Funding: Avoid Probate

A revocable living trust (RLT) is an estate planning tool that allows you to avoid the probate process while maintaining total control for yourself and your loved ones. Therefore, no newspaper notices or letters to heirs are required, no records become public, there are no court restraints on the distribution of assets, and no statutory waiting periods apply.

It is still necessary to determine what assets exist, to pay creditors, to file required tax returns and to distribute assets to beneficiaries, but avoiding court proceedings and requirements simplifies and expedites the process, and saves your loved ones the expense and delays usually associated with probate.

If you die leaving no joint owner or contractual beneficiary of your property, your estate will have to go through probate. In order for a living trust to avoid probate, ownership of assets is transferred to the trustees (managers) of the trust. Instead of owning property as Mark and Mary Welby, the name on the deed, account, security or other asset is changed to “Mark and Mary Welby, trustees, or their successor trustees, under the Welby Living Trust dated ____ .” This process is called “funding.” Proper and complete funding of your living trust is crucial to successfully avoiding probate.

Once transferred, the trustees of the trust own the property. You and your spouse, as trustees of the trust, have total control over all property just as you did before. You can spend money, mortgage, sell or give away assets, or do anything you would do if the trust did not exist. Since the trust owns the property and it is physically impossible for the trust to die, the owner of the property never dies and probate is never required. When either you or your spouse dies, probate is avoided and the trust is settled according to the guidelines and blueprints you’ve had your attorney draft in the trust.

Upon the death of the survivor of you, no probate is required since the trust is still the legal owner of the property. According to the provisions of the trust agreement, when both spouses die, the party you have named as successor trustee will have the power to distribute the property of the trust according to the terms provided in the trust. The successor trustee is typically the same person or institution who would be named as personal representative in a will. This should be someone who is capable of completing paperwork, who is responsible with money, and who can get along with the named beneficiaries. The successor trustee can be one of the named beneficiaries, any other individual, or a bank or trust department. You can also name two successor trustees, such as a trusted family member and a bank trust department, and the two will work together as co-trustees. If, during lifetime, the original owners of the property decide that they prefer to have someone else manage assets, the role of primary trustee of their trust can be given to anyone they choose. If both spouses agree that only one spouse should have management rights on some or all assets, the trust agreement can provide for management by one spouse only.

A living trust works well for either married or single people. Joint trusts may be used, where joint tenancy would typically be used, but where probate avoidance on both estates is desired. In cases where married couples choose to keep their assets separate, such as when spouses have children from previous marriages, we usually have each spouse execute a separate living trust, with the plan of distribution of each spouse outlined in that spouse’s trust.

Revocable Gift Trust

A Revocable Gift Trust is a particular type of revocable trust for educational or other specified purposes, often established for grandchildren or other close family members. This type of trust allows you, as the maker of the trust, to make gifts that are revocable during your lifetime yet protected from the beneficiary's creditors at your death.

With a Revocable Gift Trust, you retain the right to revoke the gift and, as a result, pay the income tax on the income generated by the trust. At your death the beneficiary receives the trust assets with a basis equal to fair market value at the time of your death, thereby avoiding federal income tax if they immediately sell the property. Only the value increase from the time of your death will be subject to income tax.

Beyond the Living Trust

Living trusts continue to enjoy unprecedented popularity for a variety of reasons, particularly probate avoidance and increased control during incapacity and death. Many people fail to appreciate, however, that for those with taxable estates (over $2,000,000 this year for Washington state, dropping to $1,000,000 in 2013 for the Federal Exemption) estate planning should not end with the garden variety living trust.

This article reviews advanced estate planning techniques which take you beyond the living trust.

Qualified Personal Residence Trusts (QPRT)


A QPRT is an irrevocable trust that may hold only a personal residence (either a primary residence or a vacation home). The QPRT lasts for a terms of years that the Grantor selects. During the trust term, the Grantor has the right to continue to use the property. Because the value of this retained right is subtracted from the value of the gift to the QPRT, and because the value of the gift (the remainder interest) is frozen at current values and does not included future appreciation, substantial estate and gift tax savings are possible. At times when the real estate market is depressed, this technique can be especially powerful.



Life Insurance Trusts (ILIT)

A life insurance trust is an irrevocable trust designed to own a policy of life insurance on the individual or couple creating the trust. The policy could be either an existing policy or a new policy purchased by the trust with cash gifts made by the Grantor(s). The policy might be a single life or so-called “second-to-die” policy on a husband and wife. Life insurance owned individually is subject to estate and income taxes. Life insurance owned by a properly structured ILIT can be excluded from the taxable estate, passes free of estate and income taxes, and creates flexibility and liquidity for paying death and administration expenses.

Generation-Skipping Trusts

Your current plan may provide for distribution of your estate outright to your children if they are adults, or in trusts to be distributed when they attain adulthood. If so, consider modifying your current plan to retain your children’s shares in trust for life with the trust passing to your grandchildren at the death of your children. Reasons for creating “generation-skipping trusts” include:

1. Assets in the trust, including appreciation on trust assets during your children’s lifetimes, will not be included in the taxable estates of your children, thus saving estate taxes;

2. The trust is protected from attack by a spouse if your child gets divorced; and

3. The trust’s assets will be protected from a child’s creditors in the event of a lawsuit, bankruptcy, failed business, or other financial difficulties your child might encounter. (Statistically, our children run a 50/50 chance of either experiencing a divorce or bankruptcy in their lifetime!)

Taking the concept of a generation-skipping trust one step further into the advanced planning realm, you might even consider forming the trust under the laws of a state (eg, Alaska, Delaware, Idaho, South Dakota, among others) that has abolished the antiquated “Rule Against Perpetuities” (in Washington a trust can last only for 150 years) so that the trust can run for generations without ever being subjected to estate taxes. This is sometimes referred to as a “Dynasty Trust.”


Family Limited Partnerships/Family Limited Liability Companies (FLP/FLLC)

FLPs and FLLCs enable you to make lifetime gifts of fractional interests in assets on a discounted basis. For example, if you own a business, vineyard, rental or investment real estate, stocks and bonds, etc, you can transfer those assets to a limited partnership (or the newer limited liability company), and you and your family members become limited partners. By making gifts of limited partnership interests to your children, grandchildren or to irrevocable trusts for their benefit, you can transfer the value of the assets at a fraction of their underlying value, thereby leveraging your annual exclusion ($13,000/person/year) and estate tax exemption amounts. The valuation adjustments are based on concepts of minority interest discount and lack of marketability and are a function of the restrictions placed in the partnership agreement. However, if you are considering this technique be forwarded that future discounts could be unavailable to changes in the estate tax law. During the Clinton administration and even now during the Obama administration bills have been offered in congress which would curtail the discounting. However, the FLP/FLLC is many benefits beyond discounting such as asset protection, consolidated management, and financial training for future generations which will always make it a valuable planning tool.

Charitable Trust Planning

Whether or not you are charitably inclined, if you own highly appreciated assets (such as real estate or stock) which produce a small return relative to fair market value, the charitable remainder trust (CRT) can be an attractive planning technique. Here’s how it works: you transfer assets to a trust, reserving the income stream defined either as fixed annual amount or a as a percentage of the value of the trust assets determined annually. At your death, whatever is left in the CRT passes to a charity or charities of your choice.


Not only do you receive an income tax deduction upon creating the CRT, but the CRT can sell the assets transferred by you free of capital gains tax. As a result, the full value of the assets, without reduction for capital gains taxes, is invested, producing a larger income stream than would have been possible if you had sold the assets, paid the tax, and invested the difference. Of course, by transferring assets to the CRT, the principal will not pass to your heirs. Therefore, CRTs are often paired with an irrevocable life insurance trust (the ILIT), with the insurance policy replacing the asset transferred to the CRT. (That’s why ILITs are often referred to as “wealth replacement trusts.”)


Other charitable planning techniques include outright gifts to charities, charitable lead trusts, supporting organizations, donor advised funds and the creation of private charitable foundations. For high-asset clients who are charitably motivated, the private foundation, supporting organization or donor-advised fund can be personally rewarding as well as economically rewarding from a tax planning point of view.

Annual Gifting


One of the simplest and most often overlooked ways to reduce a taxable estate is to take advantage of the annual gift tax exclusion. An individual may make as many gifts as he or she likes, up to $10,000 per donee per year, without paying a gift tax and without consuming any of his or her estate and gift tax exemption amount. Such gifts do not have to be in cash, but could include securities, mutual funds, partial interests in land, shares of stock in a family business, or interests in a family limited partnership. Gifts to minor children or grandchildren can include custodial accounts under the Uniform Transfer to Minors Act, an irrevocable trust, or perhaps the best option, contributions to a Section 529 College Savings Plan. In addition, few people know that a special gift tax provision makes it possible to give unlimited gifts to individuals for education or medical needs by making the payment directly to the school or medical provider!


Asset Protection Trusts


Many high-net worth clients with potential liability exposure (like doctors and lawyers) can combine family limited partnerships, irrevocable trusts and tax-neutral offshore trusts (eg. Cook Islands) or on-shore trusts (eg. Alaska, Delaware) to set aside a “nest egg” in case of a catastrophic lawsuit. To be done legally, such planning must be accomplished before you have knowledge of a claim.

Business Succession Planning


Statistics show that only a small percentage of family businesses pass successfully from one generation to the next. Estate taxes and the failure to plan for the transfer of control are the major culprits. Business succession planning often involves a combination of several techniques discussed above, as well as use of the Family Business Exclusion, buy-sell agreements, split-dollar life insurance, deferred comp plans, stock recapitalizations, qualified and non-qualified stock option plans, Employee Stock Ownership Plans (ESOPs), and re-structuring the form of entity, such as changing from a sole proprietorship or general partnership to a Limited Liability Company (LLC), limited partnership or corporation.



Even if you already have a basic estate plan, you should consider updating and reviewing your plan to see if some of these techniques are appropriate for you and your family. If you have not completed your estate plan, the foregoing techniques are important adjuncts to a basic plan consisting of a living trust or will, health care directive and power of attorney.

Charitable Lead Trust

The Charitable Lead Trust is a type of charitable trust that can reduce or virtually eliminate all estate tax on wealth passing to heirs. In order to accomplish this goal, you create a trust that grants to a charity or charities, for a set number of years, the first or “lead” right to receive a payment from the trust. At the end of the term of years, your children or grandchildren receive the balance of the trust property—which often is greater than the amount contributed—free of estate tax in most instances. Although the Charitable Lead Trust is a complex estate planning strategy, the steps to implement it are few and simple from your perspective. Here is how one of the most frequently used Charitable Lead Trusts, the Charitable Lead Annuity Trust, operates:

You, as grantors, create a Charitable Lead Trust as part of your revocable living trust planning. Upon the death of the survivor of the two of you, a substantial amount of property will pass to the Charitable Lead Trust. The income beneficiary of the Charitable Lead Trust will be a qualified charitable organization, chosen by the two of you or by the survivor of you, named in your revocable living trust. The charitable income beneficiary receives a fixed, guaranteed amount from the trust for a certain number of years (determined by you with the assistance of your legal and financial advisors). Generally, any charity that has received tax-exempt status through an IRS determination qualifies, but this is not always the case. It is possible for you to name a private foundation established by you as the charitable beneficiary. If so, you must have very limited authority over which charity is to receive money from the foundation. Too much control while you are alive will result in adverse tax consequences.

At the end of the Charitable Lead Trust’s term, the remaining assets in the trust pass to non-charitable trust beneficiaries such as children and grandchildren, free of estate and gift tax. These assets can pass outright to the beneficiaries, or can continue to be held in trust, either in new trusts or in trusts previously established for the benefit and protection of beneficiaries.

The charity will receive the same dollar amount each year, no matter how its investments perform. The remainder interest ultimately passing to the heirs, however, will be affected by the performance of the trust’s investments.

This is know as a Testamentary Charitable Lead Trust. This technique can use a Charitable Lead Annuity Trust, a Charitable Lead Unitrust, or both. Charitable Lead Annuity Trusts are particularly suited for hard-to-value assets (such as real estate or family limited liability company interests) and assets which are expected to grow rapidly in value.

It is also possible to create a Charitable Lead Trust during your life. If created as a grantor trust, this technique can help with your income tax planning by creating current income tax deductions.

Stand-Alone Educational Trust

A Stand-Alone Educational Trust is a type of trust that can pay for educational expenses, solve income tax issues, and provide an important piece of your estate plan. These trusts are specifically designed to manage socalled 529 plans, named after the Code section that creates these state sponsored savings plans.

More and more clients are using 529 Plans as an educational savings vehicle for their children, grandchildren and other family members. These vehicles are immensely attractive because they are estate tax free, income tax free, and in some states protected from creditors. However, as you invest more and more money in 529 Plans, it becomes more critical that these assets are managed properly during your lifetime and after death.

A 529 Plan combined with an Educational Trust provides more flexibility to move assets between siblings (the one in medical school will need more money), and just as importantly, provides a smooth transition should you become incapacitated or die. Significantly, the trust funds can also be returned to you should you experience a financial emergency. You can create one Education Trust for all beneficiaries, or one trust for each beneficiary as his or her "special" gift.