Revocable Trusts
Trusts are often used in estate planning. This is because trusts can allow you to be more specific about what happens with your property and assets – both before and after death.
In addition, because some types of trusts become the owner of assets that are transferred to them, the amount of estate taxes that your survivors owe can be reduced, or possibly eliminated.
There are many different trust types, though, so before moving forward with creating one, it is recommended that you first seek the advice of a financial, legal, and tax professional who can guide you through the process.
How Trusts Work
Contrary to what some people believe, it is not necessary to be ultra-wealthy to use trusts. Many people use trusts in their financial planning strategies so that they can protect and transfer assets without running into excessive taxation.
Trusts are legal vehicles that allow a third party – a trustee – to hold and direct assets in a particular fund on behalf of one or more recipients (referred to as beneficiaries). When working to manage your assets, trusts can greatly expand the options you have available to you. This is particularly the case if you are trying to shield your wealth from taxes and/or pass assets and property on to your heirs.
A trust has several components. These include the:
- Grantor – A grantor(s) refers to one or more individuals that set up and fund a trust with assets and/or property.
- Beneficiary – There can be one or more beneficiaries named in a trust. These are the individuals and/or entities (such as charitable organizations) that will receive the assets and property in the trust.
- Assets and/or Property – The grantor of a trust funds it with assets and/or property. There is a wide range of financial and investment vehicles that may be placed into a trust. These could include stocks, bonds, real estate, collectibles, and other valuable assets.
- Trustee – The trustee may be either a person or an entity (such as a bank or brokerage firm). It is the duty of the trustee to make sure that the instructions are followed according to the wishes of the grantor. If the trustee passes away or is deemed unable to fulfill their duties (for instance, due to a cognitive impairment or other health-related issues), then a successor trustee will take over for the trustee.
What is a Revocable Trust and How Does It Work?
There are many different ways that a trust can be structured, but there are two primary categories of trusts. These are revocable (or living) trusts and irrevocable trusts. It is important to know the difference between the two before you commit to having one created.
With a revocable trust, you are allowed to make changes – or even to cancel the trust altogether – during your lifetime. This means that you, as the trust’s grantor, can modify, update, and change the trust. You can also move assets in or out of the trust.
The assets that are inside of a revocable trust are technically owned by the trust itself, and not the grantor. This can help to reduce the size of your taxable estate. It can also be beneficial in terms of avoiding these assets going into probate.
In some cases, a revocable trust might even be used as a partial substitute for a last will and testament (although you will still usually need a will in order to cover any property or assets that are not included in the trust).
Also, revocable trusts can help with disability planning, too. For instance, the assets that are held in the name of the trust can be managed by a successor trustee if or when you are unable to make decisions on your own.
It is important to note that because the assets in a revocable trust are still accessible by the grantor, these trusts don’t necessarily provide protection against the claims of creditors (although they can make it more difficult for creditors to get to the trust’s assets). In many cases, a revocable trust will become an irrevocable trust upon the death of the grantor.
Although a revocable trust can provide you with many enticing benefits – as well as the flexibility of making changes – there are some factors to consider before you commit to using one. These can include:
- Paperwork – While revocable trusts are relatively straightforward in terms of setting up, they can require a great deal of paperwork. In addition, you need to make sure that ownership of all the property and assets you listed in the revocable trust document is legally transferred to the trust. This is the case for any asset that has a title document, such as stocks, bonds, mutual funds, and real estate. As an example, if you want to include your home in the trust, it is necessary to prepare and sign a new deed that transfers its ownership from you to the trust.
- Record Keeping – It is also necessary for you to keep written records when you transfer property and/or assets to or from the trust. (Although, if you are both the trustee and the grantor, there are no separate income tax records or returns necessary).
- Transfer Taxes – In some states, transferring real estate into a revocable trust may trigger a transfer tax.
- Can Be Difficult to Refinance the Mortgage on Real Property – Placing real estate into a revocable trust could make it difficult to refinance the mortgage. In some cases, it may be necessary to transfer the property back into your name temporarily, and then back into the trust after it has been refinanced.
- May Still Be Accessible to Creditors – In some situations – like having a large, unsettled debt – creditors may come after the assets in your estate, including those that are in a revocable trust, after you have passed away. So, based on the circumstances, it may even be preferable to let your estate go through probate. That is because, in the probate process, most states only allow creditors to make a claim for a six-month period of time. After that, no claims against the estate may be filed.
Pros and Cons of Investing in the Stock Market
| Revocable Trust Advantages | Revocable Trusts Disadvantages |
|---|---|
| Changes can be made by the grantor | Lots of paperwork may be required |
| Trust may be revoked | Record-keeping requirements |
| May be more difficult for creditors to get to your assets or property. | Not bulletproof from creditors and/or a bankruptcy court. |
| Can reduce the size of your taxable estate, and in turn, the amount of estate tax that is due | Transfer tax may be triggered |
| Can keep an estate from going through the probate process | May not be able to refinance the trust-owned property |
Unlike revocable trusts, an irrevocable trust will not allow the grantor to change or revoke it once it has been created. So, after you have placed assets and/or property into an irrevocable trust, it must remain there. Similar to a revocable trust, the assets that are placed into an irrevocable trust are owned by the trust rather than the grantor.
Upon your passing, the assets inside of an irrevocable trust will not be included in the overall value of your estate – and this, in turn, can reduce the amount of estate taxes that are due. Likewise, it is difficult for creditors – as well as a bankruptcy court – to get to any of these assets if you are sued.
Revocable Trusts vs Irrevocable Trusts
While the names revocable and irrevocable might sound similar, they actually refer to different types of trusts. Because of that, one type of trust may be better than another, based on your particular objectives.
The primary difference between these two trust types is the fact that revocable trusts may be changed – or even revoked – and an irrevocable trust cannot be. Typically, all it takes to modify a provision in a revocable trust is an amendment.
Revocable versus Irrevocable Trusts
| Revocable Trust | Irrevocable Trust | |
|---|---|---|
| Trust provisions can be changed | Yes | No |
| Trust can be revoked | Yes | No |
| Avoids probate | Yes | Yes |
| Completely removed assets from your name | No | Yes |
| Creditors can get to assets | Yes | No |
| Protects your privacy (such as assets and beneficiaries) | Yes | Yes |
