17. For whom are living trusts most appropriate? What are the pros and cons?

1. While it is true that probate can be expensive and time-consuming in some other states, in Texas, we have a streamlined system of probate. As long as you hire a lawyer with experience in probate court, you have a well-written will, and nobody files a lawsuit after your death, then probate is typically not so bad.

   Stories you read in the paper may lead you to believe otherwise. The heirs of multi-million dollar estates frequently fight it out in court for a larger inheritance. Also, bookstores carry dozens of books which talk at length about the delays and high costs associated with probate.

   Even so, living trusts are useful estate planning tools, and they do have their place in many people's estate plans. If you find any one of the following benefits appealing, then a living trust may be appropriate for you. Living trusts are useful estate planning tools, and they have an important place in many people's estate plans. If you find any one of the following benefits appealing, then a living trust may be appropriate for you.

   Benefit #1: No Court Involvement. When a person dies, most properties pass either under a person's will or under a living trust. Some properties--such as life insurance, IRAs, and certain types of bank and brokerage accounts--pass directly to named beneficiaries. If property passes under a will, then the will must be probated at the courthouse. Probate *[typically ]*entails hiring a lawyer, filing a number of papers with the court, attending one or more hearings, and providing a written inventory to the court valuing the properties which passed under the will.

   Some people don't want this type of involvement with the court, so they opt for a living trust. By transferring all properties which would otherwise pass under your will to a living trust, you can avoid the court entirely. For estates which don't owe estate taxes, there is usually less work for the lawyers, and that translates into reduced estate administration costs.

   Benefit #2: Privacy. As mentioned above, when a person dies with a will, an inventory must be filed with the court. You may not want your friends, neighbors, or the media to be able to read a listing of what you own and what it is worth. After all, an inventory is a public record. With a living trust, your properties and their values are all kept private.

   Benefit #3: Plan For Future Incapacity. You may be worried that one day you won't be able to manage your own finances, and you may want to name someone to handle these types of matters for you. You can address this potential problem with a power of attorney or with a living trust. A power of attorney will usually be accepted by banks, title companies and the like, but there is always the risk that an institution's legal department will reject it. The same person who may be denied the ability to use a power of attorney will likely be allowed to do anything he or she wants when acting as trustee of a living trust.

   Benefit #4: Harder to Challenge. If you are planning to disinherit one of your children or grandchildren, you may be better off with a living trust because there is nothing filed at the courthouse. Also, it is a little harder to contest a living trust than a will. Many people are interested in doing as much as possible to prevent a successful challenge to their estate plan.

   Benefit #5: Avoid Out-of-state Probate. If you own property in another state, you can avoid a costly probate proceeding in that state by transferring the property to a living trust.

   Before you establish a living trust you need to understand the downsides, which include the following:

   Disadvantage #1: Time-consuming to Set Up. Depending on how many different types of properties and accounts you own, it can take quite some time to switch everything over to the name of your living trust.*[ Also, some financial institutions in Texas are not geared up to handle living trusts, so you can expect a little trouble and frustration in getting the trust fully established.]*

   Disadvantage #2: Complicated. Wills are usually shorter and simpler to understand than living trusts. Also, with a will, you can sign it and forget about it. But with a living trust, you need to put your property into the trust and run your life out of it for as long as you live. For many people, this downside outweighs all the potential benefits.

   Disadvantage #3: Time-consuming to Revoke. A year after you set up the living trust, you may decide you don't want it any more. At this point, you will need to return to every bank and brokerage house, and undo everything you had done to establish the trust. You can expect more lawyers' fees too.

   Disadvantage #4: Post-Death Costs Not Eliminated. If you have a taxable estate (which is generally an estate over $1,000,000), there will be a lot of work to be done after death regardless of whether probate is required. Typically, there are tax returns to file, trusts to establish, assets to value, and more. Avoiding probate will only marginally reduce the cost of administering a taxable estate.

   Disadvantage #5: May Still Need to Probate Will. If you leave just one bank account or one piece of real estate out of the trust, probate will still be necessary. And probate takes about as long when there is one asset as when there are twenty.

17. What is the difference between a Living Trust and a Bypass Trust?

1. A Living Trust is a revocable trust created while a person is alive, whereas a Bypass Trust is typically an irrevocable trust created at death. A Bypass Trust can be created by a Living Trust or by a will. (Yes, a Living Trust can create a Bypass Trust, but a Bypass Trust would never create a Living Trust.)

   A Living Trust is simply an ownership arrangement where property is held in the name of a "trustee" rather than in the name of the person who really owns the property. People almost always create Living Trusts for their own benefit, with the goals of avoiding probate, addressing the possibility of future incapacity, and keeping matters private.

   Normally, the person who creates a Living Trust names himself or herself as trustee and as beneficiary. Upon that person's death, all or a portion of the property which remains in the Living Trust passes according to the terms specified in the trust agreement.

   Bypass Trusts are most often created when a husband or wife dies in order tosave taxes when the other spouse passes away. When a married person dies and leaves everything to his or her spouse, that surviving spouse may then be too wealthy to pass everything to their beneficiaries tax free. Being "too wealthy" means the married couple is worth over $1,500,000-the present estate tax exemption. The Bypass Trust is a way to shelter the first spouse's $1,500,000 exemption from taxation when the surviving spouse dies, thereby doubling the amount that can be left tax-free to $3,000,000.

   Bypass Trusts do have non-tax benefits though, and for some people, saving taxes is not the motivating factor in creating one. For instance, Bypass Trusts protect the trust property from creditors' claims, and they allow the deceased spouse to direct where the trust property passes when the other spouse dies.

   There are some exceptions to the statements contained in this answer. For instance, Bypass Trusts are not always created at death. Some wealthy people create them during life, and other people use their estate tax exemptions for different purposes rather than the creation of a Bypass Trust. Also, in answering your question, I have assumed that when you said "Living Trust," you meant the standard type of revocable trust people across the country regularly create and not another unusual type of trust which may be created while someone is living.*[

17. What is a Miller Trust, and how does it work?

1. A Miller Trust is a written trust agreement which makes it possible for people to obtain Medicaid nursing home coverage even though they actually make too much money to qualify for Medicaid. Importantly, they are not actually called Miller Trusts anymore. Instead, they now go by the name Qualified Income Trusts.

   The rule in Texas is that you must have both limited resources and limited income in order to qualify for Medicaid coverage. These are two distinct tests that must be met, and if you don't satisfy both of them, then Medicaid nursing home coverage will not be available.

   The first of the two requirements--that you must have limited resources--has nothing to do with Qualified Income Trusts. Basically, if you have more than $2,000 worth of assets, you are too wealthy to qualify for Medicaid no matter how little money you earn.

   Cash, stocks, bonds, retirement accounts, non-homestead real estate, and other investments are included in the $2,000 figure, but your homestead (no matter how much it is worth), $2,000 of personal property, a burial plot, a small amount of life insurance, and a car are generally not counted.

   People with more than $2,000 can give away properties or convert them into properties which are not counted. However, there is a 36 month look-back rule (60 months when gifts are made to a trust) to keep you from giving away all your property and then applying for Medicaid the next day.

   Also, there are rules which generally allow the spouse of someone trying to qualify for Medicaid to retain about $87,000 worth of property. A spouse's property is not counted when determining the total value of assets for the $2,000 resources test.

   The second of the two requirements--that you can earn no more than a certain dollar amount of income per month--is where Qualified Income Trusts enter the picture. As of March 31, 2003, the monthly dollar limit was $1,656, but this amount changes frequently. People who earn more can't qualify for Medicaid unless they have a Qualified Income Trust.

   What you do is assign your income to the Qualified Income Trust, and the wording of the trust limits how much of the income can be distributed. This way, a person who makes more than $1,656 each month will be treated as earning less than that amount, thereby satisfying the Medicaid income test. The trust can allow for certain payments, including insurance premium payments, other payments to support a spouse, and $60 each month for the beneficiary's personal needs.

   Money remaining in the trust after those payments must be paid to the nursing home for the beneficiary's care, with Medicaid picking up the balance. With Qualified Income Trusts, people can get the government to cover the portion of the nursing home costs that they can't afford.

   Lawyers prepare Qualified Income Trusts. Therefore, everyone who needs one must first meet with a lawyer to discuss the specifics of the trust and all the other planning that goes with it.

   To learn more about Qualified Income Trusts, search the internet for the words "Texas qualified income trust." You can also call the Texas Department of Human Services at 888-834-7406 or visit their website at www.dhs.state.tx.us. They have a summary of Qualified Income Trusts, and they also publish a "Medicaid Eligibility Handbook" which contains other helpful information.

   The dollar amounts in this answer are accurate as of August 15, 2002, but they change frequently.]*

17. What are the tax advantages to setting up an irrevocable trust to own an insurance policy?

1. Although life insurance is generally not subject to income taxation upon the death of the insured, it is subject to estate taxes if the insured owns the policy (or has other ownership rights).

   Owning a life insurance policy results in all or a portion of the insurance proceeds being included in the insured's estate and therefore taxed when death occurs, thereby substantially defeating the purpose of buying the life insurance. Estate tax rates start at 41% and go as high as 49%.

   While it is true that life insurance which is received by a spouse is not subject to estate or inheritance taxes because of the unlimited marital deduction (assuming the surviving spouse is a citizen of the United States), those same proceeds will be included in the spouse's estate later on when he or she dies. Therefore, life insurance trusts are often a good idea even when there is a surviving spouse to receive the proceeds.

   Life insurance trusts offer a number of significant advantages over outright ownership. For starters, the trust will insulate the proceeds from the claims of creditors and from spouses in a divorce.

   Also, life insurance trusts can be written to last for children's lifetimes and then pass without estate taxes to additional trusts for grandchildren. This is a feature commonly referred to by estate planning lawyers as "generation skipping planning." Your children shouldn't be alarmed by the words "generation skipping" because you are not skipping them. Your children can serve as trustees of their trusts, and they can be given the power to make distributions to themselves or their children according to fairly liberal standards. Normally, trusts like the ones being described would allow your children to make distributions for their health, education, maintenance and support. And your children would be the ones determining how much money it takes to maintain and support themselves. Even though the life insurance proceeds will be held in a trust, your children would not be prevented from using the trust funds.

   Even if Congress and the President repeal the estate tax in the next few years, people will still create trusts because trust property never becomes commingled with other property owned during a marriage (unless your children distribute the money from the trust to themselves), and the trust funds will generally be unreachable by creditors (as long as the trust property remains unincumbered inside the trust).

Retirement Accounts and Funding a Bypass Trust:

17. Our entire estate except for a small checking account, and a house worth about $150,000 is in my IRA account. My IRA is now worth about $1.6 million. Can my IRA be used to fund a bypass trust? What happens if we do not fund the trust and I name my wife as the beneficiary of the IRA?

1. Yes, with proper planning, an IRA can be used to fund a bypass trust.

   By way of background, bypass trusts are sometimes needed because people are allowed to leave only $1,500,000 estate tax-free at death. While it is true that the $1,500,000 amount will be increasing over the next few years, it is also likely that your IRA will increase in value too. At least you hope so.

   If you name your wife as the beneficiary of your IRA and you give her the rest of your estate, she will immediately be worth in excess of $1,500,000 upon your death. That dollar amount is much larger than the amount she can leave estate tax-free upon her death. If your wife dies first, you would likewise then be worth in excess of $1,500,000, and upon your death, the estate tax would be the same. Certainly, you would like to do whatever you can to reduce or eliminate the estate tax.

   That is why bypass trusts can be useful.

   Rather than give your entire estate to each other, the first spouse to die would instead place as much property as possible into a bypass trust. Typically, the surviving spouse would be in charge of the trust as trustee and would be able to distribute property as needed for health, support and maintenance. So there is no real loss of control or access to the property in the trust.

   Placing real estate, cash, stocks and bonds into a bypass trust is easy, as there are generally no tax consequences when setting up the trust. However, the IRS has complicated and restrictive rules when it comes to IRAs.

   The typical plan involves setting up your estate so that a portion of your IRA could be placed in the bypass trust following your death. Estate taxes would be eliminated because your wife's estate would be less than the $1,500,000 threshold upon her death.*[ Even if your wife dies first, her one-half community property interest in your IRA can be sheltered within the bypass trust created in her Will, thereby saving estate taxes upon your subsequent death.]*

   Getting the IRA into the bypass trust does have a few downsides.

   Number One: In your quest to save estate taxes, your wife may get stuck paying extra income taxes. For instance, if you die first and your IRA is paid to the bypass trust, your wife may not be able to roll the entire IRA over to her own new IRA and defer income taxes until she reaches age 70 ½. Instead, with the bypass trust named as the beneficiary, distributions may need to start soon after your death, and then continue over your wife's life expectancy. If your wife is 55 years old upon your death, that means she may need to start taking distributions 15 years earlier than if she had opted for the IRA rollover.

   Number Two: Your wife may not be able to name your children as beneficiaries and thereby extend the income tax deferral for their lifetimes. This option would be available if she rolled your IRA over to her own IRA.

   Number Three: You may not completely eliminate estate taxes. The reason stems from the fact that you have never paid income taxes on your IRA. When the IRA is owned by a bypass trust, each time a distribution is made to the trust, income taxes must be paid. If the IRA distribution is left in the bypass trust, the tax rate will generally be equal to the highest marginal income tax bracket (that figure is now 35%). Your wife can avoid this high rate of tax by giving the IRA distributions to herself (which is allowable, and possibly even required depending on the terms of your will or revocable trust, as she controls how much she can get from the trust). When the distributions end up in her hands, rather than the trust paying a high income tax, she pays income taxes at her own income tax rate, which may be far lower. The result over time is that the bypass trust keeps getting smaller and smaller each time your wife gives the IRA distributions to herself directly. That makes her worth more and the bypass trust worth less. And if she is worth too much at her death, then estate taxes will still be owed.

1. As you can see, the laws associated with IRAs and bypass trusts are extremely complicated. This answer is designed to give you a general overview of the planning options which are available, and there are exceptions to some of the statements in this answer.

17. My retirement plan at work has grown to a little over $1,000,000, and it's going to get bigger because I still have about ten years before I retire. My wife and I have some other investments, but the retirement plan is the bulk of our estate. If I die first, I want to let my wife use the income from the retirement plan for the rest of her life, but after she dies, I want the balance to pass to my two daughters, not to my wife's next husband or anyone else. What should I do?

1. You have a very complicated problem with no simple solution. Here are five approaches you can take.

   Option One. You could name your wife as the primary beneficiary and make her promise to name your daughters as her sole beneficiaries after her death. This approach is simple, but risky, as it leaves your wife in total control. After your death, your wife will have the ability to roll your plan over to her own IRA and name her own beneficiaries. With you out of the picture, your wife may break her promise and leave your daughters no part of your retirement money. Your wife would also have the ability to liquidate the plan at any time by making a distribution of the entire amount to herself.

   Option Two. Rather than naming your wife as the beneficiary, you could provide for the plan to pass to a trust for her benefit. As the beneficiary of the trust, your wife could receive the income from the retirement plan while she is alive, and then after her death, the remaining assets could pass to your daughters as provided in the trust instrument. As you can see, a trust may be a good solution to your problem, but there are a number of potential drawbacks.

   For starters, many company retirement plans cannot be paid to irrevocable trusts without income taxes being due on the plan's entire value. Even though tax laws allow your employer to administer your retirement plan following your death with continued income tax deferral, it is probably your employer's policy to make a lump sum distribution of the entire plan to the trust at your death. Most employers don't want to be bothered with years of bookkeeping following the deaths of their employees. You should check with the benefits department at your company to see what types of payout schedules are possible with your plan. If continued income tax deferral is available, you may have found the best answer to your question.

   If you go forward with the idea of a trust, you may want to name someone other than your wife as trustee. Naming your wife leaves her in total control of how the trust property is invested and distributed. She would have the power to negate your intentions by making large distributions to herself, even to the point of using up all the trust property. If you name one of your daughters as trustee (or both of them as co-trustees), then a potential family conflict arises because your wife would need to seek approval from your daughters whenever she needs money. You could name a trust company as trustee, but your wife may not be too happy having to ask a trust officer for money. Also, trust companies charge fees for their services. Trust companies are right for some people and not for others.

   Option Three. If you are fortunate enough to retire before your death, you can roll over your company retirement plan to an IRA and achieve all your goals. With an IRA, you can name one or more trusts as the beneficiary, and still continue most of the income tax deferral. Whatever is left in the IRA when your wife dies can pass to your daughters with the possibility of further income tax deferral if they choose. These issues relating to an IRA rollover are good for you to know, but they are not yet relevant because your retirement money is still in a qualified plan at work.

   Option Four.You can designate your daughters as partial beneficiaries of your retirement account, with the balance passing to your wife. This way, everyone is guaranteed to get something. After your death, your wife can roll her portion over to an IRA without current income taxation. Your daughters will likely be able to defer income taxes over their life expectancies as well.

   Option Five. Another approach is to buy a life insurance policy which names your daughters as beneficiaries. Your wife could be named as the primary beneficiary of your retirement plan. For instance, if you think $400,000 is enough for each daughter, then you could buy an $800,000 policy. Structured properly, the insurance can pass to your daughters (or to trusts for their benefit) without income or estate taxes. Everyone would get enough money, and there would be no conflicts following your death. If you consider that the combined income and estate taxes on your retirement plan could reach as high as 50 - 70% of the entire plan, then spending a few thousand dollars per year on life insurance makes a lot of sense.

   Please note, this answer contains some generalities, and many exceptions apply.