Revocable Trusts 101: How They Work

Clients who seek to disperse their worldly assets in a complex or specific manner will often use living trusts as the vehicle of choice. These versatile instruments can provide users with a wealth of benefits and protections that ensure that their financial wishes and needs are met in an efficient manner while they are living, and also after they die.

If you are unsure of exactly how your assets will be dispersed once you are gone, read on to find out how a revocable trust can be a big benefit.

Revocable Trusts’ Constitution

A trust, by definition, is a legal instrument created by a lawyer. A trust resembles a corporation in that it is a separate entity that can own, buy, sell, hold and manage property according to a specific set of instructions. Some trusts have their own tax ID numbers and can be taxed as a separate entity or structured as a pass-through instrument that passes all taxable income generated by the assets in the trust through to the grantor. This is usually the case for revocable trusts, as the tax rates for trusts are among the highest in the tax code.

There are typically three parties who are involved in a trust:

• The grantor is the person who creates the trust (by paying a lawyer to draft it) and then funds it by depositing cash or assets into the trust account. Tangible property is simply re-titled in the name of the trust.
• The trustee is appointed by the grantor to oversee the management of the assets in the trust and follow any instructions that the grantor has written in the trust.
• The beneficiary is the recipient for whom the assets are managed.

The grantor, trustee and beneficiary (or at least the primary beneficiary) can all be the same person in many cases.

All trusts are either revocable or irrevocable. The former type allows the grantor to change the instructions in the trust, take assets out of the trust and terminate it. Irrevocable trusts are called such because assets that are placed inside them cannot be removed by anyone for any reason. The instructions that are written into them can likewise not be changed. Most revocable trusts are known as revocable living trusts because they are created while the grantor is still living.

Pros and Cons of Revocable Trusts

Revocable trusts can allow grantors to disperse assets in ways that would be extremely difficult to do with a will. All assets that are deposited into revocable trusts are unconditionally exempt from the probate process, which can greatly simplify and accelerate the estate planning process. Assets that are housed in trusts are also usually exempt from creditors and legal judgments, which can make a huge difference for those who end up on the losing end of a lawsuit.

Furthermore, all activities relating to trusts and their dispersion of assets to beneficiaries are strictly confidential and are not published in the public records of probate courts.

Their primary disadvantage is probably their cost, as some trusts can cost thousands of dollars to create if they are complex or if they deal with complicated intangible assets.

Types of Revocable Trusts

There are several types of revocable trusts that are designed to meet specific objectives. They include:

Qualified Terminal Interest Property (QTIP) Trust: This type of trust is generally used when the grantor has divorced and remarried. The grantor will name the current spouse as the primary beneficiary, and they will get to use the property (such as a house) inside the trust as long as they live. The property will then be distributed to the children that the grantor had from the previous marriage upon the death of the second spouse.

Incentive Trust: This type of trust can reward beneficiaries with monetary or other incentives if they meet certain criteria that are laid out by the grantor. This could include getting an education, marrying a certain type of person or accomplishing other objectives.

There are also other types of revocable trusts that are designed to reduce estate taxes for wealthy grantors, protect land from lawsuits and facilitate the Medicaid spend down strategy.

The Bottom Line

Revocable trusts can accomplish many objectives and provide many benefits for both grantors and beneficiaries. They can be used to reduce income and estate taxes and avoid probate. Their cost can vary according to their complexity and the number of them that are used. For more information on revocable trusts and how they can benefit you, visit the Financial Planning Association website at www.fpanet.org.