Over the years, we have come to see that there are several misconceptions about the use of family trusts in estate planning. This Newsletter will highlight the most common myths about the family trust.

Having a Family Trust Avoids Probate

A family trust can be used to avoid probate, but just having a family trust is not enough to avoid the probate process at the settor's death.   Probate results from assets in the name of the deceased over a certain value ($150,000 generally) which do not have a beneficiary designation or a joint owner.

In order to avoid probate on an asset in someone's name when that person dies, title to that asset needs to be in the trust at the time of the person's death. For example, with real estate this means transferring title, through a deed, to the name of the trust. For brokerage accounts and other institutional accounts (other than IRAs and other retirement accounts), this means changing the name on the accounts to the name of the trust.

It is therefore important to make sure that all assets are either in the name of the family trust or coordinated with the trust through a beneficiary designation.

Family Trusts Save Estate Taxes

Assets held in a family trust will be included in the settlor's estate for estate tax purposes. Estate taxes are paid, in general, on assets in the settlor's estate in excess of $5.43 Million as of 2015.

While it is possible for a revocable trust to help save estate taxes for a family, this does not happen automatically. In order to save estate taxes through a family trust, specific provisions must be included in the trust and specific actions must be taken during the administration of the trust. Having a family trust, in itself, does not change the impact of estate taxes on a decedent's estate.

Family Trusts Protect Assets from Creditors

Because a family trust is revocable by the settlor, it does not protect assets from the settlor's creditors. In general, assets held in a revocable trust are treated as owned by the person with the power to revoke the trust.

If protection from creditors is desired, there are other types of trusts and techniques that can be used to minimize risk from creditors.

Family Trusts Should be Named as Beneficiaries of IRAs and Other Retirement Accounts

If a family trust is named as the beneficiary of an IRA (or other retirement account), all of the income taxes on that account will generally be due upon the settlor's death (or within five years of death).

If the settlor wants the beneficiary of the IRA to be able to minimize income taxes by taking the money out of the IRA over the beneficiary's life expectancy, she would need to (1) set up a Designated Beneficiary Trust or (2) name the beneficiaries directly on the beneficiary designation. There are certain disadvantages, however, to naming individual beneficiaries, which we have discussed in a prior Newsletter.

A Surviving Spouse Can Change the Beneficiaries of the Entire Estate

There are many different kinds of joint family trusts for married couples. Some family trusts leave all of the decedent's assets at the first death to the survivor in a revocable trust. This means that the administration of the trust is relatively easy for the survivor, and the survivor may change who will receive all of the assets at the survivor's death.

If the decedent's assets are instead placed in an irrevocable trust for the survivor (usually because of estate tax planning, protection from creditors, or to provide for children of a prior marriage), the surviving spouse will not be able to change the distribution provisions of that irrevocable trust unless he or she is given specific powers to do so in the document.

Conclusion

A family trust is the foundation of good estate planning, but simply having one does not solve every issue that will arise. To be effective, the assets of the estate must be properly titled to and coordinated with the trust document, and the provisions of the trust should be reviewed periodically to make sure it remains up-to-date.