The revocable living trust has been heralded as the perfect estate planning tool allowing you to avoid probate and estate taxes. Exactly what is a revocable trust, how does it work, and what are its advantages and disadvantages?
A trust is a legal arrangement under which the property of one person (the grantor) is held by a second person (the trustee) for the benefit of a third person (the beneficiary). It is an entity into which you transfer your assets. Any property transferred into the trust is technically not your property for estate and probate purposes. If you die owning property in your individual name, that property would have to go through probate to reach your heirs. Property titled in the name of your trust, however, would avoid probate because the trust is the legal owner and the trust cannot die.
The Grantor. A revocable living trust is a trust created during your lifetime which you can amend or revoke. Probably the easiest way to explain how a trust works is to talk about the types of persons involved in the trust. There are 3 types of persons involved in every trust. The first is called the "grantor." In establishing the revocable living trust, you would be the grantor, or creator, of the trust. As grantor, you determine, by the terms of the document, how your property is managed and invested, who manages it, who the beneficiaries are, and what happens to your property after your death. You also have the right to amend or change the trust at any time during your lifetime or revoke it in its entirety. After your death, no one else can amend the trust and your wishes must be carried out.
The Trustee. The second person involved in the trust is the "trustee." The trustee is the legal owner of the property in the trust. The trustee has the authority to manage, invest, acquire and dispose of the property. During your lifetime, you would also be the trustee. Because you are both the grantor, with full authority to change the terms of the trust, and the trustee, with full authority to manage the trust property, you will have absolute control over all of the property in the trust. You will notice very little difference in managing your property after setting up the trust from when you owned it outright.
If you should become incapacitated, the successor trustee you named in the trust will be able to immediately manage the trust assets and provide for your needs without the need of a court-appointed guardian. Upon your death, the successor trustee will have authority to distribute the trust property to the ultimate beneficiaries in the manner that you have provided for in the trust. Your successor trustee can be your spouse, one or more of your children, a close friend or a corporate trust company.
The Beneficiary. The third category of person in the trust is the beneficiary. During your lifetime, you are the beneficiary of your revocable trust. All income and dividends earned by investments in the trust will go to you. You can spend it, re-invest it, or give it away. Exactly as before you set up the trust. You will also pay taxes on this income. Your tax return will not change as a result of the trust. The trust neither helps nor hurts your income tax situation. Upon your death, the trust property will be distributed by the successor trustee to the beneficiaries named in the trust. These distributions can be made without a probate administration. Provisions can be made to hold property for minor or incapacitated beneficiaries with distributions made to them based upon need or the occurrence of a specific event such as attaining a certain age. There is a tremendous amount of flexibility associated with the trust.
Funding. It is important to understand that the revocable trust serves to avoid probate and guardianship proceedings only if it is properly funded. This means that all of your assets should be transferred to and titled in the name of the trust. You should execute and record deeds transferring ownership of real estate from you to the trustee. Your investment accounts should be titled in the name of the trustee. Beneficiary designations to annuities, insurance policies and IRAs should name the successor trustee as primary or contingent beneficiary.
The Pour-Over Will. As I said before, any property owned by you individually at the time of your death will be subject to probate. For this reason, it is advisable that you have a will in addition to the trust. The will, known as a "pour-over" will, takes any property that you own individually at the time of your death and "pours" it over into the trust to be distributed according to the terms of the trust. If all of your property is properly funded into the trust, there will be no need to use the will. It is possible, however, that you may forget to transfer certain property into the trust or that your estate could acquire property after your death. If this is the case, the only way to put this property into the trust would be through the pour-over will.
In addition to the benefits described above, use of a revocable living trust can allow a married couple to pass an estate valued at a total of $10.24 million to its heirs without paying estate taxes to the federal government. However, your estate doesn’t need to be that large for the trust to be a benefit. Probate expenses usually run from 4% to 8% of the total value of your estate. In that case, a trust could possibly save the heirs of an estate valued at $300,000 ( a typical home and some investment assets), approximately $12,000 to $24,000 in probate costs.
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