Revocable Living Trusts

A revocable living trust is a trust that can be revoked or canceled at any time by the settlor. The term “living trust” means simply that the trust is established during the lifetime of the settlor. (Testamentary trusts, those created upon the settlor’s death, do not avoid probate and are not nearly as popular today as they once were.) During the past ten or fifteen years, revocable living trusts have gained enormous popularity as a sound technique for accomplishing a number of legitimate estate planning goals.

Avoiding Probate

A revocable trust (or irrevocable trust) that is properly drafted and funded will avoid probate. This is the most significant and valuable feature of a revocable trust. The benefits of avoiding probate can only be appreciated by understanding what happens when an estate must go through the probate process.

If a person dies owning property, not protected by a trust, a court will supervise the transfer of that property to those people named in his will. If someone dies without a will, his property passes to his relatives in the manner set forth under the laws of his state. The actual transfer of title to the decedent’s property is carried out under the court’s supervision by a person designated in the will as the Executor of the estate. If a person dies without a will, the court must appoint an Administrator to carry out the transfer of the decedent’s property. An Executor or Administrator is known as a Personal Representative.

The Personal Representative has the responsibility to perform the following:

1. Locate, inventory, and appraise all of the assets of the decedent.
2. Make final payment to all of the decedent’s creditors.
3. Prepare and file any federal and state death tax returns.
4. Distribute the assets of the decedent’s estate according to the decedent’s will or according to state law.

The Personal Representative will almost always hire an attorney to perform this work on his behalf. The attorneys collect their fees from the estate for these services. The amount of legal fees, depending upon the state, is either a fixed percentage of the estate or is based upon what a judge determines to be a reasonable fee.

The reason that most people do not want their estate to go through probate is that this process is expensive, time consuming, and inconvenient. Attorney’s fees may range from 2 percent to 10 percent of the gross value of the estate. An estate of $1 million, depending upon the complications involved, may incur attorney’s fees of $25,000. These fees are usually based upon the gross value of the estate rather than the net value. An estate of $1 million with $950,000 of liabilities might still pay attorney’s fees of $25,000. But now this amount is 50 percent, not 2½ percent of the net value.

Second, attorneys rarely feel the same sense of urgency about completing the probate that is felt by the decedent’s wife and children. While the decedent’s family wishes to get on with things as quickly as possible, the attorney for the estate is often busy handling other matters and the time period for completing the probate may take from two to five years. Probate causes significant stress and frustration for the survivors, and avoiding the process is a legitimate planning concern.

Revocable trusts are effective in avoiding probate only when the trust document has been properly drafted and only when all of the decedent’s property has been transferred into the trust prior to his death. The trust document, like a will, provides for the disposition of trust assets upon the death of the settlor. In the typical arrangement, a husband and wife will create a revocable trust with both husband and wife as the initial trustees. They are also the beneficiaries of the trust. The trust provides that during their joint lifetimes the trust may be revoked at any time. Upon the death of either spouse, the trust typically becomes irrevocable and the surviving spouse becomes the sole trustee. When the surviving spouse dies, the trust property passes according to the wishes expressed in the trust document.

Funding the Trust

For the revocable trust to be effective in eliminating probate, it is essential that all family assets be transferred into the trust prior to a spouse’s death. Any property that has not been transferred into the trust will be subject to probate, defeating the purpose of creating it in the first place. An amazing number of people go to the trouble and expense of forming a revocable trust and then fail to complete the work necessary to fund it.

Funding the trust involves transferring legal title from husband and wife into the name of the trust. For example, if Harry and Martha Jones are funding their revocable trust, they will change title to their assets from “Harry Jones and Martha Jones, husband and wife” to “Harry Jones and Martha Jones as Trustees of the Jones Family Trust, Dated January 1, 2018.”

For real estate, the change in title is accomplished by executing and recording a deed to the property. Bank accounts and brokerage accounts can be transferred by simply changing the name on the accounts to reflect the trust as the new owner. Shares of stock and bonds in registered form are changed by notifying the transfer agent for the issuing company and requesting that the certificates be reissued in the name of the trust. Stock in a family owned corporation can be changed by endorsing the old stock certificate to the trust and having the corporation issue a new certificate to the trust. Other types of property can be transferred by a simple written declaration called an Assignment.

The living trust also can be funded indirectly by transferring interests in other entities. For example, if you hold your property in a Family Limited Partnership or Limited Liability Company, the living trust can hold your shares in those companies.

Tax Treatment

During one’s lifetime, revocable trusts do not provide any income tax savings, For tax purposes, the trusts are treated as if they do not exist.  A revocable trust is known, for tax purposes, as a Grantor Trust.  A grantor trust is not a taxpaying entity.  No annual tax is required to be filed. Instead, all income and loss of the trust is reported on the tax returns of the husband and wife.

Asset Protection

A revocable trust does not provide any protection of assets from judgment creditors. It is ignored for creditor purposes just as it is ignored for income tax purposes. In most states, the law provides that if a settlor has the right to revoke the trust, all of the assets are treated as owned by the settlor. Perhaps because of the promotion associated with these trusts, many people mistakenly believe that a revocable trust somehow shields assets from creditors. This is not correct. If there is a judgment against you, the creditor is entitled to seize any assets that you have in the trust. Asset protection can be accomplished when property is held in the FLP or LLC and those interests are owned by the trust.