Your client has set up a trust, now what? Hosts Anne Rhodes and Thomas Kopelman dive deep into what assets should go into a trust and what assets should not or, more often, what assets can't go into a trust.
They cover real estate, businesses, international assets, retirement accounts, brokerage accounts, bank accounts and more. And why the key may be what your state's threshold for probate is, known as "petition for small estate." They also tackle beneficiary designations and more, sharing key insights for financial advisors.
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Full transcript below:
Thomas Kopelman: All right. Hello, and welcome back to another episode of the Practical Planner podcast. I'm your co-host, Thomas Kopelman here with Ann Rhodes, chief legal officer of wealth.com. Ann, how are you doing today? Love the new background.
Anne Rhodes: Oh, thank you. Yes, I'm joining you with the greenish background that is actually very wealth.com appropriate to our branding. I'm doing well. How are you, Thomas?
Thomas Kopelman: I am doing well. I think this is the first time recording since I've been back from my bachelor party now six weeks away from the wedding, so just in this really busy season. But I'm excited to dive into the topic with you today. I think that funding trust is something that I just equate to the busy boring work. I think everybody gets excited about setting up their trust, especially the irrevocable side. And then you go through the pain point of like, "Well, now let's get to funding this trust." I think for certain ones it's really easy. You just potentially move one thing in or you're going through the process and you get the deed of your house moved. But the annoying ones with bank accounts, brokerage accounts, beneficiary designation changes, all of that, I just totally tee up to my clients and I say, "This is going to suck, and we're just going to chunk away at a few a quarter. And the goal is about a year from now, worst case two years from now, everything is funded in the right way."
But I think a lot of advisors and just people in general have no idea what goes in a trust, what doesn't, what is supposed to be a beneficiary designation, et cetera. So I'm really excited to dive into this topic with you today.
Anne Rhodes: Yes, I'm excited too. And for those of you have listened before, you should also note that we address this topic in some respects on The Long Game, which is Thomas's other podcast, woo-hoo.
Thomas Kopelman: Let's just take two. It's got to be better, right?
Anne Rhodes: Exactly. But we can't talk about trust funding enough. So here we go. First things first is, why? Why fund a trust? And I think here it's important to note that by and large people say to the extent that you can please do fund a trust. It's a little bit more important in certain states or under certain circumstances than others. And so we'll address those as well. But there are actually circumstances where you really don't want to transfer an asset into your trust. So we'll talk about that as well or can't exactly. Don't want to because you can't. And so anyways, first things first, I'm just going to address the elephant in the room, which is some estate planners really are going to push you to fund your trust, and financial advisors who have learned from those estate planners might do the same thing.
This is particularly important in certain states, so California, Florida, for example, where if any asset is outside of your trust at your death up to a certain level, if you've left enough of them outside, will then trigger probate even though you have a trust-based estate plan. So this is in California here where I am, for example. The limit is 166,000 adjusted for inflation. So it might be a little bit higher this year, but the idea is that if you didn't do your homework during your life and you left a bunch of your accounts real estate, etc, and the total value is above that threshold, then all of a sudden you might be subject to that onerous probate. So really important in certain states just to go ahead during your life chunk away as Thomas says, and just do it.
Thomas Kopelman: I was going to add, I think that's a really important number. Honestly, that was something that I did not know the exact number for, but I think it's a good reason as advisors when we're having these conversations to point people to, "Okay, you're 22 or 23, you're just getting started. It is okay to get a will in place for right now." And I think that sometimes something that I lean on for people is in the beginning it's okay just to get there and graduate eventually to it, but those basic documents are it's just easier to get done, easier to get enforced and not have to really worry about the next steps pre even a small amount of assets being built up.
Anne Rhodes: Exactly. And that threshold actually, which is called usually a petition for a small estate, is supposed to make the probate process easier because the idea is your estate is so small, not very complex, that things can just be passed to your beneficiaries much faster, and the judge has kind of a truncated process. But the issue, of course, is that different states have different thresholds. It can be as high as half a million dollars, that's great. And then it can be as low as 20 or 50k, so you have to be aware of what's going on in that state. But here in California it's in 170k thereabouts.
So then the second reason, and we've touched on this, Thomas, in our last episodes, is if you own certain assets that make it imperative or more important for your clients to transfer their assets, so this is real estate that's in a different state than where your client lives. So all of a sudden, let's say they have a vacation home, so they live in Indiana, and they happen to have a vacation home in Florida. Well, that Florida real estate then opens the potential, and actually it will just happen. If your client passes away, there will be a Florida probate that's opened in addition to Indiana probate, so it starts complicating things. And then you have businesses and assets like that where for incapacity planning purposes, you really do want to put them in the trust because the trust is a more robust vehicle. And we went through some of those decision points in a past episode.
Thomas Kopelman: I think honestly the easiest way to chunk at this is just type of asset for most people. And I think you obviously alluded to real estate. In your mind, I know if you have real estate in different states, it's like what are you doing here, nobody wants to go through and probate in two states? But let's say you just have real estate in one state, states like California, you get it right, probate's long, it's painful, do it. But what about some other states? Does it typically make sense for people if you own a house to put it inside of a trust?
Anne Rhodes: That will depend a little bit on state nuances, but by and large it's always a good idea to put it inside the trust. There are a couple of things. I will just mention it's annoying as heck when you have your real estate in a trust. So when you go to refinance or take out another loan of some sort on that real estate, your bank, the mortgager, may just require that you take it out of your trust to get the better rate because they have different interest rates depending on if it's your primary home, if it's in your own name as opposed to the name of an LLC or a trust. And so to get that better rate, they're going to ask you to take it out of your trust, do the refinancing, and then a lot of people just forget at that point in time. They just left their real estate in their own names because of some other transaction they were doing and completely forgot to then put the real estate back into the trust for all the other reasons we've mentioned including bypassing probate.
So my recommendation whenever you're putting real estate into a trust and then taking it back out is can you get a two-for-one deed preparation by asking whoever is doing the titling company or whoever is doing the transfer out to proactively also prepare the deed for the transfer back in. And then once your refi has happened and your bank usually says, "Oh, just leave it out for 60 days and then transfer it back in and we won't care," after those 60 days have passed, then just go to a notary, sign the thing, you already have the documentation, and just put it back in.
Thomas Kopelman: This is another pointer that you gave me too is if you have a client that potentially has not set up a trust yet and they're buying a house right now to do the same thing, right? Oh, I wish we would've set up our trust. We know we're about to do that in this year. Let's get the two different deeds in place. So once we do have the trust funded, we can go get it notarized as well.
Anne Rhodes: Exactly, exactly. And then there are a couple of instances, Thomas, where I'll just mention in my career where we said, "Please don't put this property into a trust," either because legally you can't as you mentioned before or because it's just a terrible idea. And so I'll address those from the get-go. So the first one is retirement accounts, sometimes even life insurance policy. There are certain types of taxable accounts as well where until you pass away, there is no way for anybody but you, yourself, to own that asset in your own name. So this is your 401k. If this was a 401k that you earned while working until you pass away, you have to be the owner of that asset.
Thomas Kopelman: So you said houses are really are good, right? Businesses typically are good. Is there any instances before we really dive into all the rest that you see that that doesn't make sense?
Anne Rhodes: Yeah, so actually that was going to be my second point, which is there are certain accounts located abroad. We're a very US focused podcast, but in a past life I did do a lot of cross-border work. And so if that asset, that bank account or real property is located abroad, you may not even legally be able to transfer it into your trust or you can transfer it into your trust, but the local laws, especially income tax laws or transfer taxes might make it impossible or just a terrible idea. So we've had certain folks, for example, who tried transferring property located abroad and their CPAs or the accountants from that other country said, "Actually you're going to be incurring so many taxes that it's a terrible idea to fund this property into your US trust."
Thomas Kopelman: What about people who are in US? I have a bunch of clients I work in this situation, I'm going to quiz you on this, we'll see if this is something you're familiar with. But what about people who they were citizens abroad, they now have US citizenship, but they're not for sure going to be staying in the US for a long time. I have a bunch of clients who are like, "Hey, I'm going to work three to five more years in the US and go back abroad. I think the difference of keeping us residency and getting rid of it obviously makes a difference. But I've seen some mixed reviews from different estate planners about, "Well, if you're only going to be here for a few years, is it worth the fees to set up a trust and fund things in the trust for a couple of years? I mean, what are the odds that we pass away?" What do you think of that?
Anne Rhodes: That's such an interesting question because when you get into as you said, they may have US citizenship or what's called residency, income tax residency in the US. So this is a green card or enough days spent in the US to trigger income tax residency, depending on what kind of immigration status they have, then they leave, there's that exit tax that's imposed. And we can talk about that some other time. But the idea here is, do you bother with a US estate plan, especially a trust-based one? That will depend a little bit I think on the circumstances of that person. If they intend to keep that real estate for the future, either their own use or they just want to pass it on as an investment property to their beneficiaries, it actually makes sense before they leave to talk to an attorney, make sure that they've done all their exit planning.
And one of the things that they want to consider is actually a holding structure so that if they ever sell the property, it won't have this basically a transfer or income tax imposed on it. That's something like 15% of sales proceeds because they happen to now be a foreign person. And so actually a trust might be a really great idea to set up in the US. And not just a revocable trust as a succession planning, like death time planning tool, but actually an irrevocable trust so that their descendants who are based in the US fall in love with US citizens, going to have US babies, just stay here forever so that their descendants have basically this US piggy bank, this US side trust that's an irrevocable trust ideally set up in a really good tax jurisdiction, the South Dakotas world, and then that becomes their big vehicle in the US to invest their family assets.
So it really depends. If they're just going to leave and they're like, "Ugh, this is my temporary home here. I don't ever plan on coming back," then in that case it may not make sense to set up a trust. They can just do a will, a US side will.
Thomas Kopelman: Okay. So really it sounds like it's more on the real estate side of things like brokerage accounts, things like that. It typically doesn't seem like it would make a lot of sense to be putting inside of a trust.
Anne Rhodes: Yeah, I would say so.
Thomas Kopelman: Okay, cool. So sorry to deviate here, but I thought it was interesting when we were talking about the foreign side of things. So now we start to go into the retirement accounts. So you're talking about 401ks, IRAs, all of these accounts that are in your individual name, are not good assets to be putting in a trust. It's not even that they're not good. It's not even something that you can do.
Anne Rhodes: Right, exactly. And I think we had a listener question about this actually, so I just wanted to address it. It's not necessarily that it's a taxable account, meaning that there are income taxes building up in some of these types of accounts and assets, but it's just simply that legally you can't transfer those into the name of the trust. Where I think a lot of confusion comes in is that they can become transferred into the name of a trust once you have passed away. Once it becomes an inherited account or you, yourself, inherit an account from a parent or somebody else, that's when the question becomes should you put that in a trust or in the individual's name? And so how do you designate beneficiaries?
That question has actually become even trickier after the Secure Act. So this is Secure Act 1.0, the one that was passed in December, 2019. So at this point it's about three and a half years old. And what that law did, and we can do a whole episode on this, I like talking about this when I have speaking engagements, but one of the things that it did was remove the ability to draw out those income tax deferrals based on the life of the younger beneficiary through a trust. So now putting that asset in the name of a trust and inheriting that way subjects you potentially to this 10-year rule and things need to come out. And so you have even more pressure when you use a trust on the income tax side. It's also because trusts that own income generating assets, they pay income taxes at a compressed rate compared to an individual, so you, Thomas.
Because these become irrevocable trusts, right? You've passed away, you're passing also retirement assets to a trust, which is part of your estate plan. So stepping back, let's say you pass away, you want your retirement accounts to go to a younger beneficiary, like your child or grandchild, and up until they are X years old or maybe for their entire lifetimes, that trust is going to hold the asset for them. So that's an irrevocable trust formed at your death. That irrevocable trust is the owner of your retirement account and is going to incur income taxes at a very different rate from having just passed that asset onto the beneficiary themselves, so that child or that grandchild. You have this issue of, "Should I just outright name my child as a beneficiary of that retirement account or should I name the trust for my child as the beneficiary?" And that will have different income tax implications to it.
Thomas Kopelman: But, really, I mean the core part that we're talking about here is if you inherited as a spouse, you have very different rules than any other person other than your spouse. The 10-year period is that big thing that it went away to just stretch it over your lifetime. And now we have this part where most people are inheriting assets in their highest income earning years in their forties or fifties, and they're required to take it out over 10 years in probably the highest brackets. And so I think that's the important deciding factor here.
Anne Rhodes: Yes, the categories of beneficiaries matters tremendously. So there's a reason I didn't mention the spouse. The spouse is an ideal candidate actually to receive retirement assets. They're something called an eligible designated beneficiary, so EDB. And so there are also special needs beneficiaries that fall into this category, beneficiaries who have disabilities, things like that. So we are setting those aside, but the idea here is inherited retirement account can be held by a trust, but there you have a whole Pandora's box of things that you're opening where you're considering income tax implications.
Thomas Kopelman: I think the big issue here really is most common we see spouse first, not trust. Second though, you still commonly do see trust if kids are young, right? So if your kids are under 18, especially way younger than that, I feel like most commonly people are going that route. But I think what you're getting at here is that might not be the best thing if you have adult children.
Anne Rhodes: Exactly. So we can, of course, talk about this in more length, but what the Secure Act basically put an onus on, an incentive on, is to revise your beneficiary designations at the point in time where you feel like your children or the grandchildren are old enough to have that asset in their own names. Before it didn't matter as much. You could just appoint the trust for that child, and then if that trust was correctly structured, you could actually draw out. So this is the life expectancy. You could draw out the withdrawals, but now that doesn't exist anymore. So there's a huge incentive for financial advisors and their clients to review beneficiary designations on retirement accounts more proactively.
In the beginning you might say it's worthwhile for me to take an income tax hit because I really do worry about this beneficiary's controlling how they spend that asset. So the control factor outweighs the income tax hit, but eventually when that beneficiary is old enough, let's say 25, they went to grad school or whatever, at that point in time you might say, "You know what? At this point, let's switch it so that it's no longer the trust that's going to get the retirement account, but the beneficiary in their own name." At that point, the control factor goes away, and the income tax benefits outweigh the control.
Thomas Kopelman: And this gets complex fast because the size of the account matters too. If you're passing on to your one adult child the $300,000 IRA, what's the income problems on that? It's really just distributing that account to you that's going to hit you at the income tax threshold because you ideally would probably space it out over 10 years unless you're going to retire around that time or have a sabbatical or low income year where you can fill up lower brackets.
Anne Rhodes: Right, exactly. And just leave it to the beneficiary and hopefully a CPA working with your beneficiary to figure out how to best withdraw the retirement account benefits. But at least your estate plan should direct the asset to the right places. And, in fact, one quick tip, your estate plan, if it is trust related ideally would also allow for distributions in kind of accounts or assets out to the beneficiary. I think most trusts do this.
Thomas Kopelman: Versus selling the asset?
Anne Rhodes: Exactly. Versus having to withdraw and then give the asset the money to that beneficiary. Instead just pass the entire account straight to the beneficiary. That might be a way to bypass a stale beneficiary designation where the trust is the beneficiary where the trustee just says, "Hey, I'm just going to pass this asset out of the trust whole as it is straight to the beneficiary."
Thomas Kopelman: This is where the advisors get to add a lot of value. I had a client in a very similar situation. Theirs was weird because the parent was still in their 401k plan active, so they had a five-year stretch period, which is super weird. I've actually never seen that, but I guess it happens sometimes. And all we did is they were business owners, husband and wife, both solo 401ks, both max them out. So as we're withdrawing these assets, filling up brackets, we're also deferring from basically funneling that income into a solo 401k. Obviously you're not, it has to be your earned income, but reducing taxes in those years is probably really important.
Anne Rhodes: Right, exactly. And then I did want to address, once you have a trust and you're starting the process of funding etc. And by the way, speaking of checklists that are account specific and you just work your way through the account, I did want to mention for those of the listeners who have a wealth.com subscription, once your client has a trust or a will, we actually do make available to you a manual. It's called an owner's manual, but the trust owner's manual has a very detailed checklist that takes exactly the approach that Thomas recommends and uses with his clients. So it's working your way through certain types of accounts quarter by quarter. But anyway, so I just wanted to mention that. But let's talk about those pay on death or transfer on death designations outside of retirement accounts or foreign assets.
Thomas Kopelman: Can I ask one thing before we go there?
Anne Rhodes: Sure.
Thomas Kopelman: Okay. So we went through business, we went through real estate, we went through retirement accounts. This is the brokerage account side of things. And we still did hit on the brokerage account side of things. What about bank accounts? I think this goes hand-in-hand with what we're going to talk about next, but I think a lot of times people sit and wonder, "Is it worth it to do with bank accounts because it's obviously painful?" And for a lot of my clients I'm thinking about they have personal checking, then they have a personal savings there, and then they have five high-yield savings accounts for each different goal, and then maybe they have a couple other ones. It's like, "That's a lot going on, and that's going to be a really painful process." Is it even worth it or is it just potentially worth it doing your one big emergency fund or something?
Anne Rhodes: So I would say at the minimum, take a look at what the threshold is for your state for those small estate probates. Because some of our clients like here in California, we're pretty resistant about putting all of their assets into their trust because you have to reopen accounts in the name of the trust. Your banker is going to ask for a certificate of trust or to look at a copy of your trust. Then new cards are going to be issued to you. All of your automatic deposits and other things like payment terms are going to need to be rejiggered and reconnected. It's really annoying. So what we usually said is, ideally you transfer everything into your trust, but if there is some working account like your principal checking account and it's under that small estate probate threshold, that's okay to keep in your own name, but just be very careful because then if that's what you're keeping outside of your trust, then make sure that you've your homework on all the other accounts.
Thomas Kopelman: The other one, something that I've heard from estate plan attorneys is always have your own individual account with some money into it. So if this does happen or whatever and probates there, you still have access to some amount of money.
Anne Rhodes: Right. And I will say one small advantage, but this is something I learned last year when Silicon Valley Bank and First Republic were struggling is that there is an insured amount from the FDIC, and it's per account X dollars. I think it's like 50k if I'm not mistaken.
Thomas Kopelman: It's 250k.
Anne Rhodes: 250k, thank you, Thomas. But the interesting thing is if you put it in the name of a trust, every single one of your beneficiary counts towards that so you can actually multiply the insurance. So that's just a side bonus.
Thomas Kopelman: And there's honestly now a lot of banks that multiply this. They have five million minimum and stuff like that. Definitely important to look at. I think people didn't think that was an issue. And then last year that happened, but then last year everybody did get their money back, and they got bailed out. So we have this weird thing of does it matter? Does it not matter? Well, who knows, but you might as well just be smart.
Anne Rhodes: Right. So something interesting there, but those transfer on death or pay on death beneficiary designations that you had, review those. If you're a financial advisor and your client finally has a trust and are starting to fund them, don't forget to review those designations because they may have become stale. Now the client has a trust. I always think of those designations, so, for example, you have a joint account with your spouse, and there's right of survivorship on that or you're single, elderly and you have pay on death to five children because that way it bypasses probate, it goes straight to those kids once you pass away. Those designations may have become stale once you have a trust for two reasons, and I just wanted to address them. The first thing is that your trust is actually a more robust vehicle for determining how things are passed at your death.
So the first thing is that it provides for the payment of your taxes, your last expenses. This would be funeral expenses, attorney's fees, whatever else. And also your last debts, so you made charitable pledges or just whatever debts you have. If all of your accounts passed by one of these designations automatically to your beneficiaries, your executor or your trustee would then have to go back to your beneficiaries and try to get assets from them in order to pay for those things. So that creates an awkward situation for your beneficiaries. It's like, "Who's going to volunteer?" Or, "In what proportions are you going to regurgitate the assets that you just got?" And do you focus only on the liquid assets or the illiquid ones too? It just becomes really awkward.
Thomas Kopelman: Yeah, so it feels like though that it's like a step one, right? That's better than nothing if you have a trust set up. I think sometimes people are like, "Do we keep those designations? Do we just end up funding it into the trust?" And it feels like from you, it's take that extra step because now that it's funded, you might as well utilize it because it's going to lead to less issues and better results at the end of the day.
Anne Rhodes: Exactly, exactly. And less issues. It also includes things like not having to always take a look at the account levels to be like, "Ooh, am I giving enough to my daughter versus my son?" And things like that. It's like if your trust just says 50% to my son, 50% to my daughter, just let your trust take care of gathering all the assets, a hundred percent of the estate and then dividing smoothly, fifty-fifty as opposed to each account trying to balance it out.
Thomas Kopelman: It feels like if you're going through the pain, and obviously it is a pain to get a trust set up and get it funded, if you went through the pain, you paid the cost, you just have that last little part to get to the finish line to get everything in the right places. Don't get lazy on it, get it done. And as advisors, it is honestly part of our job. I think sometimes advisors are always looking for more things to talk about. This is a really easy thing to talk about. It might be super boring in a meeting to watch them do some of these things, but we can help make sure that it gets done, and I think everybody will be happy because of it.
Anne Rhodes: Exactly. So that's the episode I think on trust funding and some of those designation issues that you might see once your client has a trust and is starting to revisit those beneficiary designations. And we always encourage listeners to send us their questions because I'm sure that you're touching on these issues.
Thomas Kopelman: Totally glad to finally get a question. We have more coming, but if anybody else has them, send them our way. But everybody thank you for listening. Please rate and subscribe, and we'll see you back in the next episode.
