Revocable Trusts

March 3, 2015 6:12 pm Published by

Here is an important read for individuals looking to plan their estate. Read on and let me know your thoughts in the comments.

Revocable Trusts:  What they do and what they don’t do.

So, you’re collecting your thoughts about what’s going to happen to all your stuff when you pass away.  You want things to pass as smoothly as possible with as little expense as possible.  You have a will, but you’re not sure if that’s enough.

Then you hear about another popular Estate Planning document – the Revocable Trust.  What do revocable trusts do?  And can one be used in place of a will?

What is a Revocable Trust?

A trust is a legal agreement between a grantor and a trustee, where the trustee agrees to manage the holdings of the trust according to the written provisions of the grantor.  If the provisions of the trust can be altered, then it is a Revocable Trust.

What Revocable Trusts provide that Wills don’t:

  1. Avoidance of Probate: This is the largest benefit that Revocable Trusts provide over the will.   All assets that pass through the will go through probate.  Assets held in the trust don’t pass through the will, but instead pass per the instructions of the trust.  By avoiding the will you save yourself the following:
    1. Time – The probate process typically lasts 9-12 months, so you will need to wait before you receive a probate-able distribution. Distributions from a trust usually go much quicker.
    2. Privacy – The probate process is a public affair. It needs to be, because the court needs to publicize your death and your estate in order that creditors or interested parties have a chance to make a claim against your estate.
    3. Multiple Probates – If you have real property in multiple states, each property will be subject to probate in its state.
  2. Preserve ability to control assets even if incapacitated: A trust grants authority to the trustee to handle and manage the assets of the trust even if the grantor becomes incapacitated.
  3. Harder to contest: A trust can be contested, but because it is private, a disgruntled or dis-inherited heir is less likely to hear about it, so he may not even know to contest. And, even if it is contested, it’s harder to prove incompetence or duress since so much activity takes place within trust.

Are trusts worth it?

The above advantages certainly indicate there is a value to Revocable Trusts, but be sure you don’t assume the trust is more valuable than it really is.

Common misperceptions of Revocable Trusts:

  1. Drafting the trust will save your assets from probate: This is a widespread error. Many people pay good money to have a trust drafted, but they never transfer their assets into the trust.  Once you have drafted the trust, you need to make sure that the trust is funded by retitling the assets into the name of the trust.  If you don’t, the trust is worthless.
  2. Probate applies to all assets: Many people establish a trust because they think probate applies to all assets.  That’s not the case.  There’s a good chance that a majority of your net worth will pass outside of probate.  Probate will not affect your retirement accounts (including TSP), life insurance, and probate may not affect your bank accounts or brokerage accounts if they’re titled correctly.  Even your house can avoid probate if titled correctly (varies by state).  What’s left?  Usually not much.
  3. Revocable trusts removes the need for a will: If only it were so simple.  You will still need a will to address any assets that are not addressed in the trust (nor addressed through other forms of titling or beneficiary designations).
  4. Assets held in the revocable trust are removed from my ownership: This is true of irrevocable trusts, but not revocable trusts.  An important feature of revocable trusts is that all ownership, income, gains or losses still belong to the grantor (the one who funded the trust) – not the trust itself.  As such, the trust doesn’t need to file it’s own taxes, and doesn’t need it’s own tax ID.  This is not true of irrevocable trusts where the assets are completely removed from your ownership and a new taxable entity is formed.  This distinction has numerous applications:
    1. Avoiding Estate Tax: People think revocable trusts will remove assets from their taxable estate.  This is simply not true.  As mentioned above, an important feature of revocable trusts is that all ownership belongs to the grantor, not the trust.  As such, all trust assets are included in your estate.
    2. Creditor protection: Revocable trusts don’t provide creditor protection.  You still own the assets.  In case of a lawsuit or bankruptcy, assets held in a revocable trust are considered.
    3. Student Aid consideration: Once again, you still own the assets.  As such, assets held in a revocable trust are considered for student aid qualifications.
    4. Foregoing Capital Gains Benefits: There are two capital gains benefits that people assume are lost once they give an asset over to an estate:
      1. Primary Residence Exclusion – The sale of your primary residence may generate the largest capital gain of your life. Thankfully there’s an amount of capital gains that you don’t have to pay taxes on.  This is known as a Primary residence capital gains exclusion (up to $500,000).  People assume this is lost if you transfer title of your home into a trust.  Thankfully it is not lost.  Remember, you still own the property.
      2. Stepped-up cost basis at death – Should you pass away and leave certain assets to an heir, they will usually enjoy a new “stepped-up” cost basis, which will reduce (or eliminate) any capital gain on that asset. People assume this is lost if you transfer title of such assets into a trust.  Thankfully it is not lost.  Remember, you still own the property.

Conclusion:  Revocable trusts are great vehicles but they are also super technical. Be sure to discuss it with a competent advisor.

As always, I wish you success!

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This post was written by Stephen Zelcer


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