Is a Revocable Trust Right for Protecting Your Assets?
Although it’s not always an easy topic to think or talk about, estate planning — the process of determining what will happen to your assets upon your death — is an essential element of solid financial planning. Putting legal safeguards and other provisions in place helps you protect your assets and ensure they go where you want them to when you’re no longer here. And it also helps you create a financial legacy that benefits your loved ones far into the future.
If you’re in the early stages of estate planning, one of the tools you may have come across in your research or initial discussions with a financial planner is a revocable trust. These legal entities can go a long way in protecting properties, money and other investments that you want to maintain and keep safe during your lifetime — and afterwards. But what are they, and how do they differ from other types of trusts? They’re different from other estate documents in very important ways, and they require careful thought and planning to set up. Before you move forward with a revocable trust, consider these important issues to decide if it’s right for your needs.
First Things First: What Is a Trust?
A trust is a legal entity that an individual creates that can receive and hold assets for them — and also designate someone to manage those assets — while the creator is alive. It’s different from a will, which is a legal document that describes how you want your assets distributed (and to whom) upon your death. When you pass, your assets become part of your estate, and your will dictates how those assets will be transferred to your beneficiaries. In a trust, however, the assets move out of your ownership and into the ownership of the trust once the trust is created and administered — and while you're still alive. Once you pass, the assets are transferred to your designated beneficiaries based on the terms outlined in the trust.
People who have significant assets often use trusts to make sure those assets are used the way the owners feel is appropriate — but without the need for the owners to continually manage those assets themselves if they don’t want to. Instead, a third party called a trustee is responsible for managing the assets in the trust. The trustee invests and manages the assets according to the grantor's (the person who created the trust) instructions and then distributes the assets to the beneficiaries when appropriate or when certain conditions are met.
Revocable trusts are different from other common types of trust in very important ways, and both options require careful thought. It’s essential to consider a variety of issues involved in deciding if a revocable trust is right for your needs.
The Basics of Revocable Trusts, Explained
What defines a revocable trust? It’s in the name: If you create a revocable trust — also called a living or inter vivos trust — you can change your mind about its provisions. As time passes and circumstances change, you can cancel the trust altogether, add assets to the trust, remove assets from the trust, or even remove or change beneficiaries. Living trusts offer three primary advantages:
- There’s more flexibility. You can change many aspects of revocable trusts and can transfer assets into the trust either immediately or when some future event occurs.
- Assets in a revocable trust don't need to go through the lengthy court-driven probate process that occurs upon your death. Instead, the trustee can distribute them to the beneficiaries in a much shorter time.
- The costs of administering your estate may be much lower because there could be far fewer assets — if any — going through probate, depending on what you place under ownership of the trust.
Less time in probate and lower administration costs can make a revocable trust an appealing choice. However, there are some limitations to consider before making your decision.
What Are the Limitations of Revocable Trusts?
It's important to understand what revocable trusts can not do. Revocable trusts do not protect your assets from creditors or from lawsuits. That's because, from a legal perspective, a grantor who has created a revocable trust can retain some control over that trust when they’re a trustee. Wealthy individuals or professionals who wish to protect assets from being pursued in the event of litigation, for example, should not use a revocable trust for that purpose. A court can order the assets in a revocable trust to be liquidated to pay a civil judgment against the grantor.
Revocable trusts are also not a way to avoid income tax. If the assets in the trust generate income, that income is still subject to taxation. Putting assets into a revocable trust is also not a way to avoid paying estate taxes. When you die, the assets in your revocable trust are still subject to estate taxes charged in your state and by the federal government.
Irrevocable Trusts Are Not the Same Thing
When it comes to legal, tax and investment planning, words are important. Even very small distinctions can be critical, and that’s certainly the case with trusts. A revocable trust is not the same as what’s called an irrevocable trust. This type differs from a revocable trust in that, once it’s created, it is set almost completely in stone. Only in rare circumstances can changes be made to any provisions of an irrevocable trust.
Additionally, in a revocable trust, you still have some control over the assets; that's not so true in the case of an irrevocable one. The irrevocable trust owns any assets transferred into it, and all the trust’s named beneficiaries must give permission for terms of the trust to be modified, amended or terminated. While that seems like a significant disadvantage of an irrevocable trust, it comes with a significant advantage.
Because an irrevocable trust removes the assets from your personal ownership and future estate upon your death — once they’re in the trust, they belong to the trust itself and you can’t change that — they’re not subject to actions from creditors or to legal judgments against you. If you’re in a profession that could involve significant legal action against you — say you’re a doctor who could face malpractice lawsuits — an irrevocable trust may be a better option for protecting your assets.
How to Set Up a Revocable Trust
Setting up a revocable trust involves several key steps. It’s advised to enlist the assistance of an experienced estate-planning attorney to help you make some key decisions and ensure that both the trust paperwork is completed and the trust itself is established properly.
Step 1: Choose what kind of trust you want, such as revocable or irrevocable. If your priorities are flexibility, asset protection and managing tax liability, a revocable trust may offer more advantages than an irrevocable one. To make this choice, you should consult with tax, finance, investment and legal advisors.
Step 2: Decide what assets to put into the trust. This step will require taking a full inventory of your assets and consulting with financial advisors about the pros and cons of placing each individual asset into the trust.
There are some types of assets that cannot or should not be placed in a trust — at least not without carefully reviewing the consequences, deciding if they're worth it and getting advice about alternatives that will more effectively achieve your goals. These include 401(k) and 403(b) accounts, IRAs and annuities; health savings accounts and medical savings accounts; Uniform Transfers or Uniform Gifts to Minors; life insurance (unless your state provides creditor protection for this in a revocable living trust); and motor vehicles if your state treats a transfer to a trust as a sale that would trigger significant tax issues.
Step 3: Determine who you’ll name as the beneficiaries of the trust. Who will receive each asset you dealt with in Step 2 after your death?
Step 4: Name other trustees. Who will act in your place if needed? You’ll need to appoint a successor trustee to take over managing the assets in the trust and the work of distributing assets to the beneficiaries after you die or if you become incapacitated and can no longer manage the trust. This has to be someone capable of the job, someone you trust, someone willing to do the work and someone who understands and will comply with your wishes and any other legal requirements. You might appoint a family member, trusted friend, lawyer, some investment advisors or even a professional at a trust company.
Step 5: Name a custodian if needed. Are your beneficiaries minors? If designated assets have to go to beneficiaries who may be minors at the time the trust distributes assets to them, you need to appoint a custodian — someone to manage those assets for the minors until they’re old enough to take control of the assets themselves. This may be the same person who you identify as a guardian in your absence, or it may be a professional money manager or trustee.
Step 6: Do the paperwork. You can write up the documents required to create a revocable trust yourself using legal software or forms for wills and trusts available online, but you should never do so without receiving careful and fully informed advice from a financial advisor and an attorney — especially if your assets are significant, your situation is complex or you’re dealing with the future rights of minor children. Financial advisors may recommend, after a careful review of all your circumstances, that you have all of your trust documents prepared by a lawyer. Follow this advice.
Step 7: Officially create the trust. The process to do this can vary by state, but it generally involves signing the trust paperwork in front of a witness. Unlike a will, trust paperwork typically doesn’t need to be filed or recorded anywhere. However, the state you live in may specify how the trust should be signed and witnessed and whether an attorney needs to transfer assets into its ownership once it’s established.
Step 8: Transfer the assets to the trust. Once the trust is created, the ownership of the assets you selected needs to be transferred to the trust. The way this happens will be different depending on what type of asset it is and who owns it now. There may be costs and even taxes to be paid during this process. As an example, to place your house into a trust, the deed to the property needs to be transferred from you (the current owner) to the new owner (your trust). You’ll need to fill out a quitclaim deed, have it notarized and file it with the office that maintains property records for your county.
Estate planning is complex and involves a careful assessment of goals, opportunities, present and future intentions, and risks. Revocable trusts are one way to maintain some control over assets while you’re alive and to simplify the transfer of assets to your selected beneficiaries upon your death.