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Understanding the Basics of Revocable Trusts

A revocable living trust is a legal entity established by means of a “Trust Agreement” into which you (as the “Trustor” or the “Settlor”) place property for the benefit of one or more individuals (“Beneficiaries”).  A “Trustee” is appointed to manage the assets placed in the trusts and to distribute those assets both during your lifetime and after your death according to the terms that you establish in the Trust Agreement.

During your own life you can be the Trustor (or “Settlor”), Trustee and Beneficiary of your trust, all at once. The assets within the revocable trust remain completely within your control and may be removed at any time. Assets are taxed to you personally and there is no need for a special tax i.d. number for the revocable living trust. 

As the Settlor or Trustor of the Trust you can change the terms of the revocable Trust Agreement whenever you desire to do so.  Furthermore, if during your lifetime you decide that you don’t need a Trust after all, you can revoke the entire Trust.

The Trust can be terminated at your death if all of your assets are to be distributed then, or may continue, if you want your assets kept in trust for your beneficiaries, and not given to them all at once. Once you pass on, a Successor Trustee designated by you in the Trust, takes on the role of Trustee, with either the same powers that you exercised, or powers limited by your direction.

Benefits of the Revocable Living Trust

1. Avoids the costs, public scrutiny, and delay of probate.

With a revocable living trust, you avoid the significant drawbacks of probate discussed in the prior issue of this newsletter:  significantly greater expense in the administration of an estate; greater delay in your beneficiaries getting their inheritance; and loss of privacy. For example, under California law your estate will incur at least $15,000 just for attorney fees and court fees on a $500,000 gross estate, not including the approximate $13,000, the executor is entitled to, unless some alternative private agreement has been reached.  You will also have your probate file (including the names, addresses of your heirs, the description of the assets in the estate, and how they are being distributed) available for public view! Particularly in the case of the elderly, this public access of information has given rise to countless scams on the part of the unscrupulous looking to capitalize on the vulnerability of a widow or widower.

The delay with a probate can be significant because under California law a probate estate must stay open for at least four months from the date that the executor has been appointed by the court, so the estate can almost never be distributed in less than six months.  It can take considerably longer.  I have just completed a relatively “simple” probate that took fifteen months!

A revocable living trust makes the process considerably easier for your beneficiaries.  Though there is a cost involved in administering a trust after death, it is generally far less onerous than probate.  In most cases, you can count on saving many thousands of dollars that can then go to your desired beneficiaries, and not to attorney and court fees. 

Another advantage is that the administering of your trust at your death takes place outside of the court system and is not a matter of public record (save, of course, for the real estate you own).  In most cases, the beneficiaries of your Trust can receive their inheritances far more quickly than through probate, unless you have a complicated estate requiring extensive tax planning, even after death.

Yet another benefit of a Trust is avoiding multiple probate proceedings when a family owns real estate in more than one state.  In the absence of a Trust, real estate must be probated in the state where it is located, even though the owner has already gone through probate in their state of residence!

2. Bypasses the Need for a Conservatorship If You Become Incapacitated

Beyond the avoidance of probate, a revocable living trust has other advantages.  If you become incapacitated, the Successor Trustee that you have named in your Trust can step into your shoes and manage your affairs.  You choose the person you feel is most capable to take on this job and they are then free to carry on for you free of court interference.  If you don’t have a Trust (or a Power of Attorney for Finances), then your family must embark on a costly, public court procedure to have the court appoint a conservator for you, a conservator who may not be the person you would have chosen for yourself. 

Again, a Trust is a way for you to decide the course of your fate, rather than leave it in the hands of a court that may or may not judge rightly as to what is best for you.

3. Gives You Options for Distribution of Your Assets to Beneficiaries

With a revocable living trust you can make provisions that ensure that your minor children or other loved ones are taken care of in the manner that seems appropriate to you.  Assets that you leave them can be kept in trust and disbursed to them in whatever increments you desire, under whatever conditions seem right for your goals for them, as long as those conditions are not against public policy.

Similarly, you may establish a special needs trust within your revocable living trust if you have a beneficiary who is mentally or physically disabled without jeopardizing their eligibility for public benefits.

Parents can also avoid lump sum payment of insurance proceeds to their children by naming the revocable trust as the contingent beneficiary of the policy after the spouse.  In this way, in the spouse’s absence, the proceeds can be distributed to the children in accordance with the detailed instructions that are in the Trust Agreement.

One can also make provisions for the care of beloved pets by naming caretakers, and alternate caretakers, and by providing for cash gifts that will make their kind care more likely.

Note:  Although a testamentary trust (a trust established at death through a will) can give one options for distribution that are similar to those of a revocable living trust, it does not allow the trustee to take over in case of incapacity, nor does it avoid probate--nor keep your affairs private. Also, it is usually as costly to establish a testamentary trust as it is to establish the living trust, but without the great savings on probate fees.

4.  Provides a Means to Reduce or Sometimes Eliminate Estate Taxes

Married Persons: The estate tax exemption is $5 million for 2011 and 2012 but this will change in 2013 unless Congress acts again.  The tax scheme is still in flux and in the interim, estate planning attorneys do their best to limit the tax liability of their clients given the uncertain tax environment with a number of devices. 

One popular tax-saving device used for married couples that is sanctioned by the tax law is including special provisions in a revocable living trust setting aside an amount equal to the personal estate tax exemption of the spouse who dies first in what is known as an AB trust, (also known as a “credit shelter” or “bypass” trust). At first glance this may seem unnecessary since it is true that a person with a spouse who is a U.S. citizen can leave all assets to that spouse tax-free because of something known as the “unlimited marital deduction”.  Even Bill Gates can leave his billions to his wife tax-free under this marital tax law! 

The problem is that if you left everything outright to your spouse, those assets would then be in the survivor’s estate to be taxed at his or her death, and you would have wasted the first spouse’s personal estate tax exemption.  With an AB trust, married couples can double the amounts that can be passed to their beneficiaries’ estate tax-free by making use of the two personal estate tax exemptions. For example, in the year 2013, a couple could, upon the death of the second spouse, transfer $5 million to their beneficiaries, free of estate tax if they use the AB trust.  Here’s how it works:

On the death of the first spouse, your trust estate is divided into two separate trusts, the “A” Trust (Survivor’s Trust) and “B” Trust (Exemption Trust). 

The “A” Trust is then funded with the property of the surviving spouse, which includes any separate property that the survivor owns plus the one-half of community property that belongs to him or her.  This Trust is revocable and the survivor is entitled to all the income and principal in it.  At the death of the surviving spouse, the “A” Trust will be taxed to the degree that it exceeds the personal estate tax exemption amount at the time of death.

The “B” Trust is funded with the property of the first spouse to pass on, up to the exemption equivalent amount (this will vary depending on what the personal exemption is at the time of death—presently it’s $5.25M).  Any property over the personal exemption amount is added to the “A” Trust (or is added to a “C” Trust if the first-to-die wants to control the ultimate disposition of the excess beyond the exemption amount).  This “B” Trust becomes irrevocable (meaning that it can’t be changed) upon the death of the first spouse. 

The survivor may be entitled to all of the income from this Trust, as well as any principal he or she may need for “health, education, support and maintenance.” There is no estate tax due on this “B” Trust because it does not exceed the personal exemption amount.  Also, since the assets in this “B” Trust are not left outright to the surviving spouse, they will not be taxed in the survivor’s estate at the second death.  The assets in this “B” Trust continue to appreciate estate tax-free and will, in many cases, be safe from creditors’ claims, if additional precautions are taken.  There is, however, a trade-off:  assets receive a step-up in basis at the first death, but the assets in the B Trust do not receive a step-up in basis at the second death, which may result in capital gains tax at the second death for the assets in that trust.

The surviving spouse is in most cases the trustee of the “A” and “B” Trusts and will determine which assets go into the respective trusts, although there are also downsides to the surviving spouse being the trustee of the B Trust that should be discussed with your lawyer.

The AB trust is a very popular vehicle for another non-tax purpose:  it ensures that after the surviving spouse passes away, the beneficiaries designated in the revocable trust will not be changed.  It is an excellent way of caring for the surviving spouse while at the same time securing that your chosen beneficiaries (and not creditors, unscrupulous caretakers, or gold-diggers) will inherit the hard-earned assets of the first spouse to die. Blended families most often choose an A-B Trust, or A-B-C Trust to ensure that children of first marriages eventually receive the assets of the first spouse to die.  Please note, also, that although the trust cannot be changed or undone generally speaking, it is possible to petition the court in very specific cases to do just that:  it depends on whether circumstances have changed, and how agreeable the beneficiaries are.  In any event, this is not an easy thing to do, and will involve attorney and court fees.

Another commonly-used planning tool is the Disclaimer Trust, which has the same tax-saving feature of the AB Trust, but allows the surviving spouse to make the election for the trust sometime within the first nine months after the first spouse dies, if such a trust were necessary for avoiding estate taxes, given the couple’s assets and the law at the time of the first spouse’s death.  In other words, if your only concern is estate taxes, then you don’t have to lock in a trust that may be unnecessary given a change in the tax law.  You can decide later, rather than sooner.  With this option, however, you cannot guarantee that the beneficiaries you designated originally in the revocable trust will be the beneficiaries when the second spouse dies.  For that you need the AB Trust. That being said, many couples choose this option because of its flexibility, especially in a tax environment where the estate tax exemption is as high as it has been in the past few years.

Single Persons: Since single persons don’t have the advantage of the  persons can put special gifting provisions in their trust that allow their Successor Trustee to make gifts on their behalf if death is near and it looks like the estate will be susceptible to estate taxes.  Other gifting strategies are available to single persons that can be discussed with your attorney, such as charitable giving.

In summary, probate avoidance, flexibility in planning for your loved ones, the elimination of conservatorships and potential tax savings are some of the important reasons why revocable living trusts have become a centerpiece of estate planning since the 1980’s, for a great number of people

© Aida M. del Valle.  All Rights Reserved.