in CDs. We discuss IRAs and your living trust
later in this section.
What About FDIC Insurance?
The Federal Deposit Insurance Corporation (FDIC) insures deposits
at banks and savings associations that are FDIC members for up to
$100,000 per account category per institution. "Deposits" include
checking and saving accounts, retirement accounts (including IRAs and
Keoghs), NOW accounts, and CDs. Securities, mutual funds and other
such investments are not considered "deposits" and therefore are not
covered by the FDIC.
When you retitle FDIC-insured accounts in the name of your living
trust, the insurance coverage may change. In fact, your living trust
accounts may qualify for much more FDIC insurance.
The general formula the FDIC uses when determining insurance for
living trust accounts is: (the number of grantors living at the time
the FDIC-insured institution fails) times (the number of qualifying
beneficiaries living at the time the institution fails) times
$100,000.
So, for example, if you and your spouse have one living trust
together (you are Co-Grantors) and have named your three children and
five grandchildren as the beneficiaries - and certain conditions,
explained below, are met - your trust would be insured for up to
$1,600,000 while everyone is living. (Two Grantors times eight
qualifying beneficiaries times $100,000 = $1,600,000.) By contrast,
if you and your spouse had a joint account instead, it would only be
insured for up to $100,000.
For your living trust to be eligible for this additional coverage,
it must meet certain conditions, which include:
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The title of the account must indicate that a trust is
involved. For example, " John Doe and Mary Doe, Trustees of
the Doe Family Trust, dated month/day/year," "Doe Family
Trust," and "Doe Family Revocable Trust," would all be
acceptable titles.
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A qualifying beneficiary can only be a spouse, child or
grandchild of the grantor (a parent, sibling, niece, nephew
or non-relative does not qualify) and must be listed by name
in the "deposit account records" of the institution (for
example, on the signature card).
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There can be no conditions in the trust that would
prevent a qualifying beneficiary from eventually receiving
his/her share of the trust after you (and your spouse) die.
For example, it is not okay to say that "my daughter will
receive her inheritance only when she removes that ring from
her nose" or "my son will receive his inheritance when he
graduates from medical school" - because if these events
never happen, the beneficiary would not receive his/her
share.
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Credit Union Accounts
Most credit union accounts can easily be transferred to
your living trust. To do this, you will need to set up a new account
titled in your trust's name and transfer your existing account(s) to
it.
Of course, to have an account at a credit union, you must be a
member. And in order for your trust to qualify, all "parties" of your
living trust - the grantor(s), trustees, and beneficiaries - must be
eligible for membership. Since most living trusts only include family
members (who are usually eligible to join anyway), this is not a
problem for most people.
If you have named a corporate trustee as a successor trustee
(which some people do), this may still be okay - because when a
corporate trustee steps in, they will usually close the credit union
account anyway and transfer it to an account they manage.
If your living trust does not qualify as a member, there are still
some things you can do. You can name your living trust as the "pay on
death" beneficiary on the account or add your living trust as a
"joint owner with right of survivorship" (joint owners do not have to
be members). Then, when you die, your credit union accounts will
automatically be owned by your trust.
No special membership card or agreement is usually required when
you open the new account for your living trust. The credit union will
probably ask to see your trust document to make sure it qualifies for
membership, what the trustee's powers are, who the successor trustees
are, and when they are authorized to step in. (Although they may need
to see who your beneficiaries are, they do not need to know how you
will provide for them.)
Your trust, just like any other member, will be entitled to vote
at annual meetings. However, since the trust is not a person, someone
(usually the trustee) will need to be given the authority to vote for
the trust.
These rules apply to federal credit unions (more than half of the
14,000 credit unions are federally regulated), but even those that
are state regulated will often follow these guidelines.
Note: If you think you may want to
take out a loan at some point, you should probably keep an individual
account with the minimum required balance. That's because your trust
would only be allowed to borrow an amount equal to its own
value.
Safe Deposit Box
You will need to change the box authorization card to your
trust and the trustee(s) will need to sign the card. This will allow
your successor trustee to have ready access at your death or
incapacity. Your bank or savings and loan officer can help you do
this.
Stocks/Bonds/Mutual Funds
• Street Accounts
If you maintain an account in the name of your bank or
brokerage company (called a "street account") or invest in a mutual
fund, they will need written instructions from you to change the name
on your account to your trust.
Call them first to see if you should send a letter of instruction
(remember, your attorney will probably include sample letters with
your trust) or if they have their own form they can send you - or if
they have their own procedures you will need to follow.
They may request that your signature be guaranteed. Your local
banker or broker can probably do this for you (just call ahead and
make sure). You will sign the form or your letter in your banker's or
broker's presence, and he/she will affix a stamp that "guarantees"
your signature.
They may also ask to see a copy of your trust document (again, the
certificate of trust should be all they need).
• If You Possess
Certificates
If you have possession of actual stock and securities
certificates, you can set up an account at a brokerage house or other
financial institution. They will transfer the titles to the name of
your trust for you and keep the certificates for you. This way you do
not have to worry about misplacing them, losing them in a fire, or
making frequent trips to your safe deposit box.
If you are more comfortable keeping the actual certificates
yourself, you will need to have new certificates issued in the name
of your trust. (Never write or mark on an original stock or bond
certificate.) Your broker or banker can have them reissued for you
(they may charge a small fee).
You can also do this yourself. Your attorney can prepare a "stock
power," a short document that assigns the securities to the trust,
identifies what is being transferred (for example, 50 shares of
General Electric stock), the certificate numbers, and the name(s) of
the trustees. You'll sign the stock power and have your signature
guaranteed (as above).
You'll then need to locate the stock transfer agent . This is the
organization that is authorized to transfer title on stocks and
bonds. For bonds, the transfer agent is usually the institution from
which you receive payments on the bond. If you have stock
certificates, don't rely on the name of the transfer agent on the
certificate - it may be outdated. Call a brokerage house and ask
them. Your attorney may also be able to find out the transfer agent
for you.
Send the transfer agent - by certified mail - a letter,
instructing them to issue new certificates in the name of your trust;
a certificate of trust; and the certificates. Send the stock power
separately, also by certified mail. (Do not send the stock power and
the certificates together in the same envelope - if someone
intercepts them, they would be able to negotiate them.) Make sure you
keep copies. And check the new certificates as soon as you receive
them.
If you have lost a certificate, contact the transfer agent and
request an "Affidavit of Lost Certificate and Indemnity Agreement."
Complete and sign the affidavit, and follow the instructions to
furnish bond.
Savings Bonds
Series E, EE, H and HH bonds can be transferred to your
living trust with no adverse tax consequences. You will continue to
receive current income from Series H and HH bonds. Accrued interest
on Series E and EE bonds can continue to be deferred until the bond
matures.
To have savings bonds re-issued in the name of your living trust,
you'll need form PD-1851. If you have named a beneficiary on a
savings bond, you can also change it to your trust using form
PD-4000. (If you are changing a beneficiary on a Series E bond, the
current beneficiary will need to sign the form; if this person is
deceased, you will need to send along a death certificate.)
You can call the Federal Reserve Bank yourself to order forms or
if you have questions (since forms change, make sure you verify which
one(s) you need and the procedure). If you live in the mid-west or
western U.S., you can call their customer service number in Kansas
City: 1-800-333-2919. If you live in the eastern part of the country,
call the customer service number in Pittsburgh: 1-800-245-2804. (By
the way, the representative we spoke with was very knowledgeable and
helpful - and said they get a lot of calls from people who want to
re-issue their savings bonds in the names of their living trusts.)
Automobiles/Boats/Other Vehicles
Most states will permit a vehicle title to be re-issued in
the name of your trust. Also, some states now allow you to name a
beneficiary for your vehicle. If yours does, your trust should be the
beneficiary. In some states, however, this will require the payment
of an excise (transfer) tax, just as if the trust had purchased the
vehicle.
Take Florida, for example. Currently, Florida has a $100 "new
wheels tax" (in addition to other registration fees). This fee does
not apply if you trade in your existing car for a new one. But it
does apply if you buy an additional car or if you have never owned a
car before. So, because your trust has not owned a car before, you
will have to pay the "new wheels tax" when you transfer it into your
trust. But you will only have to pay it once; you won't have to pay
it again if you replace that car with another one.
However, a car is considered "exempt" property in Florida. So, if
you plan to leave your car to your spouse or an heir, you don't need
to transfer it to your trust and spend the $100. Your spouse or heir
can transfer the car title after you die for less than $100. But if
you plan to leave your car to someone else, then it is probably worth
putting it into the trust and paying the $100 fee. (Don't you just
love finding out what's going on in Florida?!)
You may want to call your state's license bureau to find out the
process where you live. Depending on the costs involved and the value
of the vehicle, you may want to wait until you purchase your next one
and title it in the name of your trust.
If the value of the vehicle is within the amount your state allows
to transfer without probate, your attorney may even suggest that you
leave your vehicle out of your trust. (As we explained in Part One,
most states allow very small estates - some as low as $15,000 - to
transfer without probate.) Also, if you are using a corporate
trustee, they may not want to manage your car - unless, of course, it
is of considerable value.
If you do title a vehicle in the name of your trust, notify your
insurance company so they can change your policy to reflect the
change of ownership and list the trustee as an additional insured (if
you are your own trustee, it will show you as trustee instead of you
as an individual). They may request a copy of the new registration
and a letter of instruction from you. They will probably make the
change for you at no charge.
Personal Untitled Property
Many attorneys will probably prepare either a Bill of Sale
or an assignment to transfer personal property (like your furniture,
artwork, clothing, jewelry, cameras, sporting equipment, books, etc.)
to your trust. If these articles are of substantial value, you would
want them in your trust.
However, if the value of these articles is low enough that a
probate would not be required in your state (as we explained above),
your attorney may recommend leaving these out of your trust. They
could also be intentionally left out if there was a desire to cut off
creditor's claims in probate (as we explained in Part Two).
Life Insurance
In many cases, you will want your living trust to be both
the beneficiary and the owner of your insurance policies.
Naming your trust as the beneficiary gives you maximum control
over the proceeds. It keeps the courts from getting involved if your
loved ones are incapacitated, die before you (or at the same time as
you), or are minor children. You can keep the proceeds in trust until
you want your loved ones to receive the money. You can be sure the
money is used to pay your final expenses. And by naming your trust
instead of your spouse as the beneficiary, you can even keep control
of the funds if your spouse should remarry.
Note: If you live in a community
property state and the insurance was purchased with community
property funds, your spouse is entitled to half of the proceeds and
may need to sign a consent form if you want to name your living trust
as beneficiary.
Naming your trust as the owner of your policies gives you maximum
control over the policies and more flexibility. For example, if you
name your spouse or someone else as the owner, you might worry that
they will cancel the policy or change the beneficiary.
If you have a policy that has a cash value and you name your trust
as the owner, your successor trustee would be able to borrow on the
policy at your incapacity to help pay for your care. And if you
suffer from a terminal illness, your successor could apply for a
"Living Benefit" currently offered by many insurance companies.
(Under this program, the "death benefit" is paid to you before you
die - instead of to your beneficiary after you die - so the cash is
available to help meet expenses while you are living.)
However, if your estate is large enough that it would have to pay
estate taxes, you should probably consider having a Life Insurance
trust (or other arrangement, like a Family Limited Partnership) to
save estate taxes. We explain how they work in Part Nine.
Employer-Provided Insurance
These would include life insurance (including split dollar
insurance), accident insurance and disability insurance your employer
provides for you. Your living trust should be the beneficiary when
you have the option. Your employee benefits or personnel department
will have the appropriate forms and can help you complete them.
Sole Proprietorship
Business licenses and DBAs (doing business as) should be
changed to show your living trust as the owner. An assignment is used
to transfer business property to your trust.
Closely-Held Corporation
First check to make sure that transferring your interests
to a living trust will not trigger an event covered by a buy-sell
agreement. (If it does, you can request that the document be
changed.) The appropriate corporate records will then need to be
prepared to transfer title. Share certificates will also need to be
re-registered in the name of your trust. To do this, a Stock Power
(prepared by your attorney) and the certificates will need to be sent
to the attorney or officer who handles the transfers.
Subchapter S Corporation
With a subchapter S corporation, both the earnings and any
losses of the corporation are passed through to the owners
personally. Earnings are taxed only once at the personal level and
any losses can be deducted from ordinary income. (With a "C"
corporation, earnings are taxed twice - once at the corporate level,
and again at the personal level when the earnings are distributed.
And, until the corporation is sold or liquidated, losses can only be
deducted from corporate earnings.)
Transferring subchapter S corporation stock to your living trust
does not cause any change or any problem while you are living. After
you die, however, the stock can only stay in your living trust for up
to two years - after that, it would lose its "S" status and become a
"C" corporation.
But this rarely happens - because two years is usually plenty of
time to distribute the stock to the beneficiaries so the "S" status
can be retained. If you don't want your beneficiaries to receive the
stock outright, the IRS also allows it to be transferred to other
trusts that meet its qualifications to retain the "S" status. The IRS
creatively calls one of these "qualified subchapter S trusts" (QSST).
Your attorney should plan for the distribution of subchapter S
stock when he/she prepares your living trust document.
Limited Partnerships/Corporations/Limited
Liability Companies
If you are involved in any real estate (or other)
partnerships, corporations or limited liability companies, your
interest should be assigned to your trust. This probably will not
disturb the existing agreement or affect your partners in any way,
but you should check the agreement or corporate by-laws just to be
sure.
The general partner may already have a form to assign your
interest to your trust. If not, your attorney can prepare one. The
assignment should identify your interest that is being transferred,
how the interest should be titled, and that the trustee accepts any
liabilities as well as benefits.
Send the assignment to the general partner with a letter
instructing him/her to make the transfer. Since other documents may
need to be prepared to complete the transfer, you may want to give
the general partner a limited power of attorney to sign the other
documents for you. (The general partner may charge a fee to do this.)
General Partnership Interests
This transfer is handled in the same way as a limited
partnership. However, your signature will probably need to be
notarized, and the assignment should include a provision for the
other partners to consent to it. The partnership agreement may also
require you to send the assignment to the other partners or general
partner to sign - as verification of their acceptance - and return
the assignment to you.
If you are using a corporate trustee with your trust, they may not
be able to serve as a general partner. A special trustee may have to
be appointed instead.
Copyrights, Patents, And Royalties
"Intellectual properties" such as these can usually be
transferred to your living trust with an assignment drafted by your
attorney. (Make sure your attorney is familiar with these.)
Oil And Gas Interests
Transferring proven oil and gas interests - mineral
leases, overriding royalty interests, production payments, and
working and operating interests - can all be transferred to your
living trust without losing the percentage cost depletion deduction
(similar to depreciation). Your trust and/or beneficiaries can
continue to claim the deduction after you die.
The process to put these interests into your trust will vary,
depending on the state in which the property is located. You may want
to have your attorney do these transfers for you. They can be tedious
- the legal descriptions and depletion allowances must be exact, and
you want to be sure everything is done properly.
Club Memberships
As long as the membership agreement does not prohibit it,
a club membership can be assigned to your trust. Some membership
agreements allow you to name a beneficiary - if yours does, it should
be your living trust.
Foreign Assets
Foreign assets can be transferred to a living trust if
revocable living trusts are recognized in that country. You or your
attorney will need to contact an attorney in the country where the
assets are located to find out if there are any specific advantages -
or disadvantages - to putting these assets in your trust and the
process that should be followed.
ASSETS REQUIRING SPECIAL
CONSIDERATION
While you should start with the general premise that all titles
and beneficiary designations should be changed to your living trust,
there are a few assets that you may not want in, or cannot be placed
into, your living trust. Here are some you may own.
IRA, 401(k), 403(b), Pension, Profit Sharing,
Keogh And Other Tax-Deferred Plans
These are all plans that were created to encourage you to save for
your retirement. They are called tax-deferred plans because you did
not pay income taxes on this money when the contributions were made.
The income taxes are deferred until you withdraw the money at a later
time, ideally at your retirement when your income (and tax bracket)
is lower.
You can't leave your money in these accounts forever. At a certain
point (your required beginning date), Uncle Sam says you must start
taking money out. Generally, this is April 1 following the year in
which you become age 70 1/2. However, if you have money in a company
plan (pension, profit sharing, etc.), you continue working beyond age
70 1/2 and you own less than 5% of the company, you can delay your
required beginning date on those accounts until your actual
retirement date. (This exception does not apply to IRAs.)
Determining the amount you are required to take out each year,
called your required minimum distribution, has been made easier. This
amount is determined by dividing the year-end value of your account
by a life expectancy divisor found on a chart (called the Uniform
Table) provided by the IRS. You can withdraw more than this amount at
any time. But if you don't need all your money (or if you die before
you use it all up), you'd probably like to let it continue to grow
tax-deferred for as long as you can, with as much as possible going
to your spouse and/or children, and as little as possible going to
taxes.
It goes without saying that Uncle Sam would make this difficult to
do. But on January 11, 2001, the IRS changed some of the rules that
affect how distributions from these plans are determined, and
actually made it easier to get the results you want. The new rules
are effective immediately for IRAs and 403(b) plans. Qualified plans
like 401(k)s and Keoghs must amend their plans or wait until the
regulations become final, which is expected in 2002.
You will not be able to change the ownership of your tax-deferred
plans to your living trust. You can name your living trust as the
beneficiary. But before you do, you should consider all of your
options. As you will see in the next few pages, whom you name as
beneficiary will have a significant impact on how long the
tax-deferred growth can continue, and how much of your tax-deferred
savings will go to Uncle Sam in income and estate taxes.
• Who Should Be Your
Beneficiary - If You Are Married
Option 1: Spouse as
Beneficiary
Most married couples, especially those who have been married for
some time, name their spouses as beneficiary. And, in most cases,
this will be your best option. The two main reasons are 1) the money
will be available to provide for your surviving spouse, and 2) it
gives you the spousal rollover option.
Also, if your spouse is more than ten years younger than you are,
you can use a different life expectancy chart that will make your
required distributions less. (This lets the tax-deferred growth
continue longer on more money.)
Here's how the spousal rollover option works. If you die first,
your surviving spouse can "roll over" your tax-deferred account into
his/her own IRA, further delaying income taxes until your spouse must
start taking required minimum distributions at his/her required
beginning date. When your spouse does the rollover, he/she names a
new beneficiary&emdash;preferably a much younger one, as your
children and grandchildren would be.
After your spouse dies, the beneficiary's actual life expectancy
will be used for the remaining required minimum distributions.
Depending on the beneficiary's age at that time, that could mean
decades of tax-deferred growth.
For example, let's say your grandson is 30 when he inherits a
$100,000 IRA from your spouse. Assuming 10% growth, and that he takes
out only the required minimum distribution each year, over the next
52.2 years (the life expectancy of a 30-year-old), this $100,000 IRA
will provide your grandson with over $2.7 million in income!
What if you name your spouse as beneficiary and your spouse dies
before you? Under the old rules, this was often a problem. Unless you
remarried, you lost the spousal rollover option. You could name a new
beneficiary, but the distributions after your death were still based
on your and your deceased spouse's life expectancies. But now, under
the new rules, if your spouse dies first, you can name a new
beneficiary and after you die, the distributions will be based on the
new beneficiary's life expectancy.
There are some possible disadvantages of naming your spouse as
beneficiary that you need to consider. For example, after you die
your spouse will have full control of this money, which may not be
what you want. For example, you may have children from a previous
marriage or feel that your spouse may be too easily influenced by
others after you're gone. (Your spouse doesn't have to do a rollover,
you know. A total lump-sum distribution could be very tempting, even
if all the income taxes would have to be paid at once!)
Naming your spouse as beneficiary could also cause you to pay too
much in estate taxes. Remember, in Part Three, we explained how you
can waste your estate tax exemption if you leave everything to your
spouse. If your estate is large enough to pay estate taxes and most
of your estate is made up of your tax-deferred savings, naming your
spouse as the beneficiary could cause you to waste some or all of
your exemption. (If you have other assets that can be applied to your
exemption, this would not be a problem.)
If your spouse becomes incapacitated, the court could take control
of this money. The money could also be lost to your spouse's
creditors.
If any of these "disadvantages" fit your situation or concern you,
keep reading.
Option 2: Children, Other
Individuals as Beneficiary
If your spouse will have plenty of assets, or if you have reason
to believe your spouse will die before you, you could name your
children, grandchildren or other individuals as beneficiary.
The tax benefits can be great. Since you are not leaving this
money to your spouse, your estate tax exemption can be applied to it.
That saves estate taxes. And if your beneficiary is much younger than
you (like your children and grandchildren would be), you can get
maximum "stretch out" on the tax-deferred growth.
However, as we explained in Part Two, any time you name an
individual as a beneficiary, you lose control. After you die, your
beneficiary can do whatever he/she wants with this money, including
cashing out the entire account and destroying your carefully made
plans for long-term, tax-deferred growth.
There is the risk of court interference at incapacity. Also, money
that has been withdrawn would be available to the beneficiary's
creditors, spouse and ex-spouse(s). And if you leave a substantial
amount to a grandchild, it could be subject to the generation
skipping transfer tax, a 50% tax in 2002, which is in addition to
estate and income taxes. (See Part Nine for a full explanation.)
For maximum control (especially with a minor or irresponsible
individual), consider naming your living trust as beneficiary
instead, as explained below.
Option 3: Living Trust as
Beneficiary
Naming your living trust as beneficiary will give you maximum
control over your tax-deferred money after you die. That's because
the distributions will be paid not to an individual, but into your
trust which contains your written instructions stating who will
receive this money and when.
With an A-B living trust as beneficiary, you can provide for your
surviving spouse for as long as he or she lives, yet keep control
over who receives the money after your spouse dies. Plus the proceeds
can be used to satisfy your estate tax exemption and save estate
taxes. (See Part Three for an explanation of estate taxes and an A-B
living trust.) Your trust could also provide periodic income to your
children or grandchildren, keeping the rest safe from irresponsible
spending and/or creditors.
While you are living, the required minimum distributions will be
paid to you over your life expectancy (determined from the Uniform
Table). After you die, the required distributions can be paid to the
trust over the life expectancy of the oldest beneficiary of the
trust.
Just as you can do now, the trustee of your trust will be able to
withdraw more money from the account if needed to follow the
instructions in your trust, but the rest can stay in the account and
continue to grow tax-deferred. You can, of course, name anyone you
wish as trustee. But if the trust will exist for a long period of
time (for example, to provide for your grandchildren), you may want
to consider a corporate trustee. (See Part Four for more on corporate
trustees.)
There are some possible disadvantages to consider with a trust, as
well. For example, you will not be able to provide for your spouse
and stretch out the tax-deferred growth beyond your spouse's actual
life expectancy. Remember, after you die the distributions will be
paid over the life expectancy of the oldest beneficiary of the trust.
If your spouse is a beneficiary of your trust, he or she will
probably be the oldest beneficiary. If your spouse is not a
beneficiary of the trust, the oldest beneficiary may be one of your
children. That would let you extend the tax deferral over your
child's life expectancy. But then the money would not be available to
your spouse.
Also, many trusts pay income taxes at a higher rate than most
individuals, but this only applies to income that stays in the trust.
With a revocable living trust, this would only happen after you die.
Distributions from your tax-deferred account that are paid to the
trust are subject to income tax. And if the money stays in the trust,
the higher tax rates would apply. But usually this is not a problem
because the trustee distributes the money to the beneficiaries of the
trust, who pay the income tax at their own (usually lower) rates.
(See Part Eight for more information on trusts and income taxes.)
In order for a trust to work this way as beneficiary of a
tax-deferred account, it must meet certain requirements:
1) It must be valid under state law.
2) It must be irrevocable or become irrevocable at your death
(which a living trust does).
3) The beneficiaries must be individuals and identifiable from the
trust document.
4) A copy of the trust document and any subsequent revisions must
be provided to the Plan Administrator or IRA trustee, custodian or
issuer.
Depending on the kind of trust you would like to use, there may be
additional regulations governing them. Check with your attorney.
Option 4: Charity/Foundation
as Beneficiary
If you are planning to leave an asset to charity anyway after you
die, a tax-deferred account can be an excellent asset to use. That's
because when you name a charity as the beneficiary, there will be no
income or estate taxes on this money after you die.
If you name a charitable remainder trust (explained in Part Nine)
as beneficiary, your spouse, children or others can receive an income
for a set number of years or for as long as they live, and you will
still save income and estate taxes. You can also set up your own
charitable foundation and have the foundation pay your kids a salary
to run it. (See Part Nine.)
The only downside of naming a charity as beneficiary is that it
has no life expectancy. Under the old rules, if you named a charity
as beneficiary, you had to use just your life expectancy when
determining distributions during your lifetime. This made the
distributions larger than they would have been with another
beneficiary. But now, even with a charity as your beneficiary, you
use the Uniform Table to determine your required minimum
distributions, so this is not the problem it used to be.
However, you still need to be aware of a charity's "zero" life
expectancy, as you will see next.
Option 5: Some or All of the
Above as Beneficiary
You don't have to choose just one of these options. You can split
a large IRA into several smaller ones and name a different
beneficiary for each one. If your money is in a company plan, you can
roll it into an IRA and then split it.
You could name several beneficiaries for one IRA, but then you
must use the life expectancy of the oldest beneficiary for the entire
IRA, just as when you use a trust as beneficiary. This is especially
important if a charity is involved. Remember, it has a life
expectancy of zero, so the IRS would consider it the oldest
beneficiary. Depending on when you die, this could cause the entire
IRA to be paid out in just five years.
With separate IRAs, one for each beneficiary, you can use each
one's life expectancy. This will give you the maximum stretch out
over all their ages. It will also be more fair to your beneficiaries,
especially if there is a wide difference in their ages, or if you
want to include a charity.
When should you divide a larger IRA? That will depend on your
planning decisions. Doing it now, while you are living, is the
cleanest approach. If you die first, your surviving spouse can also
split your IRA when he/she does a rollover and names new
beneficiaries. And now, under the new rules and under certain
circumstances, your IRA can be divided into separate accounts in the
year after you die.
Setting up separate IRAs now will make it a little more
complicated for you when calculating your required minimum
distributions each year, because one will have to be calculated for
each IRA. But you can take the total of your distributions from any
IRA you wish. And it can be well worth the trouble. Splitting your
IRA like this can also help you save estate taxes.
Note: Any time you name someone other than your spouse as the
beneficiary, you need expert advice. You'll need to find an attorney
who is experienced in this area, especially if you have large amounts
in these plans. Also, your spouse may need to sign a consent form.
Even in noncommunity property states, spouses now have rights to
retirement plan and other benefits.
• Who Should Be Your
Beneficiary - If You Are Not Married
If you are not married, your decision will be less complicated.
You can name any individual, a trust, or a charity as the
beneficiary.
If you want an individual to receive this money after you die,
consider using a trust to keep more control.
Before you make a decision, consider all of your options
carefully. And make sure your attorney has experience in this area,
especially if you have a sizeable amount in your tax-deferred plans.
• If You Die Without A
Beneficiary
What happens under the new rules if you die without a beneficiary?
That depends upon when you die. If you die before your Required
Beginning Date, your account must be paid out within five years. If
you die after your Required Beginning date, distributions will be
paid over the remaining years of your "fixed life expectancy." This
is determined from an IRS table based on your age in the year you
die.
• How to Change the
Beneficiary Designation for Your Tax-Deferred Plans
Under the new rules, you can change your beneficiary at any time
while you are living and the distributions after you die will be paid
over that beneficiary's life expectancy.
In fact, now your final beneficiaries do not have to be determined
until the year after you die, which allows for some neat "clean-up"
planning to be done after you're gone. For example, your spouse could
"disclaim" some benefits so a grandchild could inherit. Of course, no
new beneficiaries can be added after you die. So you must have the
right beneficiaries named on your account before then.
To change the beneficiary of employer-sponsored plans (such as a
401(k), pension, or profit sharing plan), contact your employee
benefits or personnel department for the proper form. To change the
beneficiary of your IRA or Keogh, you will need to contact the
institution where your account is located.
Some plans have restrictions on what you can do on the beneficiary
designations. Be sure to read the document carefully. If the plan
will not let you do what you want to do, consider rolling your money
into an IRA as soon as you can. If your money is already in an IRA
and the institution will not agree to what you want, consider moving
your IRA to another institution.
• Roth IRA
If you qualify, you may want to consider converting some or all of
your tax-deferred money to a new Roth IRA. You can only convert from
a traditional IRA, so if your money is in a different tax-deferred
plan, like a pension or profit sharing plan, you must first roll your
money into a traditional IRA and then convert it to a Roth IRA. You
will have to pay ordinary income taxes on the amount when you
convert.
Why go to all this trouble? Because it can be well worth it. For
example:
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1)
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Unlike a traditional IRA that requires you to start
taking your money out at age 70 1/2, with a Roth IRA there
are no required minimum distributions during your lifetime.
So you can leave your money there for as long as you wish.
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2)
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Unlike a traditional IRA, you can continue to make
contributions to a Roth IRA after you have reached age 70
1/2.
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3)
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As a general rule, after five years or age 59 1/2
(whichever is later), all distributions to you and your
beneficiaries will be tax-free.
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4)
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You can stretch out a Roth IRA just like a traditional
IRA. After you die, distributions can be paid over the
actual life expectancy of your beneficiary. Your spouse can
even do a spousal rollover and name a new beneficiary.
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Your tax advisor can help you determine if converting to a Roth
IRA would be a good move for you.
Tax-Deferred
Annuities
Tax-deferred annuities sold by insurance companies are not IRAs or
qualified plans. As a result, they are not governed by the same IRS
rules as the plans listed above and the preceding discussion does not
apply to them.
Before you name a beneficiary, read your contract carefully. There
may be some restrictions or income tax issues you need to be aware of
when making this decision.
For example, if you are married, naming your spouse as beneficiary
may allow the tax-deferred payments to continue over your spouse's
lifetime after you die&emdash;while naming someone other than your
spouse (like your living trust) could cause the balance to be paid
out all at once after you die. (One solution may be to name your
spouse as first beneficiary and your living trust as second
beneficiary.)
Incentive Stock
Options
Stock options are often used as a form of compensation for valued
employees, who are given the right to buy company stock at some point
in the future at a predetermined (and usually very favorable) price.
Usually, you have to wait until a certain amount of time has
passed before you can "exercise" the option (buy the stock). You do
not pay income taxes until the stock is later "disposed of" which,
according to the IRS, is a "sale, exchange, gift or transfer of legal
title."
The laws are not clear about whether putting stock options into
your living trust would cause you to violate the "waiting time" or if
this would be considered a "transfer of legal title," which then
would cause you to pay income taxes at that time.
However, we are aware of at least one company that has written to
the IRS, asking for an opinion on whether transferring incentive
stock options to a revocable living trust would be considered a
"disposition." The response from the IRS (called a "Private Letter
Ruling") states that it would not be.
You or your attorney will probably want to read the plan document
to see if there are any restrictions on transferring these options to
your living trust. You may also want to write the plan administrator
for approval. Depending on how long you have before an option
expires, you may want to just wait until after you exercise the
option and then transfer the stock to your living trust.
Section 1244
Stock
Business owners know that many new businesses fail, so they often
incorporate under Section 1244 of the Internal Revenue Code. If the
business is later sold or liquidated at a loss, this allows the
stockholders (the owners) to take the loss on the stock as an
ordinary loss instead of a capital loss.
Normally, when you sell stock (and other investments) and have a
loss, it is considered a capital loss and can only be used to offset
capital gains (your profits when investments are sold). If your
capital losses exceed your capital gains for that year, under current
tax law you are only allowed to deduct $3,000 ($1,500 if married
filing separately) of the excess loss per year from your ordinary
income (wages, tips, etc. as defined by the IRS on Form 1040).
But with 1244 stock, the stockholders can deduct the loss from
ordinary income instead of from just capital gains. Individuals can
currently deduct up to $50,000 in these losses per year; married
couples filing jointly can deduct up to $100,000 in losses per year.
Any excess loss can be rolled forward to subsequent tax years.
Under current tax law, transferring Section 1244 stock to a living
trust would cause you to lose this tax benefit. Whether or not you
will want to put this stock in your living trust will probably depend
on how long you have been in business and how profitable the business
is.
If you think the business may have to be sold or liquidated at a
loss, you probably do not want to put Section 1244 stock in your
living trust. However, if the corporation is successful and there is
little chance of a loss, you may want to go ahead and do so. We
suggest you discuss this with your attorney and accountant before you
decide.
Professional
Corporations
State laws require shareholders of professional corporations (like
doctors and dentists) to be licensed members of their professions.
Since a living trust is revocable and you keep control of the assets
you put in it, some attorneys feel that transferring a professional
corporation to a living trust would not be a problem. But because the
laws do not specifically mention living trusts, many attorneys
suggest that you leave these out of your trust for now, at least
until the laws are changed to include living trusts.
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About The Author
Richard H. Hallstrom, Esq. was an Estate Planning and Asset Protection Attorney licensed to practice in the state of California.
This article was posted posthumously on October 3, 2004
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For more estate planning articles see Estate Planning Articles From Plan-My-Estate.com
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