Picture this. You’re taking a long vacation at a beach resort about 500 miles away, and you have a lot of things you need to take with you. Clothes, toiletries, and your medications. You also want to bring your laptop to watch movies, a few books to read, and your cell phone.
You’ll also be spending a lot of time at the beach, so you’ll need your swimsuit, suntan lotion, and a beach towel. On this trip, you also want to make sure you stay in shape, so you bring all of your workout clothes, your Bluetooth earbuds, and a shaker bottle and protein mix.
OK, time to get packed, but you want to make sure you’re doing this in the most effective way possible, so you ask a friend who travels all of the time. Here’s what they tell you:
- Make sure you put your entire wardrobe, except the workout clothes and swimming gear, into one suitcase. That will go on a plane with ABC Airlines with instructions to deliver the suitcase to your hotel.
- Next, your medications are something you will absolutely need to be available on your trip, so make sure to ship them by courier to the hotel with instructions that they are to be placed in your hotel room bathroom prior to check-in.
- Since you’ll be using your beach gear at the beach, send those clothes via UPS three days ahead of time directly to the beach right outside your hotel, so they are there when you arrive, hopefully.
- You’ll also need to use the nearby gym location you are already a member of, so box up your workout clothes and protein shake materials and ship them via Fed Ex to that gym location.
- Since you will not need your laptop or books until you get to the hotel, put them in another suitcase and get them a ticket on a flight on XYZ Airlines with instructions to deliver them to the front desk of your hotel so you can pick them up when you check in.
- Finally, you need to get there to enjoy the trip, so book your own plane ticket on QRS Airlines, and bring your phone with you so you won’t be bored on the flight.
It will all work out, right?
This sounds absolutely ridiculous, and it absolutely is. However, this disjointed, haphazard approach is similar to the way many people approach their estate planning, even with a revocable living trust, leading to what looks like three or more separate and completely uncoordinated estate plans. When I end up working with trustees and executors to settle these hodge-podge plans, I have to explain to them The Three Estates Concept so they can grasp what needs to be done to settle.
How can this happen with a revocable living trust? Isn’t that supposed to avoid probate and put all of your plans into one place? Yes, but as the lawyer, my job is to build their custom suitcase and give them instructions on how to pack it to align with their overall estate plan.
A revocable living trust isn’t some magical document that you sign and everything mysteriously happens. Settling an estate is nothing more than transferring title from the deceased person to their beneficiaries, so it matters how the assets are titled after death.
So What are The Three Estates?
Here they are, one by one:
1) Trust Estate: In terms of simplicity, the ideal situation with a revocable living trust is that all of the assets are titled in the trust or they have pay-on-death designations into the trust. Now the trust controls the entire estate plan, avoids probate, and there is one set of allocation and distribution instructions within the trust to follow.
2) The Probate Estate: Whenever you have a revocable living trust, you want to avoid probate as much as possible. However, many times there are at least a few items that end up in probate. For these, we use a Last Will and Testament to control where those items go. However, to maintain consistency and have all of the plans for allocation and distribution kept private, we use what is called a Pour-Over Will, so the only beneficiary for the Will and probate is the revocable living trust. So even though it is not “packed” in the suitcase, it still goes to the same place on the same airplane.
3) The “Other’ Estates: Banks and other financial institutions will brag about how great their accounts are because they are “beneficiary driven,” meaning they will avoid probate. All you have to do is name the pay on death beneficiaries and “not have to worry about something like a revocable living trust.” The thing is you now have a separate estate plan for each and every account if you name different people on those particular accounts. By and large, we recommend that the trust be the beneficiary of these accounts if 1) there are tax consequences or complications with putting the account into the trust, or 2) there is a tax reason in your specific case to name beneficiaries directly, such as with IRAs and other tax-qualified accounts.
While we sometimes have to make use of all three of these “estates” in the planning process, it is not an absolute mess if everything is coordinated. If the overall plan is in the revocable living trust, then make sure that the suitcase is packed as much as possible, but then everything else is either in a carry-on or in your pockets. There’s no need to send your stuff through multiple transports just to get everything to your destination.
How Did The Three Estates Concept Happen?
So how do we get to a ridiculously haphazard estate where there are really three (or more) DIFFERENT estate plans? Let me use an example from a current estate I am assisting the trustee with settling:
Mom came to us around 2008 to put together her comprehensive estate plan. We created a Revocable Living Trust with two of her daughters getting her house equally, and then two of her grandchildren would divide everything else as the beneficiaries. We created a pour-over Will that named her trust as the beneficiary of anything that ended up in probate, advised her to name her trust as the owner of her bank and investment accounts, and to change the beneficiary of her IRA to be her trust.
After that, she never accepted any invitation to an Annual Review Meeting to discuss her plans and if there were any changes. Several months ago, her daughter called to inform us that she passed on, and that she needed to settle the trust as trustee, but she had no idea what to do. Then we discovered the following things:
- The house and personal items were still in her trust, and the trust had not been changed. Two daughters were to split the house, and the two grandchildren referenced split anything else in the trust.
- She did a new Last Will and Testament through another attorney, and this Will left all of her vehicles to a different grandchild while everything else was split evenly between the same two daughters who were getting the house through the trust. But her Will only applies to what goes into probate.
- She also changed banks and investment firms since we met in 2008, so any one of those accounts could be in her name, in the name of the trust, or pay on death to any number of people. We just don’t know because each account could potentially have different beneficiaries.
So, there are potentially one, two, or even three or more different estate plans for the same person all because her written plans and assets weren’t coordinated into one effective estate plan. In other words, her clothes could end up in Miami, her gym bag could surface in Toledo, and her toiletries and medicine took a completely different flight to Little Rock. All because she made changes to bits and pieces of her estate plan along the way without ever fully looking at the big picture the same way we did back in 2008.
As for the other attorney who redid her Will… either they were the biggest morons in the legal profession, or, more likely, the mom just didn’t tell the attorney she had a trust and her house and personal items were already in the trust. When it comes to the legal end of estate planning, it’s not up to the attorney to track down all of your assets and make sure you’re not lying about whether you own certain assets or not. We rely on our clients to be honest with us and ask questions if they’re not sure.
So that’s the concept of The Three Estates. Tell us if this is how you understood estate planning to be, or, if like most Americans, you just believed if you did a Will or a Trust that it just automatically included everything. For more information, please check out the free information at www.FreeTrustCourse.com, particularly the chapter in the free e-book Estate Planning Basics on funding your trust the right way.