Probate

Probate. An arcane term that conjures up visions of dust-covered files filling cold, dimly-lit, library-quiet rooms tucked into the recesses of old government buildings. But, what is probate? Is it necessary? Can it - should it - be avoided?

For all our conjured-up ideas about them, state probate courts have vital and necessary duties to perform:

• identifying and gathering the assets of the deceased,
• seeing to it that his or her legal obligations are paid out from these assets, and
• distributing the remaining assets to those who are entitled to receive them.

The probate system is meant to protect the decedent's creditors, the decedent's heirs, and the interests of the taxing authorities. However, these protections, even though necessary, can result in significant costs (mostly legal and administrative fees and court costs) and delays, and can also complicate distributions of the assets to the heirs.

Many states have created expedited systems for dealing with smaller estates (e.g., estates under $50,000), or those that contain no real estate. But, even if the value of your estate will far exceed the amount that would qualify for expedited processing, there are things that you can do to avoid or reduce some of the costs and delays associated with probate. Some of the major strategies for doing so are discussed below, along with possible drawbacks that may be associated with each.

Wills. Having a will can help ensure that the people you want to have your property will, in fact, get it. To a certain extent, having a will can also help reduce expenses and delays. When you have a will, you name an executor. Although an executor has basically the same duties as an administrator (which you would have in absence of a will), the law gives much wider powers and authority to the executor. One effect of this is that an executor often will not need to get prior court approval for the same kind of actions that an administrator would. This usually means less delay, and smaller court costs and attorneys' fees.

Broad executor powers. For the basic reasons mentioned above, it's usually a good idea to give your executor the widest possible powers that you feel comfortable with him having. This can minimize the number of trips to the court house, and may allow you to dispense with, or at least cut back on, bond fees. (a bond is basically an insurance policy that must be taken out to cover the possibility of the executor's negligence or willful misuse of the estate, unless your will waives the need for it).

Joint tenancy. It seems that everyone has heard about joint tenancies as the magical probate-avoiding device. And while it's true that probate will be avoided on the death of the first joint tenant, this doesn't apply at the survivor's death. Further, although many types of assets may be held in joint tenancy (homes, cars, bank accounts, investments), some items, such as furniture, collectibles, and other personal effects, do not lend themselves to ownership by way of a joint tenancy. Also, there are situations where a joint tenancy may lead to higher federal estate tax.

Did You Know? Probate proceedings are generally filed with the probate court in the county where the decedent resided at the time of death. If the deceased had property located in another state, probate proceedings may have to be filed elsewhere as well. This usually comes up in the context of real estate (e.g., a vacation home), which is physically situated somewhere else and cannot readily be moved around. Going through probate is difficult and expensive enough in one state, let alone having to do it elsewhere. For example, the estate may need to hire an attorney licensed to practice in the state where the property is located. To avoid this hassle, owning real estate in joint tenancy can be a real plus. Even when there is only one survivor of the joint tenancy, it is always easier to change the title to the property to add another joint tenant (e.g., adding a child or relative) than it is to go through probate.

Life insurance. Under the laws of most states, life insurance proceeds that are paid to a named beneficiary (rather than paid to the estate) are not subject to probate. This means that the proceeds are normally quickly paid out to the beneficiaries of the insurance policy. This is often the best source of liquidity when other assets are held in probate.

If you are concerned that there won't be enough liquid assets in your estate unless you name your estate as beneficiary, consider this instead: name a trusted family member or the trustee of a testamentary trust as beneficiary of the policy (if the trustee is also the executor, make sure this person is designated in the insurance policy in his capacity as trustee, rather than as executor). Provide directions outside of your will that you would like the recipient of the proceeds to make them available as loans, to the executor, as needed.

Living trusts. Property contained in a trust created during your lifetime, known as a living trust is not subject to probate. In contrast, a trust created at death, by means of your will, must go through probate. This certainly is a fact in favor of the living trust, but it is not a reason, in and of itself, to rush out and put all your worldly possessions into one.

There are two general kinds of lifetime trusts that will avoid probate: irrevocable trusts (trusts in which you give up the right to change the terms of the trust or get the property back) and revocable trusts.

From the point of view of avoiding probate either an irrevocable or a revocable trust will do the trick. The assets in the trust will pass to your heirs—the trust's beneficiaries—without the involvement of a probate court. However, there are other ramifications than merely avoiding probate that you should consider before creating any type of trust. For example, assets in a revocable trust are subject to estate and inheritance taxes, while use of an irrevocable trust can reduce taxes.

Although an irrevocable trust can successfully be used to reduce both federal and state income and death taxes, as well as avoiding probate, it's not a device that should be entered into without careful thought, planning, and competent professional advice. "Irrevocable" means just that: you don't get to simply change your mind and take a "do over." "Irrevocable" is a long time. Circumstances and needs change. The assets you place in the trust that you are certain you will never need may turn out to be vital if you suffer a serious business reversal. Although it's true that you may be able to get a court to set aside your irrevocable trust because of changed circumstances, this requires a court action, legal fees, and the winning is not certain.

When you read an article, or hear an interview with someone talking about the use of a living trust to avoid probate, the discussion is probably referring to revocable living trusts. So what's the problem? If a revocable trust avoids probate (it does) and doesn't lock you into something that you can't get out of (it doesn't), why not have it? We're not going to say "never" here to such trust arrangements, since they do have the benefit of avoiding probate, but there are some negative factors about revocable trusts that you should keep in mind:

• They won't save income or estate taxes (since you haven't parted with the property).
• They require fees to set up, and yearly fees to administer.
• It's often not practical to re-title all your assets in the name of the trust. But if you don't go through the required formalities with respect to a particular property, your estate may end up in probate after all—at least for that property.