A trust is an agreement whereby a grantor (creator of trust) entrusts money to a trustee (who is a fiduciary), to be held by the trustee for a designated purpose and distributed to beneficiaries upon the happening of some event. The trust is the agreement. A trust is not an entity, like a corporation. Therefore, it cannot hold title to property. The trustee would hold title to the property like: “XX, as trustee for the XYZ Trust.”
A “trust agreement” or “certificate of trust” is a document establishing the trust. If the grantor can change the terms of the trust, the trust would be revocable. Of course, the grantor needs to be alive to change the terms (thus, “living trust” gets its name – they are the same thing). If the grantor could not change the terms of the trust, the trust would be irrevocable. When someone dies, a revocable trust becomes irrevocable.
Almost always, the grantor is also the trustee and the primary beneficiary during the grantor’s lifetime. That means the grantor controls the trust property and can benefit from the trust property. However, legally, the sole trustee cannot be the sole beneficiary. Therefore, the trust agreement will always name a successor trustee and contingent beneficiaries for when the grantor passes away (and contingent beneficiaries for when the other beneficiaries pass away).
To be valid, the trust must have some property in it. Sometimes there will be a list of personal property attached as an exhibit to the trust agreement, or there could be a statement that a small dollar amount (like $10.00) was given to the trustee. After the trust is created, people will gradually add property to the trust (but they should not take too long to do this, or it may defeat the purpose of the trust, which for most people is to avoid probate). Other reasons why you may want a revocable living trust are: to dictate who gets your property after the surviving spouse dies (often in cases of a second marriage), preventing probate in multiple states if you own real estate in multiple states, if you are likely to become incapacitated, for privacy reasons, and to lessen your potential estate tax liability. These topics, along with the myths surrounding revocable living trusts, will be discussed in a subsequent article.
The bulk of the trust agreement is going to consist of two provisions – one dealing with the distribution of property and one dealing with the trustee’s powers.
The distribution provisions in the trust address (1) who can access trust principle and income during the grantor’s lifetime and (2) who gets trust principle and income after the grantor has passed away. After the grantor’s death, trust property is typically divided into smaller trusts before distribution. There may be one contingency if the grantor is survived by a spouse, and a different contingency if the grantor is not survived by a spouse (for example, leaving property to children).
A brief discussion of estate tax is warranted here. Currently, for estate tax purposes, there is an unlimited marital deduction, meaning the surviving spouse does not have to pay any estate tax on the decedent’s estate passed to him/her. However, the surviving spouse’s estate will be responsible for estate taxes when the surviving spouse passes away.
The current estate tax exemption is $5,490,000. This means that a single person passing away with an estate worth $8 million will have to pay taxes on the $2,510,000 amount over the exemption (40% tax rate). For a married couple, the total amount is $10,980,000.
The trust agreement will create a “Family Trust” or “Credit Shelter Trust” or “Bypass Trust” (all of which are names for the same thing). The point of the Family Trust is to keep assets out of the surviving spouse’s taxable estate (the goal is to keep the total number below $10,980,000). To keep the Family Trust from being included in the surviving spouse’s estate, careful drafting is required--the surviving spouse cannot be the sole trustee and cannot have an unrestricted right to the trust property. The amount of property the beneficiary has a right to withdraw is included in his/her estate.
The remaining amount that can pass to the surviving spouse without him/her having to pay estate tax will either pass directly to the surviving spouse or will be included in a marital trust (see below for more details). Oftentimes, at the time of the drafting of the trust, you’re not going to know what amount is necessary to put in the Family Trust to avoid estate tax. Therefore, the trust will say something like this (except much more elaborate): “If my spouse survives me, the Trustee shall set aside, as a separate Marital Trust, the smallest pecuniary amount necessary to eliminate or reduce the federal estate tax liability of my estate. . . . The Trustee shall hold all remaining assets in a separate trust called the Family Trust.” The estate planning attorney, tax professional, and/or trustee will have to crunch some numbers and figure the amount out upon the first spouse’s death.
Whatever is not put into the Family Trust can be distributed to the surviving spouse outright. However, sometimes there may be a “Marital Trust,” which is where the grantor is concerned about the surviving spouse’s ability to manage money or, if it is a second marriage, the grantor may not want the surviving spouse’s children (that are not the grantor’s children) to inherit.
It is very important that the trust be worded correctly because the Marital Trust property must go to the surviving spouse to qualify for the unlimited marital deduction. However, the terms of the trust will provide that at the surviving spouse’s death, the remaining Marital Trust property will pass to someone whom the grantor has selected. Normally, the decedent is the one who dictates who gets her property when she dies, but not with this trust. Also, the terms of the trust will likely dictate that the surviving spouse can only use the property for her benefit only and not someone else’s during her lifetime. The most common type of Marital Trust is a Qualified Terminable Interest Property Trust (QTIP Trust).
The terms of the trust agreement control except for twelve mandatory rules under North Carolina law. Otherwise, the statute contains only default provisions that fill in when the trust agreement is silent. The trust agreement will tell the trustee how to make distributions (which is crucially important for tax planning), maintain trust property, how to terminate the trust, how to remove other trustees, how to name successor trustees, how to keep records and provide information to beneficiaries, and to use trust funds to pay the grantor’s funeral expenses, debts, taxes, etc. at the grantor’s death.
Due to the unlimited marital deduction and rising estate tax exemption (it has increased approximately two million dollars over the past ten years), the need for using revocable living trusts for estate tax planning has decreased exponentially. So why should “normal people” use them? The main two reasons are (1) to protect assets when the surviving spouse is a second marriage, and (2) to avoid probate. Using living trusts to avoid probate, and some of the other pros, cons, and myths, will be discussed in our next blog/newsletter.
Everyone has seen the commercials on television advertising reverse mortgages. Everyone has heard horror stories of elderly people “losing” their homes. But what is the truth about reverse mortgages? Reverse mortgages are not easy to understand, so I sat down with a reverse mortgage professional, Jeffrey Floyd of American Advisors Group, to learn more myself.
At the most basic level, a reverse mortgage is taking a loan out against the equity in your home. You can receive the loan proceeds in a few different ways: a monthly direct deposit, a lump sum, or a line of credit. For example, if your house is worth $300,000, and you have no mortgage, you could qualify for a $150,000 reverse mortgage. If you had a $150,000 traditional mortgage, the bank may still offer you that, but the $150,000 would go to pay off the traditional mortgage. You would then have the benefit of not making a mortgage payment every month.
Any unused line of credit balance grows. You are charged interest against what you use. However, you never have to make any payments to the bank. You must be 62 years old to get a reverse mortgage, and you must reside in the home. You must continue to pay real estate taxes, insurance, and home owner association dues. If you have poor credit, the bank may set aside part of your reverse mortgage proceeds to ensure those bills are being paid.
The bank will “call” the loan (meaning, collect the debt) when the borrower dies or moves out of the home (which most often happens when the older person has to move in with a relative or nursing home).
I’ve made a list of pros and cons (in my opinion):
Pro: You can use the money for practically anything. What was the most attractive about the reverse mortgage for me, as an estate planner, is that you can use the money to purchase life insurance or long term care insurance. How many older people don’t have this insurance because it is too expensive for them because they waited too long to purchase it? This way, if the older person does have to go to a nursing home, they have long term care insurance to pay for it.
Also, as an attorney who assists family members settling estates, I can tell you that most adult children do not care about inheriting their parents’ house. Adult children typically have their own homes, and they may not even live in the area. Leave your heirs life insurance proceeds instead of a house they will end up fixing up and selling anyway. As I have discussed before, life insurance passes to beneficiaries outside of probate and creditors cannot touch it. If the elderly parent is in money trouble, and they charge a lot to credit cards, those creditors WILL come after estate assets when the parent passes away and could even force the sale of the house.
Con: If the owner is already receiving government assistance based on income (like Medicaid), the influx of cash from a reverse mortgage could affect those benefits. Social security, Medicare, and pensions typically aren’t affected.
Pro or Con, depending on the circumstance: Anyone getting a reverse mortgage really needs to be okay with the fact that their children are probably not going to inherit the home. There are closing costs added to the loan, and then interest is charged against that. Even if the entire mortgage proceeds are not used (which is highly doubtful, as most homes are mortgaged, and the point of a reverse mortgage is to give you access to cash), the balance is going to grow and grow each day. The balance could grow to exceed the equity, and then when the house is sold, there may be nothing left.
However, it is possible that the house could be sold while there’s still equity in the home (more equity than what is owed on the reverse mortgage). For example, in our $300,000 example, if the borrower had only used $10,000, there may be more equity in the home than what is owed. The borrower could sell the home, pay off the bank, and keep the remaining equity. If the borrower passed away, the bank will give the family 6- 12 months to sell the property, pay off the loan, and then the beneficiaries can keep the remaining proceeds. If a family member is really interested in the family home, they could purchase the home or pay off the mortgage.
Realistically, this probably wouldn’t happen. The temptation to use the reverse mortgage proceeds is high. People are living longer, things are getting more and more expensive (including medical care), and with interest accruing on the loan, it’s likely there won’t be anything left. So a borrower must be okay with the bank taking their home when they pass.
Pro: In the event that the borrower dies owing more on the reverse mortgage than there is equity, the borrower’s estate is not responsible for the deficiency. Again, if someone passes away owing credit card debt, those types of creditors are allowed to come after estate assets.
Con: The bank will “call” the loan when the last owner moves out or moves into a nursing home. This is the biggest con, in my opinion, and there are three reasons:
(1) If there is any money left in the line of credit, at the time they enter the nursing home, the owner doesn’t get to keep that line open. If that person wants to use that money, they would need to draw the full amount of that line of credit before leaving the residence because the bank will take the house and there may not be any equity for you to receive after the line of credit is paid off. However, a person would not want to do this if they owe very little, because they will receive the equity after the bank sells the property.
(2) If the borrower has a lot of spare cash due to the reverse mortgage proceeds, or if the borrower gets a lot of equity proceeds after the bank sells the house, they may no longer qualify for Medicaid assistance for the nursing home. If it is likely that a potential borrower may need nursing home care in the near future, and they currently qualify for Medicaid, a reverse mortgage may not be a good option.
(3) The borrower could end up in a situation where the reverse mortgage proceeds have been spent, and there’s no money for the nursing home. The bank could take the home and the borrower not get any equity proceeds. If the borrower has no money saved up and no long term care insurance, they may not be able to pay for the nursing home and would have to rely on qualifying for Medicaid. Thus, careful planning is needed. Someone considering a reverse mortgage should use a portion of the proceeds to plan for the contingency that they may need long term care.
In conclusion, a reverse mortgage can be an excellent tool to create cash for older individuals while allowing them to remain in their home. However, there are serious consequences. A person considering a reverse mortgage should consult with a financial advisor and estate planning attorney to help them make their decision. The planning may be different depending on the borrower’s situation. Children and people with power of attorney also need to be somewhat involved, in case they need to assist an aging parent with mortgage proceeds or nursing home arrangements down the road. Please give me a call if you would like more information.
 He can be reached at firstname.lastname@example.org.
 There’s no prohibition against selling a home with a reverse mortgage.
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