What Do Revocable Living Trusts Do?
A revocable living trust (RLT) allows individuals to avoid probate and plan for incapacity. By itself, a revocable living trust does not provide asset protection or estate tax benefits. However, revocable living trusts can serve as the foundation for an estate plan that uses these irrevocable trusts.
Trusts generally consist of a grantor, a trustee, and one or more beneficiaries. The grantor funds the trust with assets. The trustee then manages these assets for the benefit of the trust beneficiaries. In the case of a revocable living trust, the grantor serves as both the trustee and initial beneficiary of the trust. As a result, the grantor’s management and enjoyment of the assets held in trust are unchanged. The only difference is that the assets will be owned in trust as opposed to outright by the grantor. A revocable living trust is “revocable” because it can be amended or revoked at any time.
Figure: The grantor of a revocable living trust is typically also the initial trustee and is the primary beneficiary.
Because the grantor is also the beneficiary and the trustee of a revocable living trust, the income generated by the RLT is taxed as the personal income of the grantor. On the death of the grantor, assets in the RLT can be subject to transfer taxes.
Generally, an RLT-centric estate plan for a married couple consists of:
- An RLT (joint or separate depending on state law and other factors)
- Healthcare powers of attorney (and associated HIPAA waivers)
- Financial powers of attorney
- Pour-over wills
For more information on the human side of an estate plan and how to prepare for the particular family dynamics you have, read more here.
Revocable Living Trusts vs. Wills
A properly funded revocable living trust is the primary way in which an individual can avoid probate. Probate, the formal legal process of carrying out a will, can be a costly and time-consuming procedure. When the testator of a last will and testament dies, his or her assets pass through the probate process. The probate process is unfavorable for three reasons.
First, it can be expensive. Probate costs vary by state, but are as high as 10% of the estate’s value in some jurisdictions. If the grantor owns fixed assets in multiple states, a probate process will likely be required in each state where assets are held, further adding to the hassle and cost of the process. Second, in most jurisdictions, probate processes become part of the public record. This can invite litigation challenging dispositions and creditor claims against recipients of probate assets. Finally, for larger estates, the probate process can be quite lengthy, taking up to two years in some jurisdictions. On the other hand, the disposition of a revocable living trust is private and swift, and it avoids probate costs.
The disposition process is much different for a revocable living trust. The trust contains various dispositive provisions, similar to those found in a last will and testament. The trust also names a successor trustee, who will take over upon the grantor’s death or incapacity. When the grantor (who is also typically the initial trustee) passes, the successor trustee automatically takes control over the trust. The successor trustee is bound by fiduciary law and the terms of the trust. Generally, upon the grantor’s death, the dispositive provisions of the trust will become effective. It is the job of the successor trustee to carry out these dispositions. The trust, not the probate process, determines the disposition process.
Role of Pour-Over Wills
In some cases, probate cannot be completely avoided. The grantor may forget or fail to transfer some assets to the trust, and at his or her death these must pass through probate. The pour-over will addresses the grantor’s remaining probate assets, if any. The pour-over will is a catch-all insurance policy that leaves all assets remaining in the grantor’s estate to the trust. Once in the trust, the assets are passed in accordance with the trust’s terms.
This process maintains privacy as the only information on the public record are dispositions to the trust, as opposed to the subsequent dispositions under the trust terms. Moreover, because there are usually few assets remaining in the grantor’s probate estate, the process can be accomplished quickly and cost effectively. Finally, the pour-over will can include guardianship appointments for minor children in the event that the grantor has any. These appointments must be approved by the probate court, but courts typically give great deference to those named as guardians in wills.
Another significant advantage to an RLT-centered estate plan is incapacity planning. Incapacity planning is generally unavailable for wills, as wills only become effective upon the death of the testator. (Trusts, on the other hand, become effective upon signing and funding and in effect during the lifetime of the grantor.) When there is no incapacity planning, family members must petition a court to have an individual declared legally incompetent. This proceeding is invasive, potentially adversarial, and potentially embarrassing.
Once a court legally designates an individual as incompetent, the ramifications that are difficult to reverse. An RLT can address this scenario by providing a private mechanism for determining grantor incapacity, usually a disability panel or a two-doctor test. In either case, the determination is private and avoids a legal designation of incompetency. If the individual’s incapacity is only temporary, the disability panel or two-doctor test makes it much easier for him or her to resume control of the assets.
If the disability panel deems the grantor incapacitated, the successor trustee automatically takes over. The successor trustee will continue to manage the assets held in trust for the benefit of the grantor/initial beneficiary, meaning that the incapacitated grantor will still receive the full benefit of his or her assets. This process is automatic upon the designation of incapacity, so there is no delay in the ongoing management of trust assets, as could be the case in a judicial proceeding. Note: this ongoing administration is only applicable to the assets for which the successor trustee has authority over—the assets held in trust. Other ancillary documents govern the management of the incapacitated grantor’s other affairs.
Powers of Attorney
The healthcare power of attorney grants agency to an individual to make medical decisions on behalf of the principal in the event that the principal is unable to do so. The principal typically names a close family member to this role. Additionally, due to applicable federal law and regulation, the holder of healthcare power of attorney should be granted a HIPAA waiver so that the individual can be informed of the principal’s medical situation. This waiver can be granted to more than just the individual holding healthcare power of attorney if the principal so chooses.
The financial power of attorney is also an agency relationship. The agent with this power can make financial decisions on behalf of the incapacitated principal including the filing of tax returns, management of litigation, and the handling of other financial matters not under the purview of the successor trustee. The incapacity determination standard for this instrument can be tied to the standard applied in the revocable living trust, ensuring privacy for the principal and family members.
Revocable living trusts let a grantor avoid probate, plan for incapacity, and grant powers of attorney. The RLT can serve on its own, or serve as the foundation of an estate plan using irrevocable trusts in order to meet a variety of asset protection and tax optimization needs.