Savings Bonds, estate planning, living trusts, and avoiding probate

What is a Living Trust?

Before we begin, let me warn you not to confuse a living trust with a living will, which is another name for an advance health care directive.

A living trust is used in estate planning as a legal alternative to a last will and testament. Instead of leaving what you own to your heirs using a will, you give everything to the living trust before you die. The living trust will have a legal lifetime that extends beyond yours.

Typically when you set up a living trust you name yourself as the trustee who controls the property in the trust. You also designate another person who will become the trustee after your death.

The primary attraction of a living trust in estate planning is that, done right, it allows your heirs to avoid the delay, expense, and lack of privacy of Probate Court. This is because you won't own anything when you die - you will have given it all to the Living Trust.

What is probate?

If you die owning property, on the other hand, a Probate Court has the responsibility to determine who your heirs are. The court's determination becomes part of the public record. If you have a Will, the court will examine it and hear arguments about its validity. If you don't leave a Will, the court will determine the disposition of your property using state law.

The probate process typically takes about six months but can take longer if the estate is complex or if there are disagreements about the will. The court will appoint an executor to handle the process. The executor will hire a lawyer to help move the case through court. Both the executor and the lawyer are entitled to fees that can be based on the dollar value of the probated estate.

If your will doesn't name a friendly executor, the court can appoint anyone to do the job and can determine how much they should be paid. In some jurisdictions, there are concerns that the court appoints cronies who, in turn, financially support the judge's political party.

Problems of Living Trusts

Of course, there will also be legal fees associated with setting up a living trust. Moreover, if the trust paperwork - such as retitling property to the trust - isn't properly completed, all your property ends up in Probate Court anyhow.

As the Office of the Attorney General of New York points out on its page on living trusts:

Contrary to the impression created by many living trust salespeople, the grantor must take affirmative steps to transfer assets and fund the trust. Merely executing the living trust itself will not cause the trust to become funded.

Consequently, even if you have a living trust, you should also have a will, known as a pour-over (to catch what pours over the brim of your living trust, I guess), to make sure any property that doesn't get into the trust is distributed as you wish.

Moreover, in terms of privacy, the NY Attorney General's office warns:

A "pour-over" becomes a matter of public record when it is submitted for probate, and the "pour-over" often incorporates the living trust by reference. In addition, when title to real property is transferred into a living trust as part of the funding process, the consent of the mortgagee is required. Before giving consent to the transfer of mortgaged property, the mortgagee typically requires that the living trust document be recorded, with the deed, at the office of the county clerk. The living trust can then become part of the publicly-accessible records.

How do Savings Bonds fit into all this?

Some types of property, including Savings Bonds, can pass to heirs outside of your will and probate court. They're like a living trust without the paperwork. These types of property have a co-owner or beneficiary and, besides Savings Bonds, include jointly owned accounts, bank accounts registered in-trust-for, life insurance, and IRA, pension, and Keogh accounts.

Any Savings Bond with a living co-owner or beneficiary automatically avoids probate. If you'd like to change how your Savings Bonds are registered after reading all this, see my post Adding a co-owner or beneficiary to a Savings Bond registration.

On the other hand, Savings Bonds registered with a single owner go through the probate process and are distributed according to the owner's will. If a Savings Bond registration includes a co-owner or beneficiary who died before the owner, the bond is actually a sole-owner bond, even though it has two names on it. It, too, must go through the probate process.

It's also possible to have paper Savings Bonds, but not TreasuryDirect's electronic bonds, registered in the name of a living trust. This is bit more complicated, but my book, Savings Bond Advisor, has all the details you need to accomplish this at the end of the chapter called Changing the registration.

A word about estate taxes

It's important to understand that keeping your property - Savings Bonds included - out of Probate Court won't lower estate taxes. Again, from the NY Attorney General's office:

There is no inherent estate tax advantage to using a living trust. While a trust may contain provisions taking effect at death which do save on taxes, the identical tax savings can be contained in the grantor's will instead of a living trust.

Although the level at which federal estate taxes begin is quite high, many states have estate taxes that begin at much lower levels. Consulting an advisor to make sure your estate pays the minimum amount of estate tax is a good idea, but doesn't require setting up a living trust. However, it may require having your Savings Bonds pass through your will or living trust rather than through the registration.

Parting advice

The NY Attorney General's page ends like this, and now, so does mine:

When you are planning for the disposition of your estate, avoid dealing with anyone but a trusted and well-referred professional in your community. Do not agree to contract for any legal service from someone selling door-to-door or over the phone. If you have already purchased a living trust on that basis, take the time to show it to an attorney.