There is no tool or technique that is without cost and totally risk-free. Trusts, even revocable trusts, are no exception. There are costs, paperwork, and other potential problems. These include:
- Legal and accounting fees – Legal fees to draft a trust may range from $500 to $5,000 or more depending on the degree of complexity in the trust, the expertise and reputation of the attorney, the prevailing legal fees in the area, and issues collateral to the creation of the trust that must be resolved. Compare these costs to buying an insurance policy and selecting a settlement option. In cases where the amount of insurance concerned is modest, a policy settlement option to provide for the management of insurance proceeds for the insured-grantor’s family may prove to be a more cost-efficient and objective effective mechanism than a revocable life insurance trust.
- Once a revocable trust is funded, filing of income tax returns may be required even though the trust may be treated as a grantor trust. IRS Form 1041, the Fiduciary Income Tax Return, is used to show the trust’s income, deductions, and credits which must be reported by the grantor for taxable years beginning before the grantor’s death. If the same person is both the grantor and the trustee (or co-trustee) or if one or both spouses are grantors and one or both spouses are trustees or co-trustees, Form 1041 is not required. If the trust has no income (as it typically would not, as long as its only significant asset was the potential receipt of life insurance proceeds), no income tax returns need be filed. At the insured’s death, as long as the trust continues in existence, income earned from insurance proceeds payable to the trust must be reported on returns filed by the trust.
- Trustee’s commissions – Although typically nominal when a trust is still unfunded, trustees’ fees may run as high each year as 1.5 to 2 percent of trust assets and therefore must be considered. The younger the client is, the longer the trust will run and the higher the overall fees.
- Hidden obstacles – There are also hidden obstacles, such as the problem where a bank that holds a mortgage on property refuses to allow the mortgage to be carried over to the trust because a lender might have difficulty selling the mortgage on the secondary market. Will the client’s property and casualty company insure cars and homes owned by a trust? (Consider the question of who has the right to drive trust owned cars?)
- Perhaps the biggest hidden obstacle is the time and trouble it takes to continually assign assets to the trust. Special forms must be completed at banks and brokerage houses and new deeds must be prepared (entailing conveyance costs) and recorded (and in some cases transfer taxes must be paid) to transfer real estate to a revocable trust. Even if the client takes the time to transfer title to all his assets to the trust at its creation, after a number of years the client will often forget or not go to the trouble of titling new assets such as a car or personal effects in the name of the trust. Yet if such items are not transferred to the trust, the benefits of probate avoidance and property management and dispositive control for which the revocable trust is formed are unobtainable.
- Estate taxes – Since by definition, the trust is revocable, insurance proceeds paid to the trust will be includable in the insured-grantor’s gross estate for federal estate, and generation-skipping transfer tax purposes. Of course, this may not be a disadvantage if the estate is less than the federal estate tax exemption amount.
- Panacea syndrome – Many promoters of the revocable trust imply that somehow this tool is, by itself, a magic pill that can be purchased generically and once swallowed will solve all problems. “Buy my book, rip out the form, sign your name, and all your problems are solved.” Not only is this incorrect; it is dangerous. Why? Because it deprives the estate owner of the advice of true estate planning professionals. It blocks questions about other problems the client may not know he has and eliminates the potential to use other tools and techniques, either as alternatives or complementary devices to the revocable trust.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM