Overview of a Revocable Living Trust

Most of us share the same objectives for our estate plan:

• Provide for our spouse or dependent children;
• Distribute our property;
• Plan for our disability;
• Organize our finances; and
• Reduce our estate taxes.

Unfortunately, most of us fail to put together a plan that achieves these goals. One way to achieve these goals is to create a Revocable Living Trust.

A Revocable Living Trust is an arrangement you make for management and distribution of your property. These Trusts are established by a written agreement or declaration which appoints a “Trustee” to administer the property, and which gives detailed instructions on how the property is to be managed and eventually distributed. Through the terms of the Trust, you keep all the benefits of any property placed into it for the rest of your life. Additionally, the Trust is “revocable,” meaning that you can modify or eliminate it at any time.

Besides the goals already mentioned, one of the most important benefits of Living Trusts is that they avoid Probate since they are completely private. Because a Trust is recognized as a separate legal entity, a Trustee can make distributions to named beneficiaries without any involvement from the courts. The courts maintain no control over the Trust’s assets, and do not tie up the assets in potentially lengthy (and costly) Probate process. The Trustee simply distributes assets to named heirs.

Since a Revocable Living Trust accomplishes the objectives that most people seek, it is a viable option in many peoples’ estate plan. Let’s look now at what else is involved in having a Revocable Living Trust.

Will My Income Taxes Change If I Create a Revocable Living Trust?

There are no substantive income tax advantages in the use of a Revocable Living Trust. You are treated as the owner of the Trust for income tax purposes, and must report all Trust income on your personal return under the “Grantor Trust” income tax rules. The Trust uses your social security number, and the same annual 1040 tax return is filed as long as you file jointly (if married) and the Trust holds no foreign property.

According to the Internal Revenue Service:

“Grantor Trusts are not recognized as separate taxable entities, because under the terms of the Trust, the grantor retains one or more powers and remains the owner of the Trust income. In such a case, the Trust income is taxed to the grantor, whether or not the income is distributed to another party.”

Generally, as a grantor, the only way you can avoid taxation on the income from the Trust (and avoid including Trust property in your gross estate) is to give up control and benefits of the assets that you assign to the Trust, and give up the right to revoke or amend the Trust. The Trust would then be characterized as an Irrevocable Trust or a Non-Grantor Trust. The Trustee would manage the Trust, and the income from the Trust would be taxed to the Trust. The Non-Grantor Trust has its own taxpayer identification number and must file Form 1041 to report yearly income and deductions.

If a Non-Grantor Trust makes distributions to a beneficiary, those distributions will be considered taxable income to the beneficiary. Let’s look at a quick example.

If a Non-Grantor Trust earns $1,000 of income and distributes $400 to a beneficiary, $400 of income is taxed to the beneficiary and the Trust gets an offsetting deduction, so that $600 is taxed to the Trust itself. If the Non-Grantor Trust has the same income and distributes $3,000, the full income of $1,000 is taxed to the beneficiary and nothing is taxed to the Trust. The additional $2,000 is considered a distribution of principal and is not taxed to the beneficiary.

Do Property Taxes Change If I Create a Revocable Living Trust?

Some people are concerned that their property taxes will go up if their real property is placed in a Trust. The truth is that transfers into a Revocable Living Trust have no effect on your property taxes.

However, some states such as Florida require that your primary residence, if it is placed into the Trust, be titled in a specific manner, otherwise it may affect its ability to qualify for what is known as the homestead exemption. Relevant state law needs to be reviewed before any transfer is made.

What Is the Annual Fee for a Revocable Living Trust?

The exact cost of a Revocable Living Trust depends on how valuable and complicated your assets are, whether standard documents can be used, how many assets must be transferred to the Trustee, and whether tax planning is needed. However, if you are the Trustee, there is no annual fee associated with maintaining a Trust.

Fees are involved when an amendment to the Trust is made which involves changing the terms of the Trust. Additionally, when a spouse of the Trustee passes away and assistance is needed in administering the Trust, attorneys fees will be charged in order to handle the Trust Administration to take advantage of certain tax benefits, if applicable, and to follow the terms of the Trust.

Annual fees do exist if the Trustee is an organization with Trust services representatives specially trained to administer Trusts. Such organizations can be credit unions, banks, independent Trust companies, qualifying nonprofit corporations, or law firms that are professional service corporations. The annual fee for Trust servicing is usually around 1 percent to 1.25 percent of the assets in the Trust.

How Do I Fund My Revocable Living Trust?

Funding a Trust is nothing more than transferring assets you own as an individual into the name of your Trust. Once you establish your Trust, you can place a wide variety of assets in it, including bank accounts, stocks, bonds, real estate, and personal property. To make them a part of the Trust, you have to transfer title to your bank accounts and stock to the name of the Trust, and sign new deeds to any real property you own.

Each asset must be transferred on an individual basis with consideration given to the legal requirements for “funding” various asset types. Out-of-state property is transferred into the Trust by using a local attorney in that state. Timeshares are transferred based upon the type of ownership you have. Some timeshares are a contract and are transferred to the Trust by an assignment of the contract. Other timeshares are a fee-simple real estate, which means you have absolute ownership. Therefore, it is transferred by deeding it to the Trust. In fact, most assets require different funding procedures specific to that asset type. Though many people elect to fund a Trust on their own, you should consult a qualified estate planning attorney for advice on how to properly re-title assets and change the beneficiary designations on insurance and retirement plans. Remember, a Trust controls only those assets retitled to the Trust or paid to the Trust at your death.

If you fail to transfer all your assets to your Trust, there are a few methods to get those forgotten assets into the Trust. Most estate plans that include a Revocable Living Trust also include what is known as a “Pour-Over” Will. A Pour Over Will says, “I leave everything I own at my death to my Living Trust.” If you neglected to fund your Trust while you were alive, the Pour Over Will funds the Trust after your death. The downside to a Pour Over Will is that the portion of your estate left outside the trust at your death will have pass through Probate prior to funding your Trust.

Another method to get those overlooked assets into your Trust is through a properly drafted Durable Special Power of Attorney, where you name someone as your agent or attorney-in-fact to transfer your property into your Trust. A Durable Special Power of Attorney addresses the issue when someone falls ill or becomes disabled and cannot complete the funding of the Trust themselves. By giving a trusted individual this special “funding” Power of Attorney, you increase the chances that whatever is left out of the Trust during your disability will be funded before it is too late.

What Assets Are Left Outside of My Revocable Living Trust?

Your contractual assets, such as life insurance, pension plans, IRAs and other retirement plans, and annuities are not funded into the Trust because these assets pass to the designated beneficiary outside of Probate administration. However, in most cases, the primary beneficiary of these assets should be the Revocable Living Trust. Additionally, some people choose to have a small checking account outside their Trust. Although you can use a Trust checking account for any purpose, some people would prefer to have only their name and not the Trust name on the check.

This is a complex area of planning and must be based on each person’s individual family circumstances and size of estate.

If I Transfer Real Estate to My Revocable Living Trust, Can the Bank Call My Loan?

Most mortgages have a “Due on Sale” clause. This means, the bank may, at its option, declare the entire balance owing to be immediately due and payable upon the transfer or sale of the property. However, this is not true when the property is transferred into a Trust.

Enacted as part of the Garn-St. Germain Depository Institutions Act of 1982, a due-on-sale clause cannot be enforced on a “transfer into an inter vivos Trust on which the borrower is and remains a beneficiary and which is not related to a transfer of rights of occupancy in the property.”

Keep in mind that this exemption only pertains to properties with less than five units and where you remain the beneficiary and occupant of the dwelling. Even so, the most prudent thing to do is notify the lending institution before the transfer.

As you can see, there are many different rules and regulations concerning the creation and funding of a Revocable Living Trust. There is no perfect solution to every transfer or estate situation. If you decide to use a Revocable Living Trust, work with an attorney well-versed in drafting Living Trusts.