IN TOTTEN DON’T TRUST

A Totten Trust is a deposit by one person of his own money in his own name as trustee for another.  The trust is a tentative one, revocable at will, until the depositor dies, or unless the depositor transforms it into an irrevocable trust.

These trusts are very popular as “will substitutes,” passing property to a named beneficiary automatically on the death of the depositor.  No will is necessary to transfer the account. So many people are attracted to its use for its simplicity and the possibility of saving “probate costs” on the settlement of their estates.  Unfortunately, because a Totten Trust is so easy to create, it is often overused.  Many people believe that a Totten Trust immediately transfers property out of their estate.  Some further believe that it saves estate taxes.  Both are misconceptions.  And, many have no idea of the traps and pitfalls they are getting themselves into once the Totten Trust is created.

The Account is Fully Includible in the Grantor’s Taxable Estate and Income.

Creating a Totten Trust does not exclude the account from the Grantor’s taxable estate.  If the Grantor’s estate is large enough to incur estate taxes for Federal purposes ( $2,000,000 for 2008), then a trust account over which the depositor maintains control until his death is fully includible in the depositor’s gross taxable estate.  Moreover, as the depositor’s money while the depositor is alive, any interest earned on the account must be reported by the depositor as income each year.  The bank reports the income to the Internal Revenue Service on the depositor’s taxpayer identification number or Social Security Number.  So a sure way for a depositor to get a letter from the IRS. is to omit this income from his or her tax return.

No Shield From Creditors.

But just as dangerous a misconception is that these trusts protect the deposits from claims of creditors.  This is not the case.  Since a depositor, prior to his death, may withdraw any or all of the fund, his ownership of the fund continues unchanged until his death.  The gift of the fund becomes complete only on the instance of the depositor’s death.  During the depositor’s lifetime, the beneficiary’s interest is only a temporary convenience for the depositor and not a vested right that the beneficiary has to the fund.

Vulnerable to claims of creditors.  Therefore, during the lifetime of the depositor and so long as the Totten Trust remains revocable, a creditor of the depositor who gets a judgment against the depositor may reach the proceeds of the account to satisfy his judgment.  

Medicaid Danger.  The danger of a creditor reaching these funds is a constant threat over  Totten Trusts.  Reason: They are so often used by elderly people to pass significant parts of their estates to close relatives, such as children and grandchildren.  Yet, there is a high risk that these same elderly persons may need nursing home care before their deaths.  So, the chance that these accounts will be subject to Medicaid reimbursement claims threatens the existence of these accounts should the depositor need  Medicaid to pay for the nursing home costs.  Protecting these funds from Medicaid claims will be the subject of a later article.

The Trust Account is Available for the Estate’s Debts.  The Totten Trust’s vulnerability to claims of creditors extends beyond the depositor’s lifetime, as well.  If an estate’s liabilities, funeral and administrative expenses and claims of creditors exceed the assets of the probate estate (the assets owned by a decedent controlled by his will), the Executor of the estate can have the Totten Trusts established by the decedent set aside as fraudulent conveyances, since up until his death the decedent retained control of the accounts and consequently the decedent’s liabilities resulting from his death cannot be cut off by the attempted transfer.  

Not Protected from Spousal Claims, Either.  In New York, the surviving spouse of a decedent has a right to elect to take a minimum amount of the decedent’s net estate, regardless of the provisions of the decedent’s will.  Some depositors believe that by setting up a Totten Trust for a third party the account is protected from these claims.  This is not so.  A Totten Trust is treated as a “will substitute” in New York and the capital value of the account, as of the decedent’s death, is included in the net estate of the decedent subject to the surviving spouse’s right of election.  However, if the depositor’s spouse is the Totten Trust beneficiary, then the amount of the account is not included in the depositor’s net estate, so it is not counted towards satisfaction of the spouse’s minimum right of election.  (If you are getting the idea that these accounts are not as simple as you once thought, you are definitely right.)

Obviously then, care and consideration must be taken when thinking about transfers to beneficiaries in the form of Totten Trusts.  The traps can easily defeat the purposes for the creation of these trusts and alternatives frequently can more efficiently accomplish the same objectives.

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Copyright © 2007 STEPHEN C. SILVERBERG, PLLC  All rights reserved.
Last modified: December 27, 2007

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