You have bank accounts and other assets that you want to leave to your loved ones. You also have a few debts. Do you know what debts would have to be paid with those assets.
Generally, your assets will need to be probated upon your death if they include real estate or are valued in excess of $22,000 (in 2014) AND are owned in your sole name. The $22,000 threshold amount is inflation adjusted annually. These assets going through the probate process will be distributed in accordance with your will. If you have not signed a will, you still have one. It just that your legislators have drafted it.
What you may not know, is that your will doesn’t control all of your assets. Any of your assets that are held jointly with others or have a beneficiary or a transfer/payable on death designation bypass your will. The instructions you have in your will are ignored for these assets.
You may attempt to avoid probate using joint ownership or beneficiary or transfer/payable on death designations. As we have discussed in previous columns, many times these attempted do-it-yourself estate plans backfire and your wishes are not followed.
When your assets are probated, any of those assets, will have to be used to pay off your debts. Your personal representative (formerly “executor”) needs to publish a notice in the local paper regarding your estate. This is a notice to all the world that you have died, that you left assets and anyone who has a claim against you must file that claim with your estate within four months of the date of publication in order to get paid. This notice must also be sent to all of your known creditors. Your personal representative then must use your probate assets to pay your debts that are valid and which you incurred during your lifetime.
Some people have the mistaken belief that assets in their revocable living trust will be protected from their creditors both during their lifetimes and after their deaths. However, if you have full access to your revocable living trust assets during your lifetime, so do your creditors. A revocable living trust does not protect you or your assets from your lifetime creditors.
Similarly, if your trust is revocable at the time of your death, it is also subject to the claims of your creditors, as are your estate’s probate assets. If you do not have a probate estate, the successor death trustee of your trust must publish a creditors’ notice in the local paper after your death just like your personal representative of your probate estate. Also like your personal representative, your trustee must send this notice to all of your known creditors.
If a creditor fails to file a claim with your personal representative or trustee within four months after the date of publishing, the claim expires. Your creditors would no longer be able to make a claim against your estate or trust.
If you are the personal representative of a probate estate or the successor death trustee of a revocable trust, you should be careful of when you make distributions to beneficiaries. I usually recommend that you do not make any distributions or only make minimal distributions to beneficiaries until after the four month claims period has expired.
If a creditor makes a claim after you have paid out everything to the beneficiaries, it is often very difficult to collect the money back from the beneficiary. The beneficiaries may have already spent their inheritance. If the beneficiaries do not pay back what they owe to the estate or trust, then you as personal representative or trustee may be personally liable for the debt. At the point, you may have to file a lawsuit against a beneficiary to collect. This is not a good position to be in. It would have been easier if you had not paid anything out to the beneficiaries until after the claims period has expired.
If you have a joint revocable living trust with your spouse, that trust is also liable for your debts after you are gone. Your surviving trustee spouse would also have to publish the creditors’ notice in the local paper and send the notice to your known creditors. Your creditors’ claims generally must be paid from the joint trust assets.
However, if you have set up an irrevocable trust during your lifetime, then that trust would not be subject to your creditors’ claims after your death. Examples of these types of trusts would be an irrevocable life insurance trust. The reason that these trusts are not subject to your creditors’ claims is because you have given these assets away and at the time of your death, you no longer had any control over them. After your death, the irrevocable trust assets would be distributed in accordance with the instructions you put in the trust, free from any claims of your creditors.
Although your trust or estate assets are available to pay your and your estate’s creditors, you can protect them for your loved ones. In your revocable trust, you can leave instructions to set up separate lifetime trusts for each of your loved ones after your death.
With properly drafted separate lifetime trusts, your beneficiaries would have access to what you left them at any time for any of their needs. They could use those trust assets to buy a home, start a business or professional practice or fund a wedding.
Lifetime trusts have five key protections, among others. Firstly, there is creditor protection. Any of the assets which you leave to your beneficiaries in lifetime trusts are generally protected from claims against your beneficiaries from lawsuits and other creditors. If a beneficiary gets sued, the creditors cannot touch the assets you left that beneficiary in the separate lifetime trust.
Secondly, there is divorce or predator protection. So long as a beneficiary keeps the assets in the separate lifetime trust and never co-mingles trust assets with marital assets, what you left that beneficiary should be protected from a divorcing predator spouse. These trust assets would generally be considered the beneficiary’s separate property and not part of a marital property settlement in a divorce proceeding.
Thirdly, you can put remarriage protection in the lifetime trust for your surviving spouse. If your surviving spouse marries Thor, her Swedish personal trainer, or Bambi, his aerobics instructor, both your and your surviving spouse’s assets can be protected from claims by Thor or Bambi.
Fourthly, there is probate protection. Anything left in the separate trust after the death of a beneficiary can be distributed to succeeding beneficiaries without the necessity of going through the probate court process.
Lastly, these protections can continue for succeeding generations. You can give a beneficiary the power to leave anything left in his or her separate trust at the time of that beneficiary’s death to protective lifetime trusts he or she has set up for his or her own beneficiaries. If each generation does this, any unspent amounts of the inheritance you leave can have all of these protections forever.
If you do not have probate or trust assets at the time of your death, there are generally no assets available to pay your debts or other claims. In such instance, your survivors do not have to publish the creditors notice in the local paper or send the notice to your known creditors.
So, do not think that just because you have a trust that your survivors could escape all your debts. If you have assets at the time of your death, whether in your revocable trust or in your own name that must be probated, they are available to pay your creditors.
By: Matthew M. Wallace, CPA, JD
Published edited October 5, 2014 in The Times Herald newspaper, Port Huron, Michigan as: Estate, trust assets subject to the deceased’s debts