A revocable living trust is an agreement you create for the management and distribution of your property. A revocable living trust (sometimes called a “Trust” in this article for the sake of brevity, but which may also be known as a “Grantor Trust” or a “Settlor Trust”) is typically established in a signed writing which appoints someone to administer the property (the “Trustee”). The Trustee must follow the Trust’s instructions about how the property is to be managed and distributed (“the Trust terms”). The Trustee also has an obligation as a fiduciary to put the best interests of the people benefiting from the Trust (the “beneficiaries”) above their own interests. You are able to modify or eliminate a revocable living trust any time before you die or become incapacitated.
A properly funded revocable trust will allow you to:
- Avoid probate (maximizing your privacy and minimizing administrative costs when disposing of your assets);
- Allow you to take advantage of the step up in basis rules; and
- Maintain control over when and how assets will be distributed after you pass away.
Other key advantages of creating a revocable trust include the fact that you can:
- Make things easier on the others involved in your plan (as you can perform a lot of the administrative work of funding the Trust personally – and without court oversight);
- Allow your beneficiaries and trustee to use the the uniform trust code (which is implemented in New Jersey and Pennsylvania) to allow appropriate changes to the structure of the trust to be made without court oversight and approval; and
- Can choose who will manage and control Trust assets if you become incapacitated or deceased (or potentially even before then to ensure a smooth transition).
These advantages of creating a Trust are magnified to the extent that you own property in multiple states, have significant wealth or complicated asset holdings, have conflict within your family, or are creating trusts for your spouse or others that are likely to hold property for an extended period of time.
WHO IS INVOLVED IN CREATING AND RUNNING THE TRUST?
Grantor: This is the person who creates the Trust. This would be you (or in the case of a “Dual Grantor” Trust, both you and your spouse). The Grantor can also be called the “Creator”, “Settlor” or “Trustor”. As the Grantor, you can eliminate or change a revocable trust at any time unless you die or become incapacitated.
Trustee: The Trustee is the person who will manage the assets in the Trust. Again, this will most likely be you while you are alive, although you do not have to be your own Trustee if you do not want to (or do not feel you are able). (Note that while we are limiting our discussion today to revocable trusts, there are other types of trusts where it would not be advisable for you to serve as your trustee.) You can serve alone, with a co-Trustee (who could be your spouse and/or a relative, friend, attorney, accountant, corporate Trustee or financial institution of your choosing) or completely delegate the responsibility to another person (or persons) of your choosing. You can also start out as the Trustee and resign at a future time. The Trustee(s) of your Trust can buy, sell, transfer, mortgage and otherwise manage the assets in the Trust according to the terms of the Trust agreement.
Successor Trustee: This is the person (or persons) who will manage the Trust’s assets in the event that your original Trustee (again, typically you) should become incapacitated, pass away or resign. The Successor Trustee will then typically have the same powers as the original Trustee had to buy, sell, borrow or transfer the assets inside the Trust. More importantly, they will also have the right to distribute the Trust’s assets according to the instructions in the Trust. This immediate control can allow assets to be transferred to your children or loved ones promptly after you pass away, avoiding probate delays.
Beneficiaries: The people who benefit from the assets in your Trust are fittingly called the “beneficiaries.” The Grantor of a Trust (and, if desired, their spouse) is typically the only beneficiary of a Trust during the Grantor’s lifetime. However, you can direct the percentages, order and duration of the benefits distributed to beneficiaries via your Trust before and after your death. Many times you will create additional trusts for your beneficiaries within your Trust, which are commonly known as “sub-trusts.”
WHAT HAPPENS WHEN MY HEALTH STARTS FAILING?
If an illness or accident leaves you (the Grantor) incapacitated, your Successor Trustee would manage Trust assets in lieu of a court appointed guardian or conservator. This is usually a much more affordable solution and has a lot more privacy and flexibility for the parties involved.
An even better option is to appoint someone as a co-trustee before your health starts to fail. This can allow them to manage trust affairs without having to obtain proof of your incapacity, which typically involves having to procure statements from multiple doctors about your mental fitness. Obviously whoever is serving as Trustee should be someone that you trust completely, but the other nice benefit of this arrangement is that it can allow you to monitor what the co-Trustee is doing while you are alive and well, giving you a better sense of how they will actually perform as Trustee. If they aren’t acting in ways that you agree with, you continue to have the power to remove them – as long as you still have capacity.
When you pass away, your Trust can dictate how people inherit assets from you and when, allowing you to send assets to your spouse, companion, and/or descendants on set terms. Through your trustee, you can control how those assets are used and who they go to and when.
IDENTIFYING MY TRUST
When your Trust owns or is the beneficiary of any property, it is usually identified as follows: “[NAME OF TRUSTEE], Trustee of the [NAME OF TRUST]”. Sometimes the date that the Trust is created or amended may also be included. For example, a Trust could be identified as “John Doe, Trustee of the John Doe Trust, Created on May 18, 2022.”
Any property that you transfer to a Revocable Living Trust can be tracked for federal tax purposes via your social security number until you pass away. All income derived from that property is reported to the IRS under your social security number. This essentially means that the trust is tax-neutral during your lifetime and you would report trust income on your own tax return, keeping administration very simple during your lifetime.
Your Revocable Living Trust will cease to be a “Grantor Trust” upon your death. The Trust must then obtain its own taxpayer identification number (also known as a Tax ID, employer identification number or EIN) and file its own tax return. (Note that the same is true of estates and trusts created under a will.) Form SS-4 is used to request a taxpayer identification number (also known as an employee identification number) from the Internal Revenue Service.
FUNDING A REVOCABLE TRUST
Signing your Trust should not be the last step in implementing your estate plan. To be distributed by the Trust, the Trust must either own or be the beneficiary of your property, depending on the type of asset involved.
In most cases, the Grantor should proceed with funding a Revocable Living Trust with all of his or her assets, with two notable exceptions. Retirement accounts cannot be owned by your Trust because they are by definition individual accounts. They can be named as a beneficiary of the Trust, but this should not be done UNLESS specific planning has been done within your Trust to maximize the unique tax benefits of these accounts. Many people choose to incorporate this planning, but it is a decision that should be made carefully and intentionally. Moreover, sometimes people choose to leave retirement accounts outright to their spouse (for the sake of efficiency) and have them pass through their Trust only if their spouse has passed away. Second, assets should not be added to your trust if you want them to pass in a different way than the rest of your Trust assets. (For example, if you choose to leave a life insurance policy to a sibling or have established another type of trust for a special purpose.) These options and the reasons for having assets pass outside of the trust should be carefully explored, and it is important to speak with your lawyer to understand how your designations should be adjusted to align with your plan.
While changing the ownership of real estate requires that a deed be filed, changing the ownership of most other investments can be accomplished by contacting your banks/other financial institutions and completing whatever paperwork they provide. This typically involves getting new account numbers and checks. If you run into issues while attempting to transfer the ownership of your assets, a quick phone call to your attorney can frequently help resolve any concerns. At The Sauer Law Firm, we help simplify the funding process by supplying our clients with a “Certificate of Trust” that gives banks key information about your Trust to help simplify the process of transferring ownership.
Changing beneficiaries that were named before you executed your plan is also crucial as a named beneficiary can supersede directions in your will and Trust. Changing beneficiaries will typically involve contacting the plan administrator to request a change of beneficiary form. (Note: I strongly recommend that you request and retain written confirmation from your plan administrators to prove that the beneficiary designations have been changed to reflect your wishes. This documentation could prove invaluable in the event that the records of the financial institution are destroyed or hacked, or more commonly, to clear up any confusion in the family about who the accounts were left to.)
When creating a revocable trust, you will likely also create a “pour-over” will, which would send assets to the trust in the event that you pass away before you are able to identify the trust as the owner or beneficiary of an asset (assuming that no other co-owner or beneficiary has been designated for the asset in question). This can help give you peace of mind in case you are not able to immediately focus on trust funding. However, bear in mind that keeping an asset outside of the trust can subject the estate to probate.
DISADVANTAGES OF TRUSTS
It can take significant time to discuss and determine how the trust should work (the “trust terms”), identify who should serve as trustee, and explain how the trust works to others (such as your spouse, descendants, and successor trustees). Funding the trust also takes time. While your attorney will typically help prepared deeds to transfer property to the trust, most clients prefer to handle the transfer of financial accounts personally, which is a significant time commitment and may prove difficult for people who are struggling with health issues or grief.
Drafting a trust and related documents (and taking time with your lawyer to review and understand how they work) will incur higher legal fees than creating a simple will.
While you are alive, you will typically report all income earned from a revocable trust on your own tax return, keeping administration simple. However, after you pass away, the trustee will need to file tax returns for the Trust (and, once funds are distributed to the sub-trusts, for each sub-trust for as long as they are generating income over the federal reporting amounts for trusts – currently $600 annually). After your death, income earned by Trust and sub-trusts are taxed at the highest tax rate unless that income is passed along to the beneficiaries and reported on their own returns, which involves filing additional tax paperwork known as a “K-1”. A K-1 is a one page document that allocates the income among the various beneficiaries of the Trust. https://www.irs.gov/pub/irs-pdf/f1065sk1.pdf
Trustees are also entitled to commission, although you have the power to specify what that commission should be.
ADVANTAGES OF TRUSTS
The key benefit of any trust you are creating for others, whether created in your will or in a revocable living trust, is control. As the creator of a trust for others, you can determine what funds should be spent on and when, and how old beneficiaries should be before any trust for their benefit should end. You can restrict funds for use of education only (for example), or allow them to be used permissively for general needs. You can specify that Trust assets be invested in businesses, property, and many other types of investments, and you can control where the funds can be invested. (One very common approach is to allow trust funds to be used to buy residences and vacation properties for the beneficiaries). You can distributed funds to your children when they turn certain ages or reach certain life milestones, or you can keep money in trust for their entire lifetime (for asset and creditor protection), or even set up trusts to continue the maintenance of funds in your family indefinitely.
On the flip side of things, you can also design trusts to create protection for assets while giving your beneficiaries all income earned by trust investments, everything they need for their living expenses, and even additional funds to use or invest however they like. You can customize this to find a balance of access and protection that you feel comfortable with.
When you have young children, creating a retirement stretch trust within your revocable living trust can allow you to hold money for their benefit while ensuring that:
- A court will not need to a appoint a guardian of the funds (which would need to happen if funds were left directly to minors);
- The funds do NOT go to them directly at the age of eighteen to do whatever they would like to with them (which is what would happen if you do not send funds to a trust, even if a guardian is appointed); and
- The funds can be removed from the tax-advantaged accounts over the longest possible period, maximizing tax benefits (generally speaking, 10 years in lieu of five years if you do not do retirement stretch planning. Note that this is not automatic, but that the Trustee would be in a position to control the distributions.).
Trusts can be designed to take advantage of the deductions available to married couples (to postpone federal estate tax) while ensuring that any remaining assets stay in your family (or otherwise go to the people or organizations you select). Setting up trusts for your spouse can help keep assets safe from the elective share in the event that they remarry after you pass away. (The elective share is a provision in New Jersey and Pennsylvania law that could allow up to a third of a person’s assets to go to their spouse upon their death in spite of what is specified their will or in their beneficiary designations.) By keeping assets for your spouse in trust, you can also protect them from creditors. If you are concerned about others taking advantage of your spouse, naming trustee other than your spouse provide an additional layer of protection for the funds, minimizing the risk of financial exploitation.
Trusts can also be particularly helpful in light of the complexities of marriage in the modern age and the likelihood that your spouse may have children from another relationship. Many people who have remarried later in life choose to create a trust when their intent is to generously benefit their spouse and provide for their spouse’s needs – while ensuring that any amounts remaining in the trust pass to their own descendants upon the spouse’s death. Similarly, with the divorce rate hovering around 50%, keeping assets for your children and other descendants for longer periods of time can help ensure that they stay in your family in lieu of being divided and split between your descendant and the divorcing spouse.
Generally speaking, the longer a trust is intended to last, the better off you are creating it as part of a revocable living trust to take advantage of the administrative flexibility offered through the Uniform Trust Code. This flexibility is a key reason why administering trusts created under revocable living trusts is generally preferred over administrating trusts created under wills by trust companies and other corporate fiduciaries.
Moreover, when you have a revocable living trust, you can be the one to decide when your successor trustee should start serving. Many people opt to appoint a co-trustee when they are getting older, which allows them to continue acting for themselves as long as they are able while also achieving a relatively seamless transition in the event of their death or incapacity.
If you own real property in more than one state, having property owned by the trust can also avoid the expense, time and hassle of multiple probate proceedings. The benefit of this is compounded by the number of states where you own property – and the locations where that property is kept. In states that have judicial backups and delays and statutory probate fees, the benefits of a revocable trust can be even more important, so it is important to consider where your property is held.
Many clients have successfully achieved their estate planning goals through the use of revocable living trusts. If you are willing to address the time commitment and cost they generate at the outset, they can help make things easier and more administratively efficient for your loved ones after you pass away.
I hope that this article has helped you to better understand how trusts work and to determine whether a revocable living trust might be a planning option you decide to pursue. Please don’t hesitate to schedule a consultation to explore your specific situation and discuss whether a trust might be the right solution for your needs! Please feel free to email me directly to request an intake sheet and schedule an appointment by reaching out to me at Jessica@SauerFirm.com or at 201-779-0416.
– Jessica J. Sauer, Esq., Attorney at Law