Ethan R. Okura
Hawai‘i Herald Columnist
“Do I need a trust?” This is the question that I hear most when people find out that I am an estate-planning attorney. The question is usually prompted by a desire to avoid probate. Sometimes they just don’t have enough information about the goal of estate planning — what we’re trying to accomplish and why. The real question we should be asking is: “Why should I want a trust?”
In the past decade, our Hawai‘i State Legislature has done a great job of passing some favorable laws to make estate planning easier, more affordable, simpler and better in terms of its protection.
For example, we now have the Revocable Transfer on Death Deed that can name a beneficiary who will inherit real estate without probate after the owner passes away. We can also transfer property into revocable trusts for married couples and still maintain Tenants by the Entirety creditor protection. Hawai‘i even became the 13th state (out of 19, currently) that has passed a Domestic Asset Protection Trust law, allowing you to put assets into a trust for yourself and shelter those assets from potential future creditors.
We can avoid probate, or at least delay it, without using a trust. But what are the advantages of having a trust besides avoiding probate?
Conservatorship requires going to court to have a judge appoint someone to manage your assets for you if you become incapacitated. This is sometimes called a “living probate,” but it is generally a much more expensive, time-consuming bigger nuisance than probate. Assets in trust can avoid conservatorship.
Control of Assets. A trust makes sure that your assets are used in the way that you want, even after you pass away. This is especially helpful in a second-marriage or blended-family situation, but even traditional families can benefit from this.
Creditor Protection. Trusts can be used to protect your assets from your beneficiaries’ creditors. “Beneficiaries” are your family members or loved ones who can receive your trust assets. “Creditors” are people or companies who might sue your beneficiaries or to whom your beneficiaries owe money. Traditionally, trusts could always protect your beneficiaries from their creditors, and now that Hawai‘i has become the 13th state to allow Domestic Asset Protection Trusts, you can even protect your assets from your creditors in a trust for your own benefit.
Divorce Protection. Inherited assets are usually considered separate in case of a divorce, but if your child inherits property from you and then adds his or her spouse’s name as a joint owner, your child could lose that protection. Keeping inherited assets in trust for your child means that the assets stay separate; even if your child gets divorced, the in-law won’t be able to come after that asset.
Qualifying for Government Benefits. If your beneficiary struggles financially and ends up needing government assistance for food, living expenses or medical care (food stamps/SNAP, SSI, Medicaid), any assets you leave to that beneficiary could jeopardize her or his receipt of government benefits. Having the assets in a properly drafted trust with supplemental-needs language may allow you to leave assets for the beneficiary to enhance the person’s life without causing loss of these government benefits.
Avoiding State Inheritance Taxes. Even if your estate is under the $5,490,000 exemption from the Hawai‘i Estate Tax, when your child or other beneficiary dies many years or even decades after you, your estate could possibly grow to more than the state estate tax exemption amount, especially if your beneficiary is a good saver and investor. Even if you can’t imagine your assets growing to over $5,490,000, it’s possible that the exemption limit will be reduced in the future, or that your beneficiary might move to a state like Washington, where the state estate tax exemption is only a little over $2 million. Or worse, the beneficiary could move to Oregon or Massachusetts where it’s only an exemption of $1 million. A properly drafted trust can hold assets for the use of your beneficiary, and not be subject to estate tax when he or she dies.
Shifting Income Tax. Trusts with flexible-distribution provisions can allow for the income of the trust to be “sprinkled” among whichever beneficiaries the trustee determines, or those who need it most. For families that are cooperating with each other, this technique can be used to shift the income from the trust from going to a family member in a higher tax bracket to one in a lower tax bracket. This means the income could be taxed at a lower rate. For families with enough income that they are already in the highest personal tax bracket, we can use a trust to shift any income that’s not sourced in Hawai‘i (e.g., publicly traded stock dividends) to a state with no income tax.
Stepped-up Basis for Assets Transferred During Life. Usually when a person passes away with assets in their name, such as their home or stock portfolio, the assets enjoy a new “stepped-up” basis at death. Basis means what you paid for the asset (with certain adjustments). In this way, owning the property until you die allows your heirs to sell the asset after your death without any capital gains tax (or only paying capital gains tax on the growth in value of the asset from your date of death until the sale date).
When you transfer assets during your life to a loved one, she or he gets what’s called “carry-over” basis instead of a “stepped-up” basis. That means that whatever you paid for the property (subject to adjustments) is that loved one’s basis. And if the beneficiary sells the property, even after you die, that person will have to pay capital gains tax on the growth in value of the asset from the date of purchase until it is sold.
There’s a disadvantage in giving away assets directly under the beneficiaries’ names. However, if you give away assets into a trust for your beneficiaries, we can preserve the “stepped-up” basis as if you were still the owner of the assets when you died, even though you gave it away during life and didn’t actually own the property at your death. This can help you with Long-Term Care Medicaid planning for nursing-home costs or with asset-protection planning without your having to give up the tax benefits associated with owning the assets at the time of your death.
I’ve only briefly covered a lot of material with highly technical information, which makes some of it hard to understand. This was intended as an introduction to the concepts listed above. If you are curious about learning more regarding any of these aspects of trusts, contact a competent estate-planning attorney to see how these concepts might fit your situation.
© OKURA & ASSOCIATES, 2020
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Ethan R. Okura received his JD from Columbia University in 2002. He specializes in Estate Planning to protect assets from nursing-home costs, probate, estate taxes and creditors.
This column is for general information only and is not tax or legal advice. The facts of your case may change the advice given. Do not rely on the information in this column without consulting an estate-planning specialist.