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How to avoid probate.
Certain property owned by the deceased may avoid probate either inadvertently or through advance planning. In some cases a deceased may have arranged his affairs by using a living trust in an attempt to entirely avoid probate. Sometimes this type of planning is effective, but sometimes there must be probate proceedings even when a living trust is created. This article describes the pros and cons of avoiding probate. It also describes a number of will substitutes - including putting property in joint names - that are frequently used to avoid probate. Finally, the article details the use of living trusts.
Probate is about as popular as a root canal job. Even people who really know nothing about the process have a very negative image of it. Most adults have heard horror stories of endless court proceedings and large legal fees depleting the estate left to a poor widow. And in fact, probate procedures are often time-consuming and expensive.
High Probate Fees
Legal Fees.
Legal fees to probate an estate can significantly diminish the amount received by beneficiaries.
The more time the attorney spends helping the executor, the higher the legal bills will be. The states have varying rules concerning attorney fees for handling probate matters. Some states have adopted a percentage system, whereby the attorney is paid a flat fee based on the value of the estate. The percentage paid to the attorney decreases as the value of the estate increases. In other states the attorney gets a "reasonable fee" based on the number of hours worked and the difficulty of the work.
Ancillary Administration. If an individual owns real estate in a state other than his residence, there will have to be additional ancillary administration in the state where the real estate is located. If property is owned in a number of states, there may have to be several such proceedings. Ancillary administration adds substantial costs to the probate bill, largely due to increases in legal fees.
Other Professional Expenses. Legal fees and the executor's fee aren't the only expenses of probate. Property must be valued for the court, so appraisers often have to be hired. Tax returns must be filed for both the deceased and the estate, so accountants must be hired. If the decedent died owning over $600,000 of property, death taxes will be due. This type of tax work can be expensive, especially if the estate is audited by the IRS. In general, the larger the probate estate, the greater the costs and the longer the delays.
EXAMPLE Assume both Mr. Jones and Mr. Smith die owning $1 million of property in a state that calculates both legal fees and executor fees based on the value of the estate. Assume that the combined fee percentage is 8 percent of the estate's assets. Assume that all of Mr. Jones's estate will pass through probate, but $400,000 of Smith's real estate will pass outside probate. The fees on Jones's property will be $80,000 ($1 million X 8%) while the fees on Smith's will be only $48,000 ($600,000 X 8%). The $32,000 fee reduction is directly attributable to the fact that Smith arranged to keep the property out of the probate estate. Instead of going to the lawyers and executor, the $32,000 will go to the heirs.
OBSERVATION An executor may not view a reduction in the executor's fee as an advantage. Most executors put in a lot of hard work and earn their fees.
PLANNING TIP If the surviving spouse is serving as executor and is to receive the bulk of the estate, it makes sense for him to serve without receiving a fee. If the funds are received as a fee, the amount must be declared as income on the individuals Form 1040 and taxes must be paid on it. If the surviving spouse receives the funds as an heir, however, the amount is received tax-free. On the other hand, an executor's fee is deductible in computing any federal estate tax. If the estate tax rate is higher than the surviving spouse's marginal income tax rate, it may be preferable to take the fee. Executors should check with their tax advisor before making this decision. The decision generally doesn't have to be made until the estate is being closed.
Delay
In addition to the complaints about high fees, heirs frequently complain about delays in probate. In most states, it is difficult to close any estate in less than six months, and twelve months is more common for even uncomplicated estates.
Lawsuits. Occasionally estates and executors get involved in lawsuits. Someone may sue the estate over unresolved business dealings that he had with the deceased before death. The executor may have to finish up a lawsuit filed by the deceased or may have to file a lawsuit to recover property owned by the decedent but held by others. Whatever the case, civil lawsuits move slowly and will invariably slow down the probate process.
Will Contests. The cost and delay of probate will expand greatly if a will is contested by a disappointed heir. A will contest usually tries to set aside a will in favor of an earlier will.
Finally, you should keep in mind that even when there is a probate procedure with an executor, some assets avoid probate by passing outside the estate, namely, property held in joint names, such as joint bank accounts; real property held in joint names; and property held in inter vivos, or living trusts. Such will substitutes will be discussed in more detail below.
With advance planning, probate may be avoided altogether. In other cases this type of planning can at least reduce the cost and duration of the probate procedure.
Advantages of Will Substitutes
A will substitute is any transfer of property that occurs outside the state probate process - the property's title is transferred without falling into the probate estate. There are three primary advantages to this technique:
the transfer of title will be immediate upon the death of the decedent;
the transfer will go unpublicized; and
will substitutes reduce probate fees.
Prompt Transfer of Title. Using will substitutes insures that the transfer of title will be immediate upon the death of the decedent. Transfers from probate estates take many months and even years in extreme cases - justifiable cause for complaints by heirs. When will substitutes are used, title vests promptly and delay is avoided.
No Publicity. Another advantage to using will substitutes is that the transfer is a private transaction rather than a matter of public record. Because the transfer is not made in the will, it will be difficult and, in some cases, impossible for uninvolved parties to learn the details of the transfer. If the deceased was well-known, the press may be interested in publicizing the contents of the will. The family may wish to keep potentially embarrassing bequests private. Even when there are no embarrassing facts, privacy is often desirable. Many individuals wish to keep their wealth a private matter.
Smaller Estates
If a person's estate is expected to be relatively small, it may be efficient to dispose of most of the decedent's property through the will substitute technique. In some states, the costs associated with probating an estate will be so high for even small estates that it is far more efficient to leave most of the property in will substitutes.
Joint Ownership
Joint ownership of property is a common form of will substitute, which allows one co-owner to leave property to the other. The property will automatically be owned by the co-owner on death, and so never pass through the probate estate. Spouses may jointly own homes and other property, and on the death of the first spouse, ownership of the property passes entirely to the other. Joint ownership is probably the most common type of will substitute.
Types of Co-ownership. There is more than one way to take co-ownership of property. Property ownership is a matter of state law. Nine states - Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin - use the community property system which creates a special type of co-interest between spouses. The other states are known as common law states. These states generally do not focus on marital status in establishing co-ownership.
There are actually five common types of co-ownership:
joint tenancy
tenancy in common
tenancy by the entireties
community property
marital property
Joint Tenancy and Tenancy in Common. There is a legal distinction between joint tenancy and tenancy in common. During life they are quite similar, though not identical. On the death of a co-owner, the difference is quite extreme. Both joint tenancy and tenancy in common are forms of "concurrent" co-ownership. Two or more individuals may own property in the same or different percentages.
Survivorship Issues. A joint tenancy is usually defined as "Joint tenancy with right of survivorship." This means that when one of the joint tenants dies, the deceased's interest passes automatically to the surviving tenants.
EXAMPLE Three brothers each own a one-third interest in a parcel of land as joint tenants with right of survivorship. If one brother dies, his interest will pass to the other brothers. The two surviving brothers will then each own a one-half interest in the parcel. This would be true even if the deceased's will read: "I leave all of my property to my wife." The deceased's interest in the land ceased on his death and his wife will not have an interest in the parcel.
A tenancy in common is a form of ownership in which each owner has an undivided interest in the property. If co-owners take title as tenants in common the result is different than if they are joint tenants with right of survivorship. A tenancy in common can be sold, gifted, willed, or passed through the laws of intestacy.
EXAMPLE Suppose the same three brothers in the prior example own the same parcel of land, but as tenants in common. The deceased brother's interest would pass to his surviving spouse under the terms of his will. The two surviving brothers would continue to own a one-third interest, as would the surviving spouse. The result would probably be the same if the deceased brother died without a will and had no children.
Creation of the Legal Interest. If a party really wants to create a joint tenancy, title must be taken as joint owners with right of survivorship rather than as tenants in common. The legal designation on the title or deed, not the intent of the deceased, will control. Although joint tenants seem to have survivorship rights in one another's property, a joint tenant can "sever" the joint tenancy and create a tenancy in common.
EXAMPLE Three brothers take title to a parcel of land as joint tenants with right of survivorship. When one brother learns that his wife will not receive his interest at death, he severs the joint tenancy and becomes a tenant in common. He then will be able to leave the property to his wife - or anyone else - in his will.
Tenancy by the Entireties. A few states still recognize tenancy by the entirety. This form of ownership can only exist between a married couple, and ceases on the death of one spouse or divorce. The legal implications are essentially identical to joint ownership with right of survivorship, except that the tenancy cannot be converted to a tenancy in common unless the marriage is dissolved or both spouses consent to the conversion. This type of tenancy prevents one spouse from selling - and sometimes mortgaging - marital property without the other spouse's consent.
Community Property. Nine states have community property systems. Although the details of the state systems differ in some respects, the general scheme is similar. Community property only relates to married couples. In a community property state, the spouses typically own property that is community property and also property that each spouse owns individually. Each spouse has a one-half undivided interest in each item of community property. At death, a spouse can dispose of all his separate property, but only his one-half interest in the community property. In some states a spouse cannot make a lifetime gift of community property without the other spouse's consent.
PLANNING TIP A competent local attorney should accurately classify each item of property as community property or separate property. An agreement between the spouses is recommended when classification is in doubt.
Marital Property. Although there are some state-by-state variations, all nine community property states use the same basic scheme to determine if a surviving spouse has a legal interest in property acquired during marriage. The situation is far more complicated in the other states. In some noncommuntiy property states, legal title controls. In others, there is still a presumption that property acquired during marriage belongs solely to the husband. In still other states, a surviving spouse will have legal rights only in property that is owned by the spouses in joint tenancy with right of survivorship. Other states, however, recognize the concept of marital property, which gives the surviving spouse some rights in property acquired during marriage, recognizing that couples frequently don't give much thought to the legal implications of putting names on deeds and car titles.
Other Commonly Held Types of Property
Spouses and other family members commonly hold property in joint names, such as joint bank accounts with right of survivorship, bank account trusts, and U.S. savings bonds. There is no legal limitation on who may be a co-owner. Additionally, an individual may make a gift of a fractional interest in property. For example, a person could give someone a 20 percent interest in a piece of real estate, which would then become theirs on death.
WARNING Individuals should always get legal advice before placing property in joint ownership. State laws distinguish between tenancy in the entireties, tenancy in common, and joint tenancy with right of survivorship. The disposition of the property at the time of death depends on the technical designation of the co-ownership. Unfortunately, property is often titled without legal advice and property owners do not understand the implications for their heirs. If joint tenancy has been arranged, executors should anticipate that they may face some unpleasant moments with disappointed heirs.
Disadvantages of Joint Ownership
Creating joint interests in property is not always advisable, even between spouses. Property can be lost if one spouse files for bankruptcy - or worse, for divorce. The law of property varies state by state and can be tricky. Although beneficiary designations can be handled by laypersons, retitling property in joint names should only be done with the advice of an attorney.
Future Interests
Besides concurrent joint ownership, it is possible to give away so-called future interests in property either currently or in a will. A person who has a future interest has an ownership interest in property but with delayed possession. For example, Grey might want his son to have his farm after his death, but Grey wishes to live on the property for the remainder of his life. Grey could retain a life estate in the property and give his son a remainder interest. Both Grey and his son would be owners but only Grey would have current possession. Grey would have the right to use the property for his life, but it would automatically become his son's property on Grey's death. This type of ownership is also an effective will substitute and can avoid probate.
There are a number of different future interests that can be tailored to meet particular needs. As with other types of ownership, there may be federal estate tax implications even though the property passes outside the probate estate for state law purposes.
Transferring a joint interest in property may create a taxable gift. This sort of tax determination should be undertaken by an attorney. Similarly, although jointly held property may pass outside the state probate estate, it may be included in the taxable estate for federal estate tax purposes. This sort of tax determination should be undertaken by an experienced estate planner.
Although joint ownership of property is the most common type of will substitute it is not the only one. An executor is likely to encounter one or more of these when probating an estate. Other types of will substitutes include:
life insurance proceeds
U.S. Savings Bonds with a payable-on-death designation
annuities
custodial accounts for minors
trusts
Another type of will substitute is the living trust, which holds all of an individual's property. Living trusts have become increasingly popular because they avoid the delay and expense of probate. These will be discussed later in the article.
All of these will substitutes have a beneficiary designation. When the owner dies, title to the property automatically vests in the beneficiary without going through probate. Because in many states both the executor's fee and fees for attorneys are based on the value of the property in the estate, the use of such will substitutes can effectively reduce probate fees.
OBSERVATION Technically, any trust that is established during a grantor's life is called an inter vivos or living trust. However, in popular usage, living trust frequently refers to an inter vivos trust intended to work as a will substitute. The trust is used in place of a will with the intent of avoiding probate.
Generally, a living trust operates as a will substitute. Instead of using a will to distribute property at death, an individual will transfer legal title to his property to the living trust during his life. The grantor of a living trust gives control over the trust property to a trustee. The trust is therefore operative during the grantor's life. Eventually, when he dies, the trustee who administers the trust will distribute the property to those parties that the deceased designated.
Although such trusts may be irrevocable, trusts used as will substitutes are typically set up as revocable trusts so that may be easily changed or canceled.
Living trusts have become increasingly popular because they avoid the delay and expense of probate. However in some states, because probate costs are not as high as generally perceived, a living trust may provide little in the way of savings.
The biggest advantage of a living trust is the avoidance of state probate fees and delay. Because the legal title to the property has been transferred to the trust, the property will pass outside probate. Accordingly, there will be little delay in distributing the assets, and probate fees will largely be eliminated.
Disadvantages of Living Trusts
There are some disadvantages to living trusts that are not always noted. First, there are set-up costs and trustee's fees. In some states where probate fees are relatively low, the costs associated with the trust will be about the same as those that would arise in the probate of a will, assuming that the person's affairs are in good order.
Selecting a Trustee
Additionally, a person must select a trustee who will be absolutely honest. The person establishing the trust is free to select either an individual or an institution, such as a trust company or a bank, to serve as trustee. Although a trustee has a fiduciary duty to protect the trust assets, individuals have on occasion stolen trust assets. The grantor of the trust should monitor the trustee's activities with some degree of diligence.
Because the trustee of the living trust will be working closely with the family and other heirs during their bereavement, the trustee's personal qualities are important. If possible, the person establishing the trust should take the time to introduce his heirs to the trustee and make sure that they understand how the trust will work after his death.
Deciding Between a Will and a Living Trust
Setting up a living trust is not terribly complicated and, in fact, the terms of most living trusts closely parallel the provisions in a typical will. Attorneys who prepare wills also typically prepare living trusts for clients at their request.
The fee for establishing a trust will typically be higher than for preparing a will, and additional costs will be incurred related to transferring legal title to the assets. However, because the trust will be outside probate, the fees after death should be minimal.
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