So you think you need a Revocable Trust?

  • Estate Planning
June 25, 2023

It is a common conception today that a revocable trust is the “one-size fits all” solution to all estate planning needs. While a revocable trust is a powerful tool in building an estate plan, it is not necessarily the right tool for all. This article will discuss the factors you should consider when determining whether a revocable trust is right for you.

What is a revocable trust?

A trust is a separate legal entity that holds property for the benefit of others. The person who creates and funds the trust is known as the settlor (sometimes referred as a grantor or trustor). The person who is responsible for carrying out the terms of the trust and managing its assets is known as a trustee. Anyone who has the right to receive assets or income from the trust is known as a beneficiary. The settlor dictates through the trust document how the assets and income are distributed from the trust. A trust is typically created when the settlor executes a written declaration establishing the trust and transfers property to the trustee for the benefit of the trust’s beneficiaries. However, a valid trust may be established without formally funding the trust with assets. Obviously, funding the trust is a critical step in establishing the trust and should not be unnecessarily postponed.

A revocable trust is a specific type of trust that is created by the settlor during their life. The settlor can alter, amend, or revoke the trust in its entirety. The settlor can also add or remove property as he or she deems appropriate. These retained rights of control and beneficial enjoyment cause the trust to be treated as a revocable trust under law. Once the grantor passes away, the trust document will dictate how the trust assets are to be administered. Those assets might be held in further trust or distributed outright to the settlor’s beneficiaries.

What are the benefits of a revocable trust?

There are two main advantages to establishing a revocable trust. The first is that a revocable trust is highly effective in transferring assets such that much if not all of an estate’s assets can avoid the probate process. With a revocable trust, the trust continues after the death of the settlor and the successor trustee can automatically transfer the trust assets to the designated beneficiaries. Since the settlor did not own the trust assets at the time of passing, they are not considered part of the probate estate. Avoiding the probate process is desirable because it simplifies the process by which the settlor’s beneficiaries receive their assets, preserves the privacy of the estate by avoiding the public disclosure of the estate’s assets, and, to the extent real estate is held in trust, avoids the need to commence multiple probate actions in other states where the real estate may be located.

The second advantage of a revocable trust, and the advantage that sets it apart from other estate planning tools, is that it affords the settlor the most amount of control over the assets in the trust. A revocable trust may be revoked by the settlor at any time and for any reason. The settlor can also add or remove assets, and change the trust’s beneficiaries at any time. This means that, even though the settlor does not directly own the assets held by the trust, the settlor still maintains a level of control over the assets that the settlor would have if he or she owned the assets individually. In these ways, a revocable trust gives the settlor the most flexibility to respond to unforeseen circumstances and adjust their estate plan if necessary.

What are the drawbacks and limitations of a Revocable trust?

While all of these benefits can make a revocable trust the best option for some people, there are other considerations that you should make when determining if a revocable trust is the best option for you. First, because revocable trusts give the settlor a high level of control over the assets in the trust, revocable trusts are considered tax neutral, and any income generated by the trust’s assets are considered income of the settlor for tax purposes. Similarly, the assets in the trust would be considered assets of the settlor for estate tax purposes. Therefore, if the total value of your taxable estate at death exceed the Minnesota estate tax exemption, $3 Million at the time of writing, a revocable trust by itself may not be the best option for you because it would have no effect on the estate tax liability faced by your estate. Second, assets held in a revocable trust are not beyond the reach of creditors and therefore creditors may recover from the assets of your revocable trust in collection actions. This includes nursing homes and medical assistance programs. Third, a trustee has a fiduciary duty to the trust’s beneficiaries. Broadly, this means that the trustee has a legal duty to act in the best interest of all the beneficiaries when managing the trust and its assets. The trustee has a duty to account for their actions and to keep beneficiaries reasonably informed of the trust’s administration. These duties don’t strictly apply to a settlor of a revocable trust, but would apply to any co-trustee or successor trustee.

Alternatives to a Revocable Trust.

There are a wide array of options available in the estate planning toolkit that can accomplish probate avoidance while also addressing the limitations associated with revocable living trusts such as tax neutrality, creditor claims, and complicated fiduciary duties.

The alternative most similar to a revocable trust is an irrevocable trust. Irrevocable trusts accomplish most if not all of the probate avoidance of a revocable trust, but because an irrevocable trust cannot be revoked by the settlor, it is considered an entirely separate entity for tax and liability purposes. This means that the assets held in a properly drafted irrevocable trust will not be considered assets of the settlor’s estate for estate tax purposes (although the transfer could constitute a taxable gift for gift tax purposes). An irrevocable trust can also protect the assets held in the trust from creditor claims or lawsuits. However, in order to enjoy the above benefits, an irrevocable trust must be specifically drafted to comply with applicable laws and requirements. Additionally, since an irrevocable trust may not be revoked or modified by the settlor after its creation, it is important to ensure that the trust is set up correctly and represents the settlor’s wishes in perpetuity.

If your estate is small enough or the mix of assets is not overly complex, you may be able to avoid probate without a trust. For example, bank accounts, individual retirement accounts, stock and other securities, and life insurance policies usually allow the owner to designate a beneficiary to receive the assets on death of the owner. Real estate, motor vehicles, and many other assets can be titled in joint ownership with the right of survivorship. These assets will transfer to the designated persons without having to commence a probate action.

Real estate and other business assets can also be transferred to a business entity, such as a limited liability company or limited liability partnership. LLCs and LLPs can function to avoid probate because the entity will typically continue in existence after the death of the shareholder or partner.1 They also provide a middle ground between revocable and irrevocable trusts in terms of the level of asset control provided to the estate planner. However, these business entities are governed by a different area of law and therefore would require different documents in order to effectively distribute the assets in accordance with your larger estate plan.

Conclusion

A revocable trust may be one of the first things that comes to mind when thinking about estate planning, however it is not the one size fits all solution that some consider it to be. While there are significant benefits to including a revocable trust in your estate plan, there could be more advantageous alternatives that better suit your needs. Sorting through these options and planning your estate may seem daunting, but making these considerations ahead of time can make a tremendous difference to you and your loved ones and there are many attorneys experienced in estate planning to assist in creating the right estate plan for you.

1 The underlying ownership interest (stock, partnership unit, etc.) is an independent asset that comprises part of your estate. To avoid probate, the ownership interest would need to be transferred to a trust or registered with transfer on death designation in compliance with Minnesota law.

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