Why Trusts Fail

From the desk of Kristina Hess, Estate Planning Attorney in beautiful San Diego (Del Mar/Carmel Valley area to be exact!)… but serving all of San Diego County and California (virtually)…

The question of the day is… Why Trusts Fail.

Now, you may be saying to yourself, “I didn’t know trusts fail.”  How can a trust fail?  Well, this may be a dirty little secret in the estate planning industry… but Trusts can and do fail all the time.

But before we get into the reasons why a trust may fail, let’s talk briefly about what a trust is.

A Trust is a legal instrument and it has to have certain things: 1) a writing, 2) trust res (or property), 3) a Grantor (or the person making the Trust) has to have intent and capacity to make a trust and you need a Grantor, a Trustee (someone to manage the Trust) and a beneficiary of the Trust.

In California, if you own your own home, or any property (real as in real estate or personal (as in things) or cash or stock) over $100,000 then you will want to set up a Living Trust.

A Living Trust is a revocable trust (which means that the Grantor (or trustmaker) can revoke it, end it, change it, amend it – do whatever he or she wants with the Trust during his or her life.

In a separate post I will talk about why you would want to establish a Trust, but for now, let’s assume that you fully comprehend why it is critical to establish a trust.  If you are not convinced, see this blog post here on Why You Need a Living Trust.

Now that you understand it’s critical to have a Trust, you want to make sure that your Trust won’t fail!

Here are the top reasons why trusts fail…

1.  Trust is not fully funded!  Yikes!  For years estate planning attorneys were generating trusts for people and then sending them on their merry way with an instruction like, “now go out and fund your trust.”  What?

Yes, you like most people, would probably be saying what?  How on earth do I do that?  Well, the truth is, it is not that complicated, but it can be time consuming.  But if you are unfamiliar with the process, you may not have any idea where to start.  I know that when I first did a trust for myself (before I was an estate planning lawyer) we never executed the trust and we never transferred our home to the trust, so pretty much our trust was worthless!

Chances are that if you paid a very low fee for your trust, or you used an online service, then your trust is not fully funded.  And guess what?  If your trust is not fully funded, it’s likely to fail!

Why?  In order for a Trust to work, the Trust (the fictious entity that you created to hold your property) needs to actually own all of your assets.

  • So, you will sign a new deed, placing all of your real estate into your Trust.
  • You will change the ownership on all of your bank accounts and brokerage accounts.
  • You will have your stock certificates reissued in the name of your trust.
  • You may (this requires a thorough analysis) assign your business interest to your trust.
  • You will change the beneficiaries on your retirement accounts (but make sure you talk with your estate planning lawyer first because retirement accounts are tricky), and your life insurance policies.

Get the idea?  This is what is called “funding” your trust.  And unfortunately, most estate planning lawyers do not have a system in place to make sure their clients fully fund their trust.  The reality is that if there are significant assets owned outside your Trust, your Trust will not efficiently accomplish one of its primary purposes — which is to avoid an expensive, long drawn out, public probate court process.  Trust me when I say that you want to avoid probate if at all possible.

Moreover, maybe you’ll have an experience like I had, where assets that were supposed to be in the name of the trust weren’t and then the beneficiaries LOST control of the money!

You don’t want your money and your assets going to anyone other than the people you designate!

The good news is that if you work with me, our firm has a funding coordinator whose sole job is to make sure that your Trust is fully funded.  We will provide you with unlimited guidance and instructions, asset inventories, and the like, or you can pay us extra to do the funding for you.  It’s up to you, either way, we want to make sure your Trust will work when your loved ones need it to the most!

2.  The Law Has Changed

Another reason why a trust may fail is the law has changed.  Now, the Estate Tax is a perfect example of a significant change in the law.  The Estate Tax exemption (the amount you can passed to loved ones without paying tax) was gradually increasing from the year 2000 to 2009 (it reached an apex of $3.5 million in 2009).  Then, pursuant to a sunset provision, the estate tax was removed in 2010.  However, in its place, we have capital gains tax on a carry-over basis.  As a result, many people who  had created trusts in the early 2000s or even before, probably had a lawyer that gave them an “A-B Trust” based upon some type of fractional or pecuniary formula.  What this means in lay terms it that at the death of one spouse, the trust was split automatically into at least 2 sub-trusts.  However, if someone died in 2010, then the surviving spouse could have all of the assets go to the family, credit shelter trust, or — all of the assets go to the survivor’s trust.  And the end result could be the decedent’s estate tax exemption (which would be zero in 2010) is not preserved.  Additionally, if the decedent had assets that had appreciated significantly, the plan might not protect against the capital gains tax.

Bottom line is this old desing based upon a formula — fails!  it doesn’t minimize taxes, doesn’t preserve the exemption, and doesn’t accomplish one of the primary goals of a good trust.  So, if the law changes and you have not updated your plan — it won’t work.

Unfortunately, no one can predict the legal changes that may or may  not happen in the future.  A best practice right now — and one that we fully incorporate at KR Hess Law — is to create trusts with great flexibility and with provisions that account for a situation where there is an estate tax, and a situation like that which we have in 2010 when there is no estate tax.  That way, unless there is a major overhaul in our estate tax system, you trust should work.

In addition, we value communication with our clients, and we will let you know if the law changes.  My firm is not based upon a one shot transaction — our goal is to be your trusted advisor for life.  So, I take my job of staying up to date on the latest legal developments seriously and endeavor to keep my clients informed on the current state of the law.

3.  Your Life Has Changed

The third reason why trusts fail is that your life has changed and your trust and other estate planning documents are not up to date.  Maybe you had another child.  Maybe you got divorced.  Maybe you got married!  Maybe you have a new job with a new retirement plan, or you bought a new house, or you moved.  Our lives change and your estate plan needs to change along with them.

You don’t want to die and have assets go to someone you no longer want.  Your choice of guardian or trustee may have changed.

Maybe your proposed guardian for your children died.  I had a client who had that happen to them.  Their dear brother passed away and he had been designated as the primary guardian for their children.  Make sure your plan is up to date!

We have a system in place to make sure your plan is regularly reviewed.

Hopefully, you now see and understand why trusts fail and what you can do to prevent your trust from failing.

We are here to serve you.

Create Legacies that Last,

Kristina Hess

San Diego trust and estate attorney serving Del Mar, Solana Beach, Encinitas, Rancho Santa Fe, Carmel Valley, Penasquitos, Poway, Carlsbad, La Jolla, all of the San Diego County and all of California (virtually)