Estate Planning, Probate and Trust Administration FAQs

Why do I need a will?

What is a Living Will?

Should I avoid probate?

How can I save estate taxes?

What taxes will the beneficiary of my life insurance policy have to pay?

What's the difference between an inheritance tax and an estate tax?

Why do I need a will?

  1. You have minor children.
    You should have a will in order to appoint guardians for your minor children, and trustees to manage their property. If you do not leave a will, the court may appoint a guardian whom you would not have chosen.
  2. You have a mixed or blended family. The need for a well-drafted will is particularly keen in the case of mixed or blended families; such cases require special planning to ensure that everyone is treated fairly and to minimize the potential for conflicts after your death. You also need a will if you intend to leave all of your property to your current spouse and you have children from a previous marriage. Under Ohio law, if you have two or more children who are not the children of your current spouse, unless you have a will, the children from your previous marriage will inherit two-thirds of your probate estate assets and your current spouse will only inherit one-third plus an allowance for spousal support. This is probably not the result that you would want if you were to die before your current spouse dies.
  3. You have no children.
    If you die without a will and you have no children, Ohio law provides that your property would be distributed outright to your spouse, if any, or otherwise to your parents, siblings, or next-of-kin. Many people desire to leave some of their property to friends or to a church or charity of their choice. This cannot be accomplished without a will.
  4. Save on Court Costs and Administration Expenses.
    If you have a will, you can nominate an executor, who will be responsible for distributing your estate in accordance with your wishes. You can also specify that the executor not have to post bond. If you die without a will, the Probate Court will appoint an administrator, which will require additional filing and court fees. The court-appointed administrator may not be the individual whom you would have wished to settle your estate. In addition, the administrator will be required to post a bond - which will be another expense of administering your estate. Estate administration is almost always less expensive with a will than without one.
  5. Plan for Federal Estate Taxes.
    If you have a large estate, your estate may be subject to Federal estate tax. By having a well-drafted tax-saving will, you can plan ahead to minimize or perhaps avoid altogether the burden of Federal estate taxes.
  6. Plan for State and Federal income taxes on Qualified Plans, Annuities, and IRA's.
    Regardless of the size of your estate, if you have an annuity, qualified retirement plan, or IRA, you should seek the assistance of an experienced estate planning attorney in planning your estate. The attorney can advise you how best to distribute these assets in the interests of saving income taxes after you die. A few hours spent with an estate planning attorney now can possibly provide your heirs or your estate thousands of dollars in income tax savings.
  7. None of the above.
    Even if you do not think you need a will, you should still see an estate planning attorney to draw up powers of attorney for health care and financial matters. If you become incapacitated by illness or accident, a power of attorney will be critical to allow a friend or loved one to pay your bills and make health care decisions for you. These simple documents not only save money later, but they give you the security of knowing things will be taken care of in your absence.

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What is a Living Will?

A living will is a document that states your wishes regarding the use of life-sustaining treatment of you should become terminally ill or permanently unconscious. A living will spells out whether or not you want life-support technology used to prolong your dying and gives doctors the authority to follow your instructions regarding the medical treatment you want under these conditions.

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Is probate really that bad?

"I've heard horror stories about a probate court that tied up the estate's assets for years. How can I make sure that my estate does not go through probate?"

First of all, you should remember that the horror stories are just that -- horror stories. They are the most grievous examples from among many different experiences. If you leave no will and your heirs all hate each other, the probate of your estate will very likely be a nightmare. But in Ohio, probate can be very simple if you leave a properly drafted will.

You may have heard that a living trust can avoid probate. A living trust works because none of your assets are in your name at death. If you have vigilantly transferred everything you own to the trust, the distribution of your assets at death will be handled under trust law, instead of under probate law. In some states, such as California, trust law is much simpler than probate law for this purpose. But in many states, including Ohio, the differences are minor. The state of Ohio is not interested in tying up your assets. Indeed probate cases in Ohio are required to be completed within six months, unless certain special exceptions apply. If you have a very simple estate, you may even qualify for a very simplified probate procedure known as release from administration.

Probate should be thought of more as a service that the state offers to help the heirs clear title to assets. Most banks and other institutions will not release assets or funds to the heirs of the account owner, because they are afraid of being sued if someone lies to them about being an heir. An order from a probate court will protect them from this liability. The Ohio probate system is designed to help the rightful heirs obtain such an order as easily as possible, while still preventing fraud by impostors.

Even if you have a fully-funded living trust, the distribution of your assets can still be delayed if your estate is large enough to owe estate taxes. Federal law holds your successor trustee and executor personally liable for any unpaid estate tax. Therefore it would be foolish for the successor trustee of your living trust to distribute the trust assets before making sure the IRS is satisfied with the amount of estate taxes paid. The IRS will, upon request, issue a "closing letter" which provides some protection to the trustee or executor, but the process of requesting and obtaining the closing letter can easily take over a year. If you have ever been told that an estate is tied up in probate, it is entirely possible that the probate court is not to blame at all; it's really the fault of the estate tax system. And avoiding estate tax, while a worthy goal, is very different from avoiding probate. A living trust does nothing to avoid estate tax that a properly drafted will cannot also do.

Probate horror stories are often caused by events outside the probate system. Estate taxes, will contests, poorly drafted wills or trust documents, family members who are unhappily surprised by the contents of a will or trust -- all of these things can and do make the process of distributing your assets long and expensive. Simply setting up a living trust to avoid probate without dealing with these other issues will not prevent your estate from suffering the expense and delay of the worst horror stories you've heard.

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Do I need a living trust?

You may have seen an advertisement in the newspaper, or perhaps you attended a financial planning seminar that described revocable inter vivos trusts, also known as living trusts. A living trust works like this: You execute a document, called a trust agreement, which creates the trust. The trust agreement names you as the trustee and the primary beneficiary of the trust. As beneficiary, you are entitled to distributions of trust assets whenever you want them. You then transfer your assets to the trust, so that when you die, you own nothing that is subject to the probate process.

Some planners assert that everyone should have a living trust, while others believe that a will is all most people need. Before you make a decision to incur the extra cost and hassle of a living trust, you should know three things:

  1. In Ohio, probate can be fast and inexpensive. Some states impose procedural requirements that generate large legal fees and take years to complete. But Ohio has a number of simplified procedures that can be used in smaller, less complicated estates. In addition, Ohio law requires that probate cases be completed in six months, unless the estate is very large or complex. So the cost-savings from a living trust in Ohio are likely to be disappointing. A living trust won't even save you the cost of the executor's fee; if you don't have a relative or friend who is available to serve as executor for free, then you probably won't be able to find anyone to serve as successor trustee of a living trust for free, either. Finally, in Franklin County and most other Ohio counties, attorney fees are not based on a percentage of the estate assets, but rather, on the amount of work actually performed by your attorney. Attorneys are required by the Probate Court to document their time and expenses and their fees are required to be reasonable: excessive attorney fees will be disallowed by the Probate Court.
  2. Ohio Law Provides Alternative Options for Avoiding Probate. In very simple estates it is sometimes possible to avoid probate through the use of some very simple devices that are available under Ohio state law, without having to set up a living trust. An experienced and ethical estate planning attorney can advise you which if these vehicles, if any, make sense in your case.
  3. Living Trusts do not save Taxes. Anyone who tells you that a living trust will save estate or income taxes is mistaken. A living trust can do nothing about income taxes. And while it is true that a living trust may contain the same estate tax-saving provisions as a will, and therefore is better than nothing, the decision to execute a living trust instead of a tax-planned will is going to have no effect on your estate tax bill.

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Can my estate avoid paying an executor's fee?

Executor's commissions are set by state law and are based, generally, on a percentage of the value of the assets of the estate. At present, the commission varies between one and four percent of the value of the assets (combined with the income on those assets) depending on the nature, amount and title of the assets at death. However, surviving spouses and other family members often serve as executors and may waive these commissions. If the executor is the sole beneficiary of the will, then an executor's fee may not be important to him, because it will come out of the same funds he would otherwise receive as a bequest. If your will leaves property to multiple heirs, any one of them might jump at the chance to be in charge, fee or no fee. Ohio law does not disqualify a beneficiary of the estate from serving as executor merely because he or she is a beneficiary.

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What is a bypass trust?

A bypass trust, also known as a credit shelter trust, is a long-term planning device. If you leave property to someone in the form of a bypass trust, that property will not be subject to estate taxes when that person dies. (The property will still be taxed in your estate, however; to save tax in your own estate, other methods must be used.) A bypass trust is particularly useful for spouses who plan their estates together. By leaving property to each other in bypass trust form, they can guarantee that the property will only be taxed once between the two of them.

To effectively save taxes, a bypass trust must follow certain rules laid out by the IRS. Let's suppose your will sets up a bypass trust for your spouse, and you die first. In order to keep the trust from being subject to estate tax when your spouse dies, your will must place the following conditions on the trust:

  1. You must limit your spouse's power to access the trust during his lifetime.
  2. Your spouse must not have an unrestricted right to withdraw principal. However, you can give him the right to withdraw principal to provide for his health, education, maintenance, or support, and you can also give him the right to withdraw up to $5,000 of principal per year for any purpose, or 5% of the total principal, whichever is greater.
    You can also give your spouse the right to all of the interest and dividends earned in the trust each year, and you can appoint your spouse to serve trustee or successor trustee. As trustee, your spouse would have full discretion to decide whether principal is needed for "maintenance" or "support." Thus, this condition is ultimately quite flexible.
  3. You must limit your spouse's power to distribute trust assets upon his or her death.
    Except as provided above, your spouse cannot have the right to give the trust assets to himself or herself, to his or her creditors, to his or her estate, or to the creditors of his or her estate. You can, however, give your spouse the right to name in his or her will specific persons who will succeed to the trust assets upon your spouse's death. For example, you could authorize your spouse to leave the trust to any of your nieces and nephews, or to divide it as your spouse pleases among your children. Alternately, you can specify who gets the trust next and leave your spouse no discretion.

Although a bypass trust can be very flexible in practice, it is critical that the trust be drafted with absolute precision. The IRS has specified the words that may be used in a bypass trust, and if these words aren't duplicated perfectly, the trust might not be excluded from tax in the second estate. Even the slightest drafting error can cost hundreds of thousands of dollars in taxes, so be sure your bypass trust is being drafted by an attorney who is knowledgeable about Ohio and federal tax law.

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What is a life insurance trust?

A life insurance trust is a trust that is set up for the purpose of owning a life insurance policy. If the insured is the owner of the policy, the proceeds of the policy will be subject to estate tax when he or she dies. But if he or she transfers ownership to a life insurance trust, the proceeds will be completely free of estate tax. The proceeds will be exempt from income tax either way.

Given current effective Federal estate tax rates of up to 40%, a life insurance trust can save hundreds of thousands of dollars in estate taxes. However, there are several drawbacks to such an arrangement:

  1. You can't change the beneficiary of the policy.
    You must give up the right to change the beneficiary of the policy (the trust itself will be the beneficiary). The trustee alone has that right, and you cannot serve as trustee of your own life insurance trust. Of course, you may designate the beneficiaries of the trust (for example, your children). But because this designation cannot be changed after the life insurance trust has been set up, you will lack the flexibility to deal with changed family circumstances with this particular policy.
  2. You can't borrow from the policy.
    You can no longer borrow against the policy. If the trust allows you to borrow against the policy, you will be deemed to be an owner of the policy for estate tax purposes.
  3. You can't transfer an existing policy to the trust -- unless you live for at least three more years after the date of the transfer. If you transfer an existing policy to a life insurance trust and you die within the next three years, you will be treated as the owner of the policy and it will be taxed in his estate. Even if you survive another three years, you will have made a taxable gift in the amount of the cash value of the policy (of course, this is usually preferable to having the entire face value subjected to estate taxes). If the life insurance trust takes out a new policy on your life, however, you will never be deemed to own the policy. Furthermore, no cash value will have built up yet, so no taxable gift will be made.
  4. The life insurance trust must be irrevocable.
    Once you set up and fund the trust, you cannot get the policy back. If you become uninsurable, you will be committed to this trust as your only life insurance.
  5. Premium payments may use up your estate tax exemption.
    If the policy has not yet endowed, you must find a way to pay the premiums without using up your estate and gift tax exemption. If you transfer securities to the trust so that the trustee will have income with which to pay the premiums, the full value of the securities will be a taxable gift. If you transfer cash to the trust each year to pay the premiums, each transfer will be a taxable gift. However, you may be able to exempt these premium payments from gift or estate taxes by setting the life insurance trust up as a Crummey Trust (see the FAQ on Crummey Trusts). Then each premium payment can be sheltered by your annual gift tax exclusion, which is currently $14,000 per trust beneficiary.
  6. You must find or hire a trustee.
    You cannot serve as trustee of the life insurance trust. This means that you will have to find or hire a third party trustee. However, many banks and trust companies offer reduced fees for life insurance trusts because they involve essentially no investing decisions.

Despite these drawbacks, many people find that the tax saving potential of a life insurance trust is worth the cost and hassle. It allows you to remove from your estate a significant asset that you are unlikely to want access to during your life. And it ensures that the life insurance proceeds go 100% to your beneficiaries, not to the federal government.

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What is a Crummey trust?

Many people wish to make lifetime gifts to their children in order to save estate taxes. As long as a parent gives his child no more than $14,000 per year, the gifts will be entirely excluded from gift or estate taxes. (This $14,000 gift tax exemption is indexed for limit increases regularly with inflation.)

The problem with gifts so large is that children do not have the legal capacity, or in many cases the maturity, necessary to handle so much money. You can solve the issue of legal capacity by appointing yourself as custodian of the funds you have given your child (such as by making the gift subject to the Ohio Transfers to Minors Act), but under a custodial arrangement, the child obtains access to all of the money upon turning 21. To many parents, this is still too young.

To keep the money out of a child's hands until he is, say, 28 years old, you must set up a formal trust. You would then make your gifts to the trust, and the trustee would invest the money. To conserve costs, you could even serve as trustee yourself. The trust documents would direct that the assets be distributed to the child when the child reaches age 28. Some people have the trust distribute the funds in steps: the child receives one-third when he turns 25, one-third when he turns 30, and the final third when he turns 35.

The one catch to all of this is that the $14,000 annual exclusion only applies to gifts in which the recipient has a "present interest" - as opposed to a "future interest" -- in the gift. In order to completely avoid gift or estate tax on the money you give to the child's trust, you must give the child some right that qualifies as a "present interest."

What qualifies as a present interest? Generally, the child has to have the right to take the money and spend it immediately. However, you can place significant restrictions on this right without losing the gift tax exclusion. A common method of doing so is to set up what is known as a Crummey Trust. It's named after the Crummey family, who set up such a trust. The IRS tried to deny them the annual gift tax exclusion, but they went to court and won.

A Crummey Trust does not give the child any rights to the income. It does, however, give the child the right to withdraw the amount of each gift for up to 30 days after each gift is made. Since the withdrawal right begins immediately after the gift is made, it is considered a present interest. If the child does not withdraw the gift within the 30 days, the withdrawal right lapses and the money remains in the trust until the child attains the designated distribution age.

Of course, the parent must still convince the child not to withdraw the money during those 30 days. However, even if the child decides to withdraw the money, he can only withdraw the amount of the most recent gift, not the entire trust. And after that the parent can eliminate all future withdrawal opportunities simply by ceasing to make any more gifts. The property in the trust will still remain intact and growing until it's ready to be distributed.

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What taxes will the beneficiary of my life insurance policy have to pay?

The beneficiary will not have to pay income taxes -- life insurance proceeds are exempt from the federal income tax if they are received as a result of the insured's death. Your estate may owe estate tax on the value of the proceeds, however. Without careful estate tax planning, your life insurance proceeds will be included in your taxable estate. Your estate will owe federal estate taxes if it is larger than the applicable exclusion amount (currently over $5 million), after subtracting any amount received by your spouse. The maximum effective federal estate tax rate is currently 40%.

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What's the difference between an inheritance tax and an estate tax?

An inheritance tax is a tax imposed on the people (beneficiaries) who receive property from the deceased. The tax is calculated separately for each beneficiary, and each beneficiary is responsible for paying his or her own inheritance taxes. Those states that have inheritance taxes frequently tax spouses and children of the deceased at lower rates than other heirs.

An estate tax is a tax imposed on the deceased's estate as a whole. The executor fills out a single estate tax return and pays the tax out of the estate's funds. The heirs will only be held liable for the tax if the executor fails to pay it.

The Federal government imposes an estate tax on all citizens and residents of the United States. It imposes no inheritance tax. Every estate gets an estate tax deduction for all property received by the deceased's spouse or left to charity, as well as an applicable exclusion of at least $5 million for all other property. Thus, under current law, the estates of most middle class Americans will not be subject to Federal estate tax.