Estate planners are finding the revocable living trust (RLT) to be an increasingly popular and useful tool. Some, however, are guilty of overstating the benefits of the RLT, and this can confuse clients and lead to some embracing RLTs for the wrong reasons.
In this article, we will answer frequently asked questions about RLTs, explain the benefits of the tools and try to dispel some common misconceptions.
What is a Revocable Living Trust?
An RLT is simply a form of ownership in which the creator of the trust, sometimes called the grantor or settlor, transfers property to a trustee (who may be the creator or others) with directions to hold the property pursuant to the certain terms of the trust agreement for the benefit of the beneficiaries. The trust agreement creating an RLT typically has three parts.
Part one applies to the period the grantor is alive and competent. During this period, the grantor is typically the sole beneficiary and sole trustee. The grantor has complete control over the trust property, including the power to withdraw all of the property and revoke the trust at any time and for any reason. Part two of the trust agreement states that if the grantor becomes incapacitated, a new trustee (the successor trustee) steps in to manage the trust assets for the grantor. The grantor remains the sole beneficiary of the trust during this time, but control of the assets is held by the successor trustee. Part two helps avoid the need for the grantor's family to go to probate court for the appointment of a conservator or guardian to manage the grantor's financial affairs upon incapacity; the functions that would be served by a court-appointed conservator or guardian are instead performed by the successor trustee. Part three provides for the disposition of the trust assets upon the grantor's death and, in many respects, functions as the grantor's will.
Will an RLT save estate taxes?
A properly designed RLT can help save on estate taxes by providing for maximum use of the grantor's available estate and generation-skipping tax exemptions and, if the grantor is married, the marital deduction. However, many clients seem to believe that RLTs provide estate-tax benefits that aren't available through a well-designed will. This simply isn't true. There are no estate-tax benefits available through an RLT that you could not also achieve through a properly designed will. There are certain kinds of trust agreements that do provide tax benefits beyond those available through a will, but these trusts are not RLTs; they are all irrevocable trusts.
I've heard that an RLT will help me avoid probate. What does that mean? What costs am I saving by avoiding probate?
If a client dies without an RLT, a probate court will oversee the management and transfer of his “probate property” at death. A client's probate property consists of any assets that were in his name at death other than property that passes by beneficiary designation or property that is held as joint tenants with right of survivorship with another person. In many states, the degree of court supervision is fairly limited. In others, however, the court is involved in virtually every stage of the estate administration. Judicial supervision of an estate can result in additional costs and inconvenience, but those burdens are generally nowhere near as significant as many RLT promoters allege. An individual who has funded an RLT during his lifetime will avoid probate with respect to the assets in the trust at death. An unfunded RLT will not allow the grantor's assets to avoid probate.
Are there other reasons to avoid probate?
Two situations in which probate can be particularly burdensome are where there are testamentary trusts under a will and where the decedent owned real estate in a state other than the state he or she resided in at death. Some states require ongoing judicial supervision of testamentary trusts established under a will. Trustees of these trusts must file accountings of all trust transactions every few years. For smaller trusts, the costs associated with such accountings can unnecessarily reduce trust assets. For an individual who has established an RLT, there is no court supervision of trusts established under the RLT. If an individual owns real property in more than one state there will be a probate procedure in the individual's home state at death as well as an ancillary probate procedure in any other state in which the individual owned real property. If the real estate in any state in which the client is not domiciled has been transferred to an RLT during his lifetime, there will be no need for an ancillary probate.
Do I need a will if I have a revocable living trust?
The short answer is yes. Few people will want to (or be able to) transfer all of their assets into an RLT. Accordingly, if a client has an RLT he will still need a very simple will (a “pourover will”) that adds to his RLT at death any property not added during his lifetime. A will also is necessary to appoint an executor. In most cases the trustee of your RLT will not be authorized to handle all matters relating to the settlement of the estate. If the client has minor children, he should name a guardian for those children in the will.
Does a revocable living trust file separate income tax returns?
If an RLT has taxable income or tax deductions, the trustee will have to maintain all of the usual financial and tax records. However, where one of the trustees is the person who created the trust, the information can be shown directly on that person's individual tax return (Form 1040) as if the trust didn't exist. In some other situations, a special trust tax return (Form 1041) must be filed, although the income and deductions still will be reported on the grantor's personal tax return while he or she is alive.
Are there any other advantages of a revocable living trust?
Other advantages of establishing an RLT include the following: First, if there are portions of the estate plan that should be kept confidential, an RLT provides more privacy than a will does because an RLT usually does not become a matter of public record. Second, in some states, an RLT may be somewhat less susceptible than a will to challenge by heirs. Third, in almost all states, a surviving spouse has the right to ignore the provisions of a deceased spouse's will and instead claim his or her “statutory share” of the estate of the amount guaranteed a surviving spouse by law, often one-third of the estate. A few states currently permit a married person to defeat this statutory claim of a surviving spouse by placing his or her assets in an RLT during lifetime (although such laws have been subject to recent criticism).
What are the disadvantages of a revocable living trust?
The disadvantages of an RLT are largely practical in nature and include the following:
Problems of Transferring Property
If an individual intends to transfer property to his RLT during his lifetime (which is not necessary to achieve many of the advantages of having an RLT), doing so can occasionally prove cumbersome and expensive. The nature of the property will determine the degree of inconvenience. For example, transferring cash and securities held in a brokerage account to an RLT is relatively simple. Transferring real estate becomes more complicated and expensive, as deeds must be prepared and recorded on the land records. Placing a condominium or a cooperative apartment in an RLT can be very difficult if various board of directors' approvals are needed and may not be permitted under state law.
Increased Planning Costs
If an individual wishes to establish an RLT there will be a legal charge for drafting the necessary agreement and the companion pourover will. It is somewhat more expensive to have two documents (will and RLT) drafted rather than one (will). In nearly every case, however, the existence of an RLT will sufficiently streamline the management of your affairs to more than recoup the initial setup costs.
Despite the popularity of the RLT, many persons and businesses remain unfamiliar with the concept and hesitate to get involved in what otherwise would be normal, everyday transactions. For example, refinancing a home or obtaining a home equity loan may be difficult if the property is owned by a trustee. Insurance companies and brokerage firms, especially the smaller or more cautious ones, can be difficult to deal with when real estate is owned by a trustee.
Lack of Court Supervision
The fact that an RLT is not subject to the same court supervision as are guardianships, conservatorships and wills (and thus does not incur the costs and other inconveniences associated with court proceedings) is one of the benefits of an RLT. However, in certain family situations, the lack of judicial supervision can prove to be a disadvantage. If a client is worried about his family members or selected fiduciaries abusing their positions of trust or otherwise wasting trust assets, judicial supervision of the assets of the estate can be a good thing. Accordingly, the decision to remove his affairs from the supervision of the probate court is one that should not be taken lightly.
Under most circumstances, an RLT can prove to be a beneficial addition to a client's estate plan. It will not, however, save estate taxes and, unless fully funded during a lifetime, will not result in avoiding probate.
REVOCABLE LIVING TRUSTS AT A GLANCE
WHAT IT IS:
A living trust is a formal revocable trust, usually set up by an attorney in which the owner specifies who will receive the trust assets when the owner dies. The owner keeps control of the trust assets during his or her lifetime and can change the trust at any time.
The Grantor — This is the person who creates the trust, and usually the only person who provides funding for the trust. More than one person can be grantor of a trust, such as when a husband and wife join together to create a family trust.
The Trustee — This is the person who holds title to the trust property and manages it according to the terms of the trust. The grantor often serves as trustee during his or her lifetime, and another person or a corporate trust company is named to serve as successor trustee in the event the grantor is unable to continue serving for any reason.
The Beneficiary — This is the person or persons who will receive the income or principal from the trust. This can be the grantor (and the grantor's spouse) during his or her lifetime and the grantor's children (or anyone else the grantor chooses to name) after the grantor's death.
HOW RLTS ARE INSURED
The owner of a living trust bank account is insured by the FDIC for up to $100,000 per beneficiary, if all of the following requirements are met:
The beneficiary must be the owner's spouse, child, grandchild, parent or sibling.
The beneficiary must become entitled to his or her interest in the trust when the owner dies.
The account title at the bank must indicate that the account is held by a trust.
An RLT should be considered when:
A client owns real property, OR
A client's estate has a value of over $100,000.
Sources: FDIC, The Missouri Bar Association