Living Trusts / Revocable Trusts
Are trusts right for you?
Essential Elements of a Trust
Living trusts also known as revocable trusts are created by a legal document called a Declaration of Trust or a Trust Agreement. Every trust document must take three separate classes of parties into consideration. The person who creates the trust is called a “declarant,” a “trustor,” a “grantor,” or a “settlor.” The person who manages the trust is a “trustee.” Persons who receive distributions from the trust are “beneficiaries.” The trust document should clearly define the relationship among these three classes regarding the management of trust assets. In trusts that are not tax sensitive the same person can “wear all three hats” — they can be the trustor, the trustee, and the beneficiary. The trust document should also name a successor trustee or trustees to manage the trust if the original trustee dies or becomes incapacitated.
Dual Purpose Document
A living trust can be used to manage a person’s assets if they become incapacitated. In this respect, the trust is similar to a power of attorney. This feature can avoid the expense of a court conservatorship. A living trust can also be used to distribute a person’s assets following his or her death. In this respect, it acts like a Will. For this reason, living trusts have become popular as “probate avoidance” devices. A living trust avoids probate because it does not “die” when the person who created the trust dies. Because the assets are registered in the name of the trust rather than the name of the decedent, the trust assets can be distributed to the trust beneficiaries without court involvement. However, other formal documentation is still required to prove the trustee’s authority to distribute the trust assets.
A living trust can be used as a “Will substitute.” A Will transfers assets from a deceased individual to his or her beneficiaries. However, to be legally effective, the Will must be filed with a court and undergo the probate process. If most of a person’s assets are in a living trust at death, his or her Will does not have to be filed with a court or undergo the probate process. However, even when a trust is used to transfer a decedent’s assets, other non-judicial paperwork associated with death is not entirely eliminated. For example, the value of the decedent’s assets must still be determined for distribution purposes and also for future tax reporting if the assets are later gifted or sold. Also, if the decedent’s estate is of sufficient size, estate tax returns have to be prepared and filed with the appropriate taxing authorities.
A Will Still Necessary
A living trust does not eliminate the need for a Will. A Will is needed if not all of the deceased person’s assets are in held in trust at his or her death. Therefore, a “pour-over” Will is usually prepared for the trustor to transfer any of the decedent’s probate assets from his or her probate estate to the trust for ultimate distribution to the beneficiaries in accordance with the terms of the trust.
Trusts Not Always Cost-Effective
Sometimes the costs associated with preparing the trust document, transferring assets to the trust, and managing the trust can equal or exceed any probate costs saved at death. Unfortunately, some living trust preparers do not inform their clients that there are still costs associated with living trusts following death. Such costs include correctly valuing the assets at their date of death values, preparing and filing trust income tax returns, and possibly preparing and filing estate tax returns. Knowledgeable professionals will still be required to assist in the transfer process following death. Using a trust to distribute assets may require even more involvement (and, thus greater expense) by capable professionals to prepare and file income tax returns for the trust and to properly allocate assets between multiple trusts to insure future estate tax savings.
Anyone considering a living trust should compare the pre-death and post-death costs with the advantages and disadvantages of using a trust to transfer assets at death. For many persons (but certainly not for all persons) a living trust can be a cost-effective device to handle the transfer of a decedent’s assets following death. As more persons with living trusts are dying, the problems of unnecessary or ill-advised living trusts are coming to the forefront. Many persons who were told that a living trust would save their families “unnecessary” costs and taxes are learning that the highly touted savings in administration costs associated with living trusts can be illusory.
Taxation of Revocable Trusts
A revocable living trust is ignored for income tax purposes if the trustor, the trustee, and beneficiary are all the same person. This sensible rule eliminates the need to get a separate tax reporting number for the trust and filing separate tax returns for the trust during the trustor’s lifetime. However, when the trustor dies his or her trust is considered a separate legal entity for tax purposes. Separate income tax returns must be prepared for the trust if it is used to administer assets following the trustor’s death. For estate tax purposes, there is no difference between revocable living trusts and Wills. For estate tax purposes assets held in a revocable living trust at a person’s death are taxed in exactly the same manner as if the assets were held outside the trust.
Other Necessary Documents
A well-drafted and properly used living trust can have great advantages. However, it cannot be relied upon as the sole estate planning document. For a complete estate plan, a Will coordinated with the trust is needed to insure the proper distribution of assets at death. Also, a Living Will and Powers of Attorney for personal and health care matters are vital to assure proper care before death. If properly prepared and used, these documents can avoid the expenses associated with a court conservatorship and guardianship and also with the judicial distribution of assets following death. Conversely, a living trust that is not coordinated with the registration of a decedent’s assets or is improperly administered during the trustor’s life or following the trustor’s death can be a “financial disaster.”
No general conclusions can be abstractly drawn as to whether a funded revocable trust as a probate avoidance device is more or less advantageous than using other probate avoidance devices or a Will. It is necessary to analyze the advantages of a living trust versus a Will and other probate avoidance devices before any intelligent decision can be made in individual situations.