Frequently-Asked Questions (FAQs) about Revocable Living Trusts
• What is a trust anyway?
• Does a trust have to be in writing?
• Are there different types of trusts?
• How do living trusts avoid probate?
• Have living trusts always been used to avoid probate?
• Is it a good idea to avoid probate?
• Are there disadvantages to a living trust?
• If I have a living trust, Do I still need a will?
• Are there tax benefits with a revocable living trust?
• Can a living trust reduce estate taxes?
• Will a living trust protect my property from creditors?
• Can I qualify for Medicaid (Title XIX) with a living trust?
• Do I need an attorney to set up a living trust?
What is a trust anyway?
In a general sense, a trust is nothing more than an arrangement whereby one person agrees to hold property for the benefit of another. We create trusts all the time without even thinking about it.
For example, how many times have you given money to a baby sitter in case he or she needed something for the kids? In a strictly legal sense, your baby sitter accepted the money and agreed to hold it and use it for their benefit. That is the essence of a trust - someone agrees to hold money or property for the benefit of someone else. In a pragmatic sense, you trusted your baby sitter to hold on to the money and use it for the purpose you intended. Although you may not have discussed this with your baby sitter, there probably was an implied understanding that whatever wasn't spent would be returned to you.
Even the most complicated trusts have the same basic components as our baby sitter example; i.e.:
• Someone is the creator of the trust. We call this person the "grantor." Other people call the creator of a trust the "donor," or the "settlor," or the "trustor." All these terms are used interchangeable. In our baby sitter example, you were the grantor because you created the trust between you and the baby sitter.
• Someone agrees to hold money or other property for the benefit of someone else. We call this person the "trustee." There may be more than one trustee and the trustee need not be a person. It may be a corporation with trust powers, such as a bank. In our baby sitter example, your baby sitter agreed to serve as the trustee.
• Some money or other property must be held by the trustee for the benefit of someone else. We call this money or other property the "principal" of the trust. Some people also call this money or other property the "corpus" of the trust. The principal (or corpus) of the trust never stays the same; some is spent by the trustee, some is invested - earning dividends and interest, and some of the principal appreciates and/or depreciates in value. Collectively, we call all of this money or property the "trust fund."
• Someone else must benefit from the trust. We call this person the "beneficiary" of the trust. There may be more than one beneficiary. In that case, they are collectively called the "beneficiaries." In our baby sitter example above, your children were the beneficiaries of the trust.
All trusts have these four basic components. For more detailed information concerning a trust and the different types of trusts that exist today, please refer to our section entitled "Types of Trusts."
Does a trust have to be in writing?
Well, yes and no! Most states have adopted a common designation for a very celebrated English statute passed in 1677, called the "statute of frauds." The statute of frauds says that no person shall maintain a suit or action on certain contracts or agreements unless there is a note or memorandum thereof signed by the person to be charged. The intent was to eliminate the many frauds that existed when there was nothing in writing to support the agreement. A trust will generally come under this statute.
Despite the statute of frauds, many courts will uphold an oral or otherwise informal trust upon a clear showing that the grantor intended to create a trust. If a trust is intended to hold real estate, however, then a trust instrument should be prepared and executed with the same formalities required of a deed.
Some states have passed legislation that specifically requires a revocable living trust with testamentary features (i.e., the trust instrument contains provisions for the disposition of trust property following the death of the grantor) to be executed with the same formalities as a Will.
See 2004 Florida Statutes, §737.111, which invalidates the provisions of a revocable living trust that dispose of trust property after the grantor's death if the trust instrument is not executed with the formalities of a Will.
Because more and more states, like Florida, are passing legislation affecting revocable living trusts, it is important that you become aware of any statutes in your home state that might affect your revocable living trust.
Are there different kinds of trusts?
Yes, there are different kinds of trusts. First, there are testamentary trusts and there are living trusts. A "testamentary trust" is a trust created under a Last Will and Testament. As such, a testamentary trust becomes effective only after the testator's death and, even then, the will must be approved and admitted to probate.
A "living trust," on the other hand, is a trust created during the grantor's lifetime, and the trust becomes effective immediately upon its creation. Living trusts are created by a written instrument, called a "trust instrument." If the grantor is also the sole trustee, then the trust instrument is called a "declaration of trust," because the grantor simply declares his or her intentions to the world. However, if someone other than the grantor is a trustee, then the trust instrument becomes a "trust agreement," because the grantor and the trustee must agree on the terms of the trust.
Since living trusts are created during one's lifetime, they can be either revocable or irrevocable. A "revocable trust" or "revocable living trust" is one that can be amended or changed, or even terminated, during the grantor's lifetime. In almost all cases, it is the grantor who reserves this right when the trust is created. Even so, the trust becomes irrevocable upon the grantor's death because only the grantor retains the right to amend or terminate the trust.
An "irrevocable trust" or "irrevocable living trust" is one that cannot be amended or changed, or even terminated, during the grantor's lifetime. Once created, an irrevocable trust is governed exclusively by the terms of the trust instrument without any control by the grantor. For this reason, irrevocable trusts are created almost exclusively to obtain favorable income tax and/or estate tax benefits for the grantor, although irrevocable trusts are also created by the courts in divorce cases and property settlement cases involving minor children. A Life insurance trust is an example of an irrevocable trust that is often created by wealthy individuals to exclude the death benefits of a life insurance policy from federal estate taxation.
How do living trusts avoid probate?
First, we have to digress for a moment. One of the greatest benefits of living in this country is our right to own property and to be able to transfer that property to our intended beneficiaries upon our death. Not all countries allow that privilege to their citizens.
We not only have that privilege, we also have a system of laws and regulations that are designed to bring that privilege to fruition. First, we have the right to designate the person or persons who will receive our property upon our death. We can exercise that right through a Last Will and Testament if we wish. If we choose not to exercise that right, then the state will still try to get our property to the "natural objects of our bounty." Second, whether we choose to designate the beneficiaries of our property through a Last Will and Testament or not, the transfer of property to our beneficiaries is made possible by the probate court system of the state in which we live.
The probate court system is designed to settle decedents' estates and transfer property to designated beneficiaries. However, it is important to know that all property does not pass through probate. Property that is owned jointly with another person, when there are rights of survivorship, does not go through probate. Jointly-owned property passes automatically to the surviving joint owner. Married couples often own their property jointly, such as bank accounts, cars, even their home. When one spouse dies, the surviving spouse automatically becomes the sole owner of the property without going through probate. Death benefits payable under life insurance policies also avoid probate if a valid beneficiary designation is on file. Upon the death of an insured, the insurance company issues a check directly to the designated beneficiary. The same is true with annuity contracts and retirement plans, including IRAs. As long as a valid beneficiary designation is on file, the death benefits payable under those properties are paid directly to the designated beneficiaries. There is no need for probate with these types of properties because a procedure to determine the intended beneficiary is already in place. Of course, if a valid beneficiary designation is not on file, or if the designated beneficiaries do not survive the owner, then these types of property will be paid to the owner's estate, which then passes through probate.
For all practical purposes, the only property that does pass through probate is property that was owned solely by a deceased person at the time of his or her death. Think about it for a moment. Let's assume that you are married and both you and your spouse are retired. You own your home, your car, your bank accounts, and everything else in joint name. Let's assume further that you die and your spouse survives you. All of your jointly-owned property automatically becomes owned solely by your spouse as a matter of law. There is no probate of that property. Now let's assume that your spouse dies. Who gets her property? How do we transfer the house, and the car, and the bank accounts when your spouse is the sole owner and she's no longer here?
We would have a real problem if it weren't for the probate court system. First of all, your spouse has the right to designate the beneficiary of all her property under a Last Will and Testament. If she fails to make a valid Last Will and Testament, then the state will determine the beneficiary based upon existing laws. Finally, the probate court will appoint someone to represent your estate (most likely a child or other relative, if available) and authorize that person to identify your assets, pay your bills, and then transfer your property to the proper beneficiaries. The authority of the probate court allows for the orderly transition of property upon death. Without it, there would be total chaos. As vital as the probate court system is - and as good as the probate court system is - it is not always perfect. There are administrative delays and there are costs. In too many cases, the delays seem to go on forever and the costs eat up a good portion of the estate. It is these delays and these costs that have caused many people to seek alternatives to the probate court system.
So, how does a living trust avoid probate? Earlier we mentioned that certain types of property do not pass through probate because they already have a designated beneficiary. Life insurance policies, annuity contracts, retirement benefits, and jointly-owned property all fall into this category. Property held in a living trust also falls into this category because the trust instrument provides for a designated beneficiary of the trust property upon the death of the grantor. Living trust are recognized as legal entities in every state, and laws of every state exempt property in a living trust from probate.
Have living trusts always been used to avoid probate?
No, the use of living trusts solely to avoid probate is actually a relatively new phenomenon.
Although living trusts have been around for hundreds of years, their purpose has been largely the same as testamentary trusts; that is, both were used primarily to hold and manage property for the benefit of surviving family members following the death of the owner.
At some point around the mid-twentieth century, estate planners discovered that living trusts had certain advantages over testamentary trusts, including the following:
• Unlike testamentary trusts, living trusts are not dependent upon the admission of a Last Will and Testament to probate. And, it is just as easy to create a living trust under a separate trust instrument as it is to create a testamentary trust under a will.
• A living trust is created under a separate instrument, so it can be changed or terminated without going though the legal formalities of creating a will.
• Under most state laws, probate courts do not have jurisdiction over living trusts. Living trusts are private and not open to public inspection. Therefore, trustees operate under much less scrutiny and disgruntled heirs have a much harder time voicing their opposition.
While living trusts were being created with greater frequency after the 1950s, they were seldom funded during the grantor's lifetime. The intended purpose for a living trust was still to hold and manage property for the benefit of surviving family members following the death of the owner. Since the trust was unfunded during the owner's lifetime, the property had to pass through probate into the living trust after the owner's death via his Last Will and Testament. When used in this manner, the Last Will and Testament was called a "pour-over will" because it was used to pour-over the probate property into the living trust.
Nonetheless, there were a certain number of wealthy individuals who actually did fund their living trusts during their lifetime. Those individuals did so because they didn't want the responsibility of managing and investing their wealth. They preferred to have their wealth managed and invested by professional trust companies so they would be free to attend to other matters. The living trust was an ideal vehicle for this purpose because it allowed the trust company to have investment and management powers over the property, while ownership remained with the grantor.
In the 1970s and 1980s, estate planners began to realize that living trusts offered more benefits than previously thought. Here was a time-tested legal entity that had been used for hundreds of years to hold and manage property for others. It was also being used by many wealthy individuals to have their assets professionally managed for their own benefit. It wasn't long before estate planners realized that a living trust was also a very effective way to avoid probate and the horror stories associated with the probate process.
For all these reasons, the use of revocable living trusts has grown rapidly over the past several decades, and it is likely that the popularity of living trusts will continue for years to come.
Is it a good idea to avoid probate?
It depends. Many states provide for independent administration of estates, so the personal representative of an estate is allowed to handle estate business without on-going court supervision and approval. Many states also provide for simplified administration if an estate is under a certain amount, typically under $20,000.
Even with larger estates that are fully supervised by the probate courts, there seems to be a concerted effort to help families get through the settlement process with as little aggravation as possible.
That doesn't mean that you will sail through probate with the greatest of ease. There are still many factors that will make the experience less than desirable, despite the best intentions of the probate court system.
The following are a few of the more important factors that may steer you away from probate:
• None of your intended beneficiaries are able to handle the settlement of your estate. If the people you're leaving your property to are not going to be settling your estate, then a big, red flag should go up. It should come as no surprise that when beneficiaries are in charge of settling an estate, the delays and the costs will be kept to a minimum. Why? Because it's their time and it's their money. When independent, third-party professionals are in charge, the process will take longer and the costs will escalate. It's only human nature - if someone's handing out cookies, we'll be polite and take one. If we're handing out the cookies, we'll take as many as we can.
• Your intended beneficiaries are not of legal age. The law does not allow a minor to hold property in his or her name. If you name a minor as beneficiary of your property, the probate court will appoint a guardian to hold the property until the minor reaches majority age. Creating a trust to hold that property for the minor would be much better than having the court appoint a guardian because you can spell out the terms of the trust, you can designate one or more people of your own choosing to serve as trustee, and you can hold the property in trust beyond the age of majority. You can create a testamentary trust for this purpose, but a living trust may be better because it will allow you to avoid probate as well.
• Your intended beneficiary is a spendthrift. It may be that you want to leave property to a particular person, but you know that it will all be spent in a short period of time. Or, maybe you're concerned that your intended beneficiary will get a divorce and all of the property will end up with the spouse. Or, maybe you have an elderly parent or relative that you want to provide support for after you're gone, but you want the property to pass to your children after that parent or relative dies. In all these cases, the only way to accomplish your objective is to place the property in trust. Again, a testamentary trust can be used for this purpose, but a living trust may serve you better because it will allow you to avoid probate as well.
• An impending disability is likely. If your age or medical condition is such that you have a real concern about managing your property on your own, then a living trust may enable you to have a hand-picked manager take over for you without any court intervention. For this purpose, a revocable living trust is much better than a durable power of attorney, although both may be advisable.
• You own real estate in another state. If you own real estate outside of your state of domicile, then an ancillary probate will be required in the state where the real estate is located. However, if that real estate is held in a living trust rather than your own name at the time of your death, then an ancillary probate of that property will not be required.
• You have concerns over privacy. If you are concerned about other people knowing your business if you become disabled or die, then a living trust is something you should consider. A living trust will allow you to transfer management to someone you know and trust without fear of having your business made public.
• You may have disgruntled heirs. If your loved ones are likely to fight over your property, then a living trust will make it harder for them to do so on the grounds of incapacity, undue influence, and the like.
If your only objective is to avoid probate, then you have to carefully weigh the costs of setting up and funding a living trust against the costs and delays associated with probate. However, if one or more of the above factors are legitimate concerns, then the scales become more noticeably tipped in favor of a living trust.
Are there disadvantages to a living trust?
Although there are very significant benefits to be gained from a living trust, there may be some disadvantages as well. The following are some of the disadvantages often associated with a living trust:
• Lifetime effort. It takes more time and effort to implement a living trust than it does to just make a will. Where the objective is to avoid probate, it is critical that assets be re-titled in the name of the trust once the trust instrument has been created. Furthermore, once the living trust has been completed and fully funded, it is important that the entire estate plan be monitored annually to insure that all assets are properly titled and that your overall objectives are being met. That does not mean that all assets have to be transferred to your living trust. It simply means that you must understand your objectives and know whether they are being met.
• Costs. There are more costs associated with a living trust than there are with just a traditional will. There are additional costs to plan the living trust and the overall estate plan; there are additional costs in transferring assets to the living trust; and there are additional costs in monitoring the overall estate plan from year to year. If someone other than the grantor is acting as trustee, then there may be trustee fees as well. However, if the additional costs associated with a living trust are within the normal cost parameters for this type of work, then the benefits should far out weight the costs.
• Lack of court supervision. One of the benefits of the probate system is that someone is watching over your interests and the interests of your loved ones. That does not normally happen with a living trust because the probate courts do not have jurisdiction over living trusts. While many individuals prefer to keep the courts out of their business, it could also be a disadvantage under certain circumstances.
• Tax disadvantages. A revocable living trust does not give the grantor any tax benefits during his or her lifetime. Upon the grantor's death, there are a number of federal income tax provisions that give somewhat more favorable treatment to an estate than a trust. For example, a trust is required to report and pay taxes on a calendar-year basis, whereas an estate may choose a fiscal year other than a calendar year. An estate is also entitled to an exemption of $600 a year while a trust is entitled to an exemption of only $300 a year (if the trust is a 'simple'; trust) or $100 a year (if the trust is a 'complex'; trust). A simple trust is one that is required to distribute all income to beneficiaries currently instead of keeping it in the trust. A complex trust is not required to distribute all income to beneficiaries currently. It can accumulate income if it chooses. There are also some restrictions on the type of business entities that a trust can hold, whereas those restrictions do not apply to estates.
If I have a living trust, do I still need a will?
Yes! A will is still necessary because it is very unlikely that you will have all of your property in a living trust upon your death. There may be a bank account in your own name or there may be debt owed to you by someone. There may be an income tax refund or a stock dividend paid to you. Whatever property is not in your living trust will pass through probate if it is owned solely by you. A will is the only way that you can designate a beneficiary for that property.
As a practical matter, a Last Will and Testament and a revocable living trust go hand in hand. The revocable living trust is set up to hold property during your lifetime and it serves as an excellent vehicle for the management of your property in the event of incapacity. It also serves to avoid probate on any property in the trust upon your death. Furthermore, it becomes an excellent vehicle to hold and manage your property for any beneficiaries that are minors or spendthrifts, etc. Although it is highly recommend that you fund your trust as soon as possible, you can fund it at any time. Once the vehicle is in place, then the decision is up to you. The Last Will and Testament is a fail-safe devise to pick up any property that did not get into your living trust during your lifetime and "pour it over" to your living trust after your death. In that way, your living trust becomes the sole vehicle for disposing of your property after your death.
So, if you have a living trust, make sure you also have a Last Will and Testament.
Are there tax benefits with a revocable living trust?
No! With a revocable living trust, the grantor retains the right to amend or change the trust instrument or to revoke or terminate the trust at any time. Because the grantor retains that much control over the property, the federal tax laws hold that the grantor still owns the property. Therefore, the grantor must report the income of the trust on his or her tax return, and must pay the taxes on that income, the same as if the property had never been transferred to the trust.
If the grantor is also acting as the sole trustee, then the grantor reports the income from the trust as though the trust did not exist. In that case, the trust is not considered a separate entity for tax purposes and there is no requirement that a separate employer identification number (EIN) be obtained for the trust. The grantor's social security number is used for all trust investments.
On the other hand, if someone other than the grantor is acting as trustee, then the trust is required to obtain its own EIN, and all trust investments will be listed under that EIN. In that case, also, the trust will file its own federal and state income tax return. The federal income tax return for trusts and estates is filed on Form 1041. If distributions are made to trust beneficiaries during a taxable year, then trust income for that year will be deemed distributed to those beneficiaries pro rata. The federal tax laws provide a rather complicated formula for determining the amount of income that is deemed distributed to beneficiaries during a tax year based upon the distributable net income (DNI) of the trust. The allocable share of trust income distributed to beneficiaries during any taxable year is reported to the beneficiaries on Form K-1, which is similar to a W-2 form or a 1099 form. The information on the K-1 form will then be reported by each beneficiary on his or her own federal income tax return for that year.
Most revocable living trusts that are established for estate planning purposes will not have a trustee other than the grantor. In that case, the income tax reporting of income earned by the trust during the grantor's lifetime will not present any particular problems. However, once someone other than the grantor is serving as trustee, then the federal and state tax laws become quite complicated and beyond the abilities of most grantors. For that reason, professional tax preparation and advice is highly recommended.
Can a living trust reduce estate taxes?
A revocable living trust does not reduce estate taxes, per se. That's because the grantor retains the right to amend or terminate the trust and to take back the property at any time. Under the tax laws, the grantor's right to take back the property means that he or she still owns it. And, if you own property, then you're going to be taxed on its income while you're alive and it's going to be subject to the estate tax when you die.
However, it's important to realize that a living trust can - and often is - used as a vehicle to take advantage of certain estate-tax saving techniques available under the estate tax laws. These techniques are perfectly legal and are fully sanctioned by the tax laws and the Internal Revenue Service. Examples of these techniques include the Credit Shelter Trust to take advantage of the Unified Credit, the Generation-Skipping Trust to take advantage of the Generation-Skipping Tax (GST) exemption, and the Q-Tip Trust to take advantage of the unlimited marital deduction while preserving the right to pass property on to children from a previous marriage. There are others, too, but these are the most utilized techniques to achieve estate-tax savings through a trust.
It is important to note, too, that these estate tax saving techniques can be utilized through a testamentary trust as well. So, it is not necessary that you have a living trust in order to achieve these tax savings. Still, a living trust is generally preferred over a testamentary trust for other non-tax reasons.
Will a revocable living trust protect my property from creditors?
No, creditors can reach the property in a revocable living trust during the grantor's lifetime since the grantor is still considered the owner. Even if the trust is irrevocable, creditors will be able to reach the property if the debt was incurred prior to the property being transferred to the trust. As a general proposition, if the grantor has any rights to the property in the trust, the creditors will be able to reach it. Upon the death of the grantor, creditors may or may not be barred from filing a claim against a living trust. So, a living trust will not provide any greater protection against creditors than if you continued to hold the property on your own.
Can I qualify for Medicaid (Title XIX) with a living trust?
The property in a revocable living trust is a "countable resource" for purposes of Medicaid qualification. Property in a revocable living trust is treated just the same as if it was owned by the grantor. So, in terms of qualifying for Medicaid, there is no advantage or disadvantage to a revocable living trust.
There is an exception for irrevocable living trusts. Under current Medicaid rules, any property transferred to an irrevocable living trust more than five (5) years before application for Medicaid benefits is not considered a "countable resource." However, you should consult a competent elder-care attorney if this situation is applicable to you.
For additional information on the medicaid program, including qualification requirements, see CMS, the Centers for Medicare and Medicaid Services. You should also visit ElderLawAnswers, a web site providing information on all areas of elder law.
Do I need an attorney to set up a living trust?
No, but it's a good idea. Living trusts are complicated, legal arrangements that require considerable knowledge and expertise. Qualified, estate planning attorneys have the skill and the legal training to advise you along the path to a sound estate plan that may or may not include a living trust.
Don't be fooled into believing that any of the off-the-shelf documents sold by a door-to-door salesman or by an internet web site will be just as good. The final documents for your estate plan, including a Last Will and Testament, a revocable living trust instrument, and possibly other legal documents, must be the product of a thorough analysis of your goals and objectives, your personal and financial circumstances, and your personal tolerances for risks and rewards. Moreover, a successful estate plan will often include the valuable input of an accountant, a trust officer, a banker, an insurance advisor, and an investment manager. If required by your particular circumstances, these professionals can mean the difference between a very successful estate plan and one that is not.
That does not mean that all professional advisors are created equal. Some have more experience and skill than others. Often, there is no correlation between a professional's level of expertise and the fees that are charged. For this reason, it is imperative that you do your homework before committing to the services of any one professional. Don't be afraid to ask questions, and don't be afraid to negotiate fees.
The fees you pay to have a living trust prepared will be more than just having a traditional will prepared. If you're not ready to pay for those services, then you should not even consider it. It is far better to have your loved ones navigate their way through probate than it is to have your property eaten up by legal fees when things don't go right. Remember, you may never see the results of the planning you do for your loved ones, but your loved ones will!
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