One of the most frequently asked questions we hear when it comes to estate planning is “Do I need a Revocable Living Trust?” Trusts are no longer a planning tool reserved solely for the rich and powerful to pass on their wealth—now they can be useful for the middle class and sometimes even for Medicaid planning.
So what is a Revocable Living Trust? It is essentially a contract with three parties: the Grantor (the person who creates the trust and can make changes), the Trustee (the person or entity who manages the property and distributes the money), and the Beneficiary (the persons who enjoy the benefits from the trust). The Grantor expresses how they wish for their assets to be handled during their lifetime and after their death. The Trustee must manage the trust in a fiduciary capacity (a high legal duty) to carry out the intentions of the Grantor in the best interest of the beneficiaries. The Beneficiaries are the persons who receive the income or other property from the Trust, based on the terms set out in the trust document. It sounds crazy, but most revocable trusts are created with the Grantor, the Trustee, and the Beneficiary being the same person. This kind of trust uses one’s Social Security Number as its tax number and there is no trust income tax filed—the income of the trust is taxed directly to the Grantor.
One of the best things about a revocable trust is that its revocable—if at some point the Grantor decides that they no longer want it, they can revoke it, amend certain parts of it, or entirely re-do it. However, when the Grantor passes, the trust becomes irrevocable; a dead Grantor cannot come back to change it. But that does not necessarily mean everything is set in stone until the end of creation. Often a trust will allow the beneficiary to change the trustee and can allow a beneficiary to name future beneficiaries. Toggles can be proscribed to allow for changes in the administration if a beneficiary is disabled or has creditors, so that the corpus of the trust is protected. And the best trusts have provisions naming a Trust Advisor or Trust Protector, an individual who can step in and make changes if there are changes in law that affect the trust administration without the expense or time required to go to Court. Otherwise, an irrevocable trust can be changed with the permission of a Court.
Revocable Living Trusts offer a host of other benefits. During your lifetime, if you are not disabled, you can control all of your assets as if they were yours individually. They can dictate your wishes for your care during times you are disabled—we’ve even had clients specify what kind of wine they prefer to have with their dinner. They allow flexibility for passing on inheritance in ways that Wills cannot provide. Irrevocable trusts established for your spouse or children can provide asset protection for the beneficiaries from a divorce, creditor’s judgement, Medicaid estate recovery, and even Bankruptcy. A properly funded trust provides privacy, avoids probate and court costs, can be administered much faster than a court administration, and should save you and your loved ones a great deal of money! Most importantly, a trust allows you “full control” during your lifetime; and allows you to leave your legacy to your loved ones upon the terms that you set out for them.
There can be potential downsides to irrevocable trusts—trusts created as irrevocable trusts or revocable trusts that become irrevocable when the Grantor dies. For large trusts, administration often requires help from legal counsel or accountants. They create a penalty if one needs to apply for Medicaid within 5 years of funding that living trust. Poorly written trusts can make it difficult for beneficiaries to receive government assistance that they may otherwise be entitled to without exhausting the entire share of the trust property. Income of an irrevocable trust can be taxed at a much higher rate than an individual (anything over $12,500 is taxed at 37%!) if the income is not distributed to a beneficiary, and a separate trust tax return is often necessary.
Lastly, a trust is only as good as it is funded! If you fail to fund your trust (which happens often), your Trustee must wait for your Executor to go through probate and court administration, costing your loved ones’ time and substantial money. This issue undermines part of the reasons you chose to create a trust in the first place. So rule number one in creating a trust is to fully fund your trust, transferring your property to the Trustee, soon after you sign your trust agreement.
A well drafted trust will not only give you full control with the ability to change it as life changes, it allows you to appoint the next Trustee to manage things when you can’t, and can provide the best long term family planning, tax planning, and asset protection planning for your family as you wish. You can’t create a Last Will and Testament that can do all that for you.