For Some Estates, Probate May Be a Better Choice Than a Trust

Question: My 86-year-old father has an estate that I believe will be worth more than $1 million when he dies. This includes two homes that are paid for and various bank accounts, stocks, bonds and other miscellaneous accounts. He has a will, but he refuses to set up a trust that could help his estate avoid probate, which is a lengthy and costly process here in California. He says his heirs will be “just fine” if his estate goes through probate and that it won’t “cost us in taxes.” I’m concerned he’s making a mess that will cause delays and cost us all financially.

Answer: Your dad may be confused about what probate is. Or he may know exactly what he’s doing.

Probate is the court process that typically follows a death. Property is identified and appraised, creditors are paid and assets are distributed to heirs. If any estate taxes are owed, they are paid as well. The estate tax system, however, is separate from the probate system--something that often confuses people who think they have taken care of one when their plans address only the other.

In some states, probate is a relatively easy and inexpensive procedure. In other states, including California and New York, probate is long and expensive, costing as much as 3% to 4% of the gross estate. (The gross estate is the total of everything your dad owns, not counting anything he may owe.)

These costs aren’t taxes. They’re mostly attorneys’ fees.

That’s why revocable living trusts, which help estates avoid probate, are almost a no-brainer if you live in a state in which probate is expensive. Living trusts typically cost $2,000 to $5,000 to set up, but they would help your father’s estate avoid $30,000 or more in probate fees when he dies. That would be money that could be going to his heirs.

Some people worry about the hassles of setting up a trust. When it comes to living trusts, however, the hassles are relatively small. Once the trust is created and his assets are transferred into it, there is little additional paperwork and he doesn’t have to file a separate tax return for the trust.

And because the trust is revocable, your father wouldn’t be giving up any control. He can do whatever he wants with the property until his death.

Your father might not understand all that. Or he might actually want his estate to drag through the probate system.

Probate, after all, is a public process, as it takes place in court. People who value their privacy usually want to avoid that scrutiny, but your dad may prefer court supervision if he isn’t certain his estate will be divided the way he wants.

Living trusts are much more private. The trust usually names someone to oversee the distribution of the estate, and an unethical person in that post can create quite a bit of havoc. Estates that go through probate can have similar problems, but at least in theory there’s a judge looking over the executor’s shoulder.

Also, if your father is involved in numerous lawsuits, has a failing business or owes a lot of money, probate might be preferable, because probate has mechanisms that can resolve such issues, sometimes more speedily than when a living trust is used.

Finally, your dad just might not care that probate will mean less money for his heirs if he thinks he’s already leaving you enough. Some people would rather not pay for probate avoidance when it’s their survivors, rather than themselves, who will benefit.

*

Life Insurance Benefits May Be Subject to Taxes

Q: I was very surprised to read in your column recently that life insurance policies are part of an estate and taxable. I always have been told that this is “free money” and not taxable. In fact, I just read that is how wealthy people can leave money to their heirs and avoid paying taxes on the funds.

A: It’s true that you typically don’t have to pay income taxes when you’re the beneficiary and get the proceeds from a life insurance policy. If you’re the one who bought the policy, however, estate taxes may apply.

The wealthy know (or have been told by their advisors) that life insurance proceeds will be included in their estates if they’re named as the owner of the policies. To avoid estate taxes, they may transfer their policy to another person or decide to create an irrevocable life insurance trust that will “own” the policy.

Whether you should consider such maneuvers depends on your individual financial and estate situation.

That brings us back to the original advice, which is to consult a qualified estate-planning attorney if your estate, including life insurance, is likely to exceed $1 million.

*

Liz Pulliam Weston is a contributor to The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at [email protected] or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at www.latimes.com/moneytalk.