Introduction
Trusts are a massively underused estate planning tool. They are formed by drafting a trust agreement that clearly sets forth the trust’s operating parameters, identifies who will manage the assets (the trustee), and names who will have access to the trust’s principal and/or income (the beneficiary). The person who organizes and contributes assets to the trust is known as the grantor or trustor. A trust that is established during the grantor’s lifetime is referred to as a living trust, and a trust that is organized when you die is called a testamentary trust. Regarding the latter, testamentary trusts are usually established in the grantor’s last will and testament.
Trusts can be revocable or irrevocable, and the difference is fairly self-explanatory. Revocable trusts can be amended or dissolved by the grantor as long as he or she is alive, while irrevocable trusts generally cannot be changed after the grantor signs the trust agreement. In some situations, an irrevocable trust can be altered with the beneficiary’s permission, but that depends entirely on the provisions in the trust agreement. By and large, it’s safe to say that assets you transfer to a revocable trust can be reclaimed, and assets transferred to an irrevocable trust are permanently gifted to the trust.
Pros of Revocable Living Trusts
The greatest benefit of a revocable living trust is the ability to bypass probate. Where a will directs how your assets should be distributed through probate, a trust transfers the assets to your beneficiaries without the need for probate. Not only does this save you in legal costs over the long run, but it also gets your assets to your beneficiaries much faster (think weeks instead of months).
If you want additional control over how and when your beneficiaries receive the assets, a trust will let you apply stipulations to the assets. You could instruct the trustee to withhold the assets until the beneficiary graduates from college, or you could allow the beneficiary to receive only the investment income so that the principal value remains intact for generations.
While a will is traditionally used to designate a guardian for your minor children, transferring assets directly to a minor through a will would require a court-supervised conservatorship or guardianship. Instead, you can avoid the hassle by setting up a trust for their benefit. A revocable living trust would allow you to retain control over the assets while you’re alive, and it would provide a trustee to administer income and support to your children when you die. A common distribution plan is for the trust to provide income until the minor child reaches adulthood, at which point they can receive all of the assets in the trust.
It may be an unpleasant subject, but end-of-life healthcare contingencies are a necessary part of estate planning. If you ever become incapacitated and are unable to communicate important decisions, a trust would allow a secondary trustee to step in and manage your affairs. As with the previous example, a revocable living trust would allow you to retain full control as long as you possess mental capacity, and would only authorize the trustee to step in if you become incapacitated. The same individual would become the successor trustee to administer the trust after you die.
Finally, using a trust instead of a will lets you keep your assets and beneficiaries private. Because probate takes place in a public county court, your last will and testament will be publically available through the probate proceedings. The public would be able to see all of your assets, who you gifted assets to, and any other aspects of the proceedings. In contrast, a trust agreement is private. Even if a portion of your estate passes through probate court, the assets held by the trust would remain private, as would the trust’s beneficiaries.
Cons of Revocable Living Trusts
While retaining control of the assets in a revocable living trust provides greater control, that control comes at a price: the assets in a revocable trust will still count towards the value of your estate. If your estate is at risk for estate taxes, an irrevocable trust may be a better solution to transfer assets out of your estate and limit your exposure to an estate tax. This isn’t a concern for over 99% of Americans who don’t qualify for estate taxes, but it can be a serious problem for high-net-worth individuals who do.
Similarly, assets in a revocable living trust are considered by the government when assessing your eligibility for Medicaid assistance. Should you be placed in a nursing home, you would be expected to deplete your personally-available funds before the government steps in to assist with the bill. Doing so would obviously erode the value you can ultimately leave to your heirs. If, however, your assets were in an irrevocable trust, they would be outside of your estate, and therefore would not affect your eligibility for Medicaid or other government assistance programs.
Assets held in a revocable living trust are also within reach of creditors and lawsuits. If you are at risk for either of these (usually entrepreneurs whose personal credit and liability are tied to their business), an irrevocable trust may be a better solution, since assets in an irrevocable trust are separate from your personal estate.
Compared to the cost of drafting a will, setting up a trust is much more expensive. Where you may be able to get away with creating a simple will on your own, you will definitely need an attorney to help establish a trust. Keep in mind, though, that the cost of probate may be more expensive than a trust in the long run. The rule of thumb is wills are best for small estates, and trusts may be the better option for larger estates.
Funding a trust can also be a challenge. While it sounds fairly simple, transferring ownership of your assets will involve a lot of paperwork and phone calls, especially if it involves real estate. Some attorneys have a designated secretary to help you through the process, and larger law firms may even have a department to handle the tricky business. At the very least, your attorney should provide you with detailed written instructions on how to transfer your assets, and you should meet for a review to ensure everything is properly transferred.
Finally, while a revocable living trust can replace a last will and testament, you’ll probably still want to draft a pour-over will to sweep up any assets that don’t make it into the trust. If you acquire assets later in life and forget to transfer them to the trust, the assets will have to go through probate and will be distributed according to the state’s intestate succession laws.
Call our Arizona Estate Planning team at (480)467-4325 to discuss your case today.