Revocable Trusts

Essential Elements of a Trust

Revocable Trusts, also known as Living Trusts, are created by a legal document called a Declaration of Trust or a Trust Agreement. Every trust document has three separate parties. 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. For 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 to manage the trust if the original trustee dies or becomes incapacitated.

Dual Purpose Document

A revocable trust can also be used to distribute a person’s assets following their death without a probate proceeding. In this respect, it acts like a Will. For this reason, revocable trusts have become popular as “probate avoidance” devices.

A revocable 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 revocable trust can also be used to manage a person’s assets if they become incapacitated. In this respect, the use of a trust is similar to a power of attorney. This feature can avoid the expense of a court conservatorship.

“Will Substitute”

A revocable trust can be used as a “Will substitute.” A Will transfers assets from a deceased individual to their beneficiaries. However, to be legally effective, the Will must be filed with a court and undergo probate. If most of a person’s assets are in their trust at death, their 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. They also must be valued 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 revocable trust does not eliminate the need for a Will.  Unless most of the deceased trustor’s assets are held in trust at their death, a Will still may be needed. If the value of a decedent’s “probate” assets exceeds a specific amount specified by state laws, a formal probate is required to transfer them. Therefore, a “pour-over” Will should be prepared for the trustor to transfer any probate assets to the trust for ultimate distribution to the trust beneficiaries.

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. 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 ensure future estate tax savings. 

Anyone considering a revocable trust should compare the pre-death and post-death costs with using a trust to transfer assets at death. For many persons (but not all) a revocable trust can be a cost-effective device to handle the transfer of their assets at death. 

Taxation of Revocable Trusts

A revocable trust is ignored for income tax purposes if the trustor, the trustee, and the beneficiary are all the same person. This eliminates the need for a separate tax reporting number for the trust. It also eliminates the need to file separate tax returns for the trust during the trustor’s lifetime. However, when the trustor dies, their trust is considered a separate legal entity for tax purposes. Therefore, separate income tax returns must be prepared for the trust if it is used to administer assets following the trustor’s death.

There is no difference between revocable trusts and Wills for estate tax purposes. For estate tax purposes, assets held in a revocable trust at a person’s death are taxed exactly the same as if the assets were held outside the trust.

Other Necessary Documents

A well-drafted and properly used revocable trust can have significant 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 ensure the proper distribution of assets at death. Also, a Living Will and Powers of Attorney for financial, personal, and health care matters are vital documents. If properly prepared and used, these documents can avoid the expenses associated with a court conservatorship and guardianship and 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.”

Summary

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 a Will or other probate avoidance techniques. Therefore, it is always necessary to analyze their estate planning options. For some individuals, a funded revocable trust is definitely appropriate. For other individuals, a Will or other probate avoidance device may be more appropriate.