by Kevin G. Harvey February, 2012
A popular estate planning tool is the revocable living trust. A living trust is an agreement that determines how a person's property is to be managed and distributed during his or her lifetime and also upon death. There are normally three parties to a trust agreement:
The Settlor - This is the person who creates the trust, and is usually the person who provides the funding for the trust. There can be more than one settler of a trust, such as when a married couple create a single estate plan. The settlor is sometimes also referred to as the "grantor".
The Trustee - This is the person who holds title to the trust property and manages it according to the terms of the trust. The settlor usually serves as the trustee during his or her lifetime, and a successor trustee is named in the trust agreement to serve after the settlor's death or if the settlor is unable to continue serving for any reason.
The Beneficiary - This is the person or persons who will receive the income and/or principal from the trust. The settlor is usually the beneficiary during his or her lifetime and the settlor's children after the settlor's death. However, the settlor is free to name any persons or organizations (such as a charity) as the trust beneficiaries.
When a trust is created during the life of the settlor, it is described as a "living" trust. When the settlor reserves the right to amend the trust or to revoke it during the life of the settlor, the trust is described as "revocable". The most common trust agreement used in estate planning is the revocable living trust. The trust agreement itself is sometimes referred to as a "declaration of trust."
Creation and Funding of the Revocable Living Trust.
The process of creating a revocable living trust usually begins with a meeting with the attorney who will be drafting the trust agreement. Once the attorney has gained an understanding of the client's estate planning goals, the attorney will prepare the trust agreement. The trust agreement will then be signed by the client both in his or her capacity as the settlor and as the trustee - assuming the settlor will also be serving as the initial trustee.
After the trust has been created, the assets of the settlor will need to be transferred to the trust. The decisions to be made about transferring assets to the trust will usually be made with guidance and advice from the attorney. Transfer of the settlor's assets into the trust is important: only those assets that are held by the trustee at the death of the settlor will be distributed directly to the beneficiary or beneficiaries without first being processed through probate estate administration.
The Benefits of Using a Revocable Living Trust
There are several benefits to using a revocable living trust as an estate planning tool. First, a properly funded revocable living trust will result in avoidance of the probate process after the death of the settlor. The "probate process" involves administration of a deceased person's property with the assistance of a court. A person's last will and testament is "probated" (determined to be valid) by the court, and the person nominated in the will to serve as the administrator is then appointed by the court. The administrator then collects the assets of the deceased, liquidates them, pays valid claims against the estate, and then distributes the remainder to the beneficiaries named in the will.
The probate process lasts a minimum of three months after the date that notice of the opening of the estate is published in the paper. However, estates normally take nine to twelve months before they are fully administered, and longer in some cases. The legal assistance that is required for administration of an estate is usually greater than that which is required for administration of a trust. Thus, estate administration takes more time and is usually more costly than administration of a trust.
Secondly, the probate process is a matter of public record. The contents of the deceased's last will and testament and all documents filed in the court for the probate proceedings are available for inspection and copying by anyone. Trust administration, on the other hand, is typically completed privately without court involvement. To the extent that privacy is valued by the person creating the estate plan, a trust is a better option than a last will and testament.
Third, use of a trust can allow for a seamless transfer of administration of the trust assets if the settlor becomes incapacitated prior to death. Trust terms typically include provisions for transfer of control of the trust to the named successor trustee upon the incapacity of the trustee. Thus, if the settlor should become incapacitated, there is no disruption in the use of trust assets for the benefit of the settlor. This can be an especially important reason for small business owners to consider using a revocable living trust.
Finally, a married couple can benefit from using living revocable trusts as part of their estate plan to help lessen or avoid the amount of federal estate tax due upon the death of the surviving spouse. The topic of using revocable living trusts for federal estate tax planning purposes is fairly complex. For those married couples with a desire to make certain that federal estate taxes are minimized or eliminated through proper planning, analysis with an attorney should be completed.
The Deterrents to using a Revocable Living Trust
A revocable living trust is not necessarily the right option for every person or couple. There are several reasons why a person or couple might not choose to use a revocable living trust as an estate planning tool. First, the initial cost of utilizing a revocable living trust is greater than an estate plan that is built around a last will and testament. Trust agreements are usually more complex to draft and prepare than a will, and the legal assistance required in funding the trust after it is created is not required when only a last will and testament is used.
Second, because the trust must be funded after it is created, a significant deal of work by the settlor remains to be completed after the trust is created. When a last will and testament is signed, a person's estate planning efforts are usually (but not always) complete. However, because the trust only controls the assets that are transferred into it, after the agreement is signed the settlor must go through the process of funding the trust. This may involve creation of deeds to transfer real estate into the trust, change of beneficiary forms being completed for certain assets, titles to vehicles being changed, and title to accounts being changed at financial institutions. The process of funding the trust is sometimes daunting enough for some clients that they conclude it outweighs the benefits to be gained from using a trust.
Third, for married couples whose asset levels are such that payment of long term care costs would be a challenge and the prospect of long term care for one of the spouses seems real, a revocable living trust may not be the best option. If one spouse is facing long term care and assets will be transferred to the other spouse so Medicaid qualification can occur, the spouse who is not needing long term care may wish to utilize a will with a special needs trust in it for planning purposes. While this issue gives rise to an entirely separate analysis, the point to be made here is that a revocable living trust is not necessarily the ideal choice for everyone.
Finally, after the settlor's death, some of the income tax rules applicable to a trust are not as liberal as those available to a probate estate. For example, an estate may elect to use a fiscal year as its tax year, while a trust is restricted to the calendar year. Trusts must pay estimated income tax payments after the death of the settlor while an estate is exempt from this requirement for the first two years. Trusts are also subject to other tax rules that do not apply to probate estates.
Revocable living trusts can provide significant benefits to persons who utilize them in their estate planning process. However, whether the revocable living trust is the right tool for any particular person requires careful analysis that takes a person's age, health status, asset status, planning goals, and relationship to beneficiaries into account. Therefore, a thorough consultation with an estate planning attorney should occur before the particular components of a person's estate plan are selected.