Fix Your Outdated Living Trust Now!
By James L. Cunningham Jr, Attorney-at-Law
Remember that Living Trust you created five or ten years ago? I’m sorry to tell you it was just the beginning. Since then, your family probably changed, your assets certainly changed, and believe me, the tax laws changed a lot. That means the Estate Plan that’s been sitting quietly in your drawer all this time has likely developed some highly dangerous traps—just waiting to cause havoc for you and your loved ones.
Here are five of the top hidden traps we estate attorneys often see in outdated living trusts.
Trap #1: Having an Out-of-Bucket Experience
You rightly created a Living Trust as a portable “bucket” in which to pass on your assets. But that was only the first step. You actually have to put all your assets into the bucket for it to work. Do you have all your real property, bank accounts, and investment accounts still titled in your Trust?
The biggest reason you created your trust was to avoid probate. But if you failed to fill your bucket, your estate will still go to court. Think of it like buying a life jacket and leaving it on the boat when you jump in the water.
Every single asset must be accounted for, including those obtained long after you created the trust—and exactly how you title or designate those assets is of vital importance. Did you refinance, causing your home to be taken out of your trust? Were accounts “temporarily” created outside the trust and never re-titled?
Don’t let this trap pull your loved ones into court, drowning all your goals in the process.
Create the bucket. Then fill the bucket, over and over and over.
Trap #2: The Structure of your Trust Fails
Living Trust attorneys are always thinking about taxes when they create a trust. For example, whether you know it or not, your trust likely has a structure built in to take into account what’s often called the “death tax,” aka the federal estate tax. Some States also have a separate death tax, although California doesn’t currently have an estate tax, it has in the past and it might in the future.
The problem is that inheritance tax laws have changed significantly, and now your trust structure might actually be harming you. Yes … harming both you and your spouse!
You see, there was a time everyone worried about being subject to a death or inheritance tax, because the amount you could die with tax-free was very low. However, in 2020 you and your spouse each get $11,580,000 to die with, inheritance-tax free, meaning $23,160,000 for a married couple.
Not very many people now fit that category, but their outdated Living Trust thinks they do!
An older trust will often include a mandatory split of all assets when one spouse passes away, along with an irrevocable trust created with restrictions on use by the spouse remaining. Married couples often don’t know they have that kind of tax planning in their trust, but as soon as one spouse dies, the survivor is stuck with it forever.
Instead of saving money, the outdated trust costs survivors money, disqualifies them from public benefits, and has a hugely negative tax consequence to their loved ones.
Yikes. That trap hurts!
Trap #3: Not Protecting Your Beneficiaries
Sometimes “protecting your loved ones” in an estate plan means protecting them from themselves. But as divorce and litigation numbers continue to rise, it most often means protecting them from others.
We can all agree that we want the inheritance we leave behind to go to our loved ones, and not get lost to a broken marriage, a bad debt, or a targeted lawsuit. A well-written Living Trust will consider the current or future financial and marital status of our loved ones—but ill-considered trusts may include hidden traps for those we want most to help.
Divorce is certainly the most common way an inheritance is lost, and a well-drafted trust can protect the beneficiary. But did you realize a well-intended gift could kick a disabled or special-needs loved one off public benefits? Unless structured properly, it certainly can.
Did you create a trust that tries to protect a beneficiary by allowing distributions only at certain ages, say 1/3 at age 21, 1/3 at age 25, and all the rest at 30? Not good enough! Creditors will likely be able to reach right into your trust for those monies.
There’s no “generic” next generation. You absolutely have to discuss your unique family situations with an estate planning attorney, so you don’t end up creating disasters with your best intentions.
Trap #4: Not Planning for your Retirement Accounts
Retirement plans (IRA, 401K, 403B, TSA, or any qualified plan) are probably your largest asset next to your home. Have you neglected to learn the complexities of passing retirement accounts to your loved ones? If so, you have likely set an especially dangerous trap for your loved ones—or perhaps I should say that the IRS set the trap for you.
The laws governing retirement accounts changed radically with the passing of the SECURE Act (Setting Every Community Up for Retirement Enhancement) that went into effect January 1, 2020. That law sets lots of new rules—some good and some bad, depending on whether you like paying more taxes.
One of the most drastic changes affected the inheritance of IRAs. Under the old rules, beneficiaries could take out a little at a time, and pay income tax a little at a time, over their entire lifetime—allowing them to grow your retirement funds and lessen their tax burden. The new rules make them take it all in just ten years.
What does it mean if an inherited IRA must pay out in ten years? Without good planning, many beneficiaries will lose about half of their inherited IRA to taxes, depending on the size of your retirement and the wealth of the beneficiary—unless you consider some alternative tax planning strategies with an expert before you pass away. We might be able to strategize depending on the unique situation of your loved ones and exceptions to the Ten-Year Rule. For example, a disabled or special-needs loved one can receive an exception, and be allowed to withdraw funds slowly over their lifetime to receive a better quality of life with the income an IRA account produces.
On the other hand, see Trap #3. We mustn’t let an inherited retirement plan kick a loved one off of public benefits! Sound the alarm, this one is big—we always have to be extremely cautious when public benefits are involved. Indeed, we do have a solution to give back asset protection to those on public benefits: we can create a special kind of trust just for your retirement plans, and especially tailored to those with disabilities or special needs.
A more common trap for retirement accounts may be the Living Trust itself. Retirement accounts like IRAs generally do not belong inside your Living Trust at all. I haven’t the space to go into the reasons here, but retirement accounts should almost always be passed on using the “Payable on Death” beneficiaries listed at the institution holding the account.
Clumsy estate planning for retirement accounts can trigger multiple traps of this kind: If you aren’t aware of the rules, opportunities, and dangers, your loved ones will have no asset protection for inherited retirement plans.
There are all kinds of tools in an attorney’s toolkit. The important thing to understand is this: You can’t let your largest asset not have a plan. If you remember one thing from Trap #4, remember that whatever plan you had in place for your retirement funds pre-2020 is now risky. Consider your options with an estate planning attorney, but remember that not all attorneys are the same. Indeed, few understand the complexities of inherited retirement accounts the way they should.
Trap #5: Planning Has Outlived Its Purpose
InTrap #2, we learned that Living Trusts can go dangerously out of date. But the same can be true of other plans you made when you were younger, and had different concerns.
A good example is life insurance. When you have young children, typically you invest in life insurance for the purpose of paying off a mortgage, replacing income to your family, or paying for the education of your children if something were to happen. However, time goes by. One day the children will be adults and have families of their own, and one day the mortgage will be paid off. At that point, life insurance won’t really have the same purpose, and you really need to consider re-aligning your insurance for something more pressing and perhaps more expensive like long-term care.
Long-term care in a skilled nursing facility has an average cost in California of around $10,000 per month—varying, of course, due to location and level of care. You and I would have to pay that sum out of our own pockets, unless we come up with a better plan. Statistics show that we are living longer; but with that great news may come a very large price tag.
Bottom line? All estate planning must be reviewed as life changes. I can find insurance products which allow me to repurpose my life insurance with a long-term care rider that could be used for skilled nursing, in-home care, or memory care. It’s a win if I need it, but if I don’t, the death benefit can still pay out to my loved ones. Indeed, life insurance policies should be reviewed every three years for these kinds of issues: always look at your whole plan to avoid the trap of a plan outliving its purpose.
Bonus Trap #6: Getting the Wrong Estate Attorney
It is extremely rare for an old trust not to have a trap buried deep inside all its well-purposed legal language. It’s not your job to know what traps are there, but now that you’re aware they exist, take action and have an attorney review the trust.
The attorney you work with matters. A lot.
Estate planning is an extremely complex topic. Not all attorneys can double as estate attorneys, and not all estate attorneys are created equal. If your second cousin’s sister practices personal injury law and threw together a plan for you 10 years ago that is 10 pages long, my advice is simple: Run. Run to our office before that trap snaps shut.
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We look forward to working with you!
James Cunningham Jr., Esq.
At CunninghamLegal, we guide savvy, caring families in the protection and transfer of multi-generational wealth.