A common question that comes up during consultations, networking meetings, seminars, estate plan reviews, or sometimes at a neighborhood gathering is: “Do I need a will or a trust?” When making the decision of whether to create a plan using a North Carolina will or trust, there are really six (6) main issues to consider.
To be clear, everyone needs a will, or Last Will & Testament if you want to be formal. The difference in planning strategy is whether the will is the main succession tool for your assets or if a revocable living trust would be better to control the distribution of your wealth. When considering the use of a trust, we generally look at these six (6) factors:
This is generally a question of responsibility and maturity, and one that’s specific to your family – there is no “right answer.” If you were to leave my office and not make it home, would your current plan, or lack of plan, help or harm your beneficiaries? We could be talking about minor children, young adults, or well-established and mature kids – every family is different. Depending on when you pass and the nature of your wealth, a lump sum distribution or immediate access to investments or cash could have a negative impact on your surviving family.
Wealth passes in a number of different ways depending on your specific assets and the structure of your plan. Assets, for the purposes of estate planning and wealth succession, are classified into two major categories: Probate Assets and Non-Probate Assets.
Since Non-Probate Assets generally pass immediately upon death, according to your beneficiary designations or survivorship rights, there’s really no way to control or protect those assets (or your beneficiaries, for that matter) during that succession. For instance, when a beneficiary is listed on a life insurance policy, the entire death benefit is paid in one check to that beneficiary – no further requirements or rules apply. The question then becomes, do you want to delay the gratification of these assets, or are you okay with your beneficiaries receiving them outright and all at once? If you are leaning toward the latter (or screaming “hell no my kids don’t need that much money all at once”), the best option to place structure and a set of rules across all assets, probate and non-probate alike, is with a revocable living trust. The assets would then be directed to pay to the trust after your death, having no impact on your present ownership of those assets. If you’re okay with your kids receiving everything all at once, then a trust is probably not a good option for you. Your circumstances and wishes dictate this point, though. Trusts are not right for everyone and they are certainly not some silver bullet for estate planning, as some lawyers would have you believe.
Qualified Retirement Accounts (think 401(k)’s, Traditional IRA’s, SIMPLE or SEP IRA’s, and 403(b)’s) are tax-deferred retirement accounts are contributed to with “pre-tax money” (i.e., it’s deducted from your paycheck before your income tax withholding is applied to it) and the growth inside the account is not subject to capital gains tax like a traditional investment or brokerage account would be. These Qualified accounts are treated a little differently when you pass them on to your family. A surviving spouse can roll the deceased spouse’s account into their own name and continue the tax-deferred treatment of the account, and kids inheriting accounts from their parents receive “Inherited IRA’s,” which allows them, too, to continue tax-deferred growth over their own life (the “Generational Stretch”). However, passing on an account to children can be tricky without a strategy in place. If the account is beneficiary designated to a minor, a Guardianship Preceding is need to gain control over the asset until the child turns 18 – a costly and time-consuming endeavor.
If the child is just an immature adult, the child would have immediate access to take as much or as little of the account’s balance out whenever he or she would like (subject to income tax, of course). But allowing the Qualified Account to pass through probate, either by failing to designate it or forcing it into a testamentary trust, can have a significant negative tax implication.
An estate is not a qualified beneficiary under the IRS regulations controlling the treatment of Qualified Retirement Accounts. So, if such an account falls, or is forced, into probate, the entire balance of the account is liquidated and the full balance is taxed as income in that year. All of that money you worked for and deferred over your career? Take about 25-40% tax off the top and say goodbye to the significant tax advantaged growth the kids could’ve had with that (or those) account(s).
If your intent is to create structure around an account like a 401(k), potentially allowing the children to receive income (or RMDs) from the account but only allowing access to its principle when they are older, the best way to do that is have a revocable living trust be the beneficiary on the account instead of the kids. Then, your rules would be structured in the trust and would govern all of the trust assets, including the Qualified Accounts.
Obviously divorce is a reality in our world and so are second or third marriages. If either you or your spouse (or both) came to the marriage with kids from a previous relationship, the traditional estate plan does not work as easily. The common consideration is that neither spouse will want to leave everything to the survivor to the exclusion of their own kids, for fear that the surviving spouse would cut the deceased’s kids out of the plan after the deceased spouse is gone. So, if the intention is to safeguard a portion of your wealth for your kids regardless of who passes first, the best option for your family is a revocable trust plan with credit shelter or bypass provisions.
This type of trust would become irrevocable after the first spouse passes, and would split the deceased spouse’s assets into two equal shares: one for the surviving spouse and one for the kids of the deceased. The kids’ share would be separate and not susceptible to change from the surviving spouse. The surviving spouse would be able to live off of the income from their share and have discretionary support from the principal of their share during his or her lifetime. After the survivor passes, the remaining assets would pass to the first-to-die’s kids. This makes sure that the surviving spouse does not go wanting, but that the kids of the deceased spouse are adequately protected. A will-based plan cannot accomplish this type of strategy.
The surviving spouse would still, of course, have their own assets and wealth that were not impacted by the death of the first-to-die. To reiterate a common theme for this article, there is no “right plan” for everyone. This type of plan may be a good idea for you if your wishes and concerns are similar to those set forth above, but not everyone feels this way.
What do I mean by “special needs”? When it comes to estate planning, we’re really talking about beneficiaries who need to maintain public means-tested benefits like SSI and Medicaid. The reason why this distinction is incredibly important, and why it necessitates advance planning, is that beneficiaries who are participating in these program must have at or below $2,000 in assets. Any, even modest, inheritance would disqualify a beneficiary from these important and needed benefits (for some even “life or death”) without property planning in advance.
Special Needs Planning is a trust-driven estate planning strategy that allows you to provide a significant benefit to a beneficiary with special needs but in a protected and preserving way. Assets that would normally transfer to the individual would instead transfer to their Special Needs Trust to be held for their benefit, in a way that would not violate the SSI and Medicaid regulations.
This sort of strategy is also appropriate when the beneficiary is not currently eligible for means-tested benefits, but will likely be or may be in the future.
Trusts can be used to help preserve the wealth of an elderly parent for their kids in event that skilled nursing care will be needed in the not-so-near future (5 years out, at least). Medicaid Asset Protection Trusts can be used to hold a variety of different assets, though they are most commonly used to hold a personal residence. The intention for this strategy is to protect those assets from a future Medicaid Estate Enforcement action by the Division of Medical Assistance (NC Medicaid). After someone passes away, if they were a medicaid recipient NC Medicaid can seek reimbursement from that person’s estate for moneys paid on their behalf for medical treatment. If the asset is in the MAPT, its outside of the reach of NC Medicaid. This is a strategy that requires a lot of research in advance and is not intended for crisis or immediate need planning.
“Significant wealth” is relative, but for the purposes of this articles we’re really talking about a net worth that comes close to or exceeds the Federal Estate Tax Exemption rates, currently sitting at $11.16M per individual (doubled for married couples). Trusts are used to hold assets or transfer wealth in a way that minimizes or eliminates estate tax liability. They can also hold life insurance policies that are purchased to pay the expected estate tax liability in the case where most of the wealth is not liquid (cash or easily made into cash). This is obviously not a problem for most people, though.
Moved to North Carolina from another state and kept your old home as a rental? Vacation property at the lake in Michigan? Condo in Florida? These all cause a logistical headache, for your family, if you pass away in North Carolina. Why? Good question.
If you pass away in North Carolina, your probate jurisdiction will be in the county where you resided and intended to remain (your “domicile”). So, your will is submitted to the court in that county, and your will acts to pass title to a real property you may own in that county (likely your home). But for any property you own outside of that county also needs a copy (an “exemplified copy,” to be exact) of the will to do the same thing – transfer legal title to the beneficiary(ies). You see, when you pass on real estate via inheritance, there’s no deed being created and recorded like there is when you sell real estate during your life. The will is the conveying document. When a potential buyer hires a lawyer to “check title” of that property, they need to see how the seller got title to the property. If it’s by inheritance, the will is what the lawyer will be looking for.
So, for your family, that means they will need to hire a lawyer to transfer the probate file from North Carolina to [Michigan, Florida, etc.] and have it filed in the other county where the out-of-state real estate is located. Difficult? Not terribly. But there’s cost, time, and a headache for sure. Want to keep your family from dealing with this? Transfer the real estate into a revocable living trust during your life and you avoid all of it.
Everything set forth above are reasons why a person may want to implement a trust-based estate plan. However, all of these reasons have to be reflected against your own family circumstances, your wishes, and the relative risk or chances of each situation happening or not. For instance, if under #1 you are considering a trust because your child is 18 and is immature, but you feel confident that he or she would be fine in 4-7 years, you may be willing to roll the dice and risk the chance that both you and your spouse would pass away sooner than 4-7 years from now. The likelihood of that happening is low, of course. However, if you are more risk adverse generally, that may not be a risk you’re willing to take. There’s no right answer. This is very specific to you.