Revocable trusts are useful tools to manage your assets during your lifetime and after your death. As the name implies, revocable trusts may be revoked or amended while you are alive giving them the nickname, “living trusts”. They are useful estate planning tools for individuals with moderate and high asset values because they avoid probate and can protect beneficiaries’ inheritances through additional trust planning.
All trusts (revocable or otherwise) involve three parties: the creator, the trustee, and the beneficiary. The person who creates the trust is the “grantor” or “settlor.” The grantor creates a trust agreement that designates one or more people to serve as trustee and contains directions for distributing trust assets to the beneficiaries. The grantor can transfer cash, non-qualified financial accounts, real property, and personal property to the trust and the trustee has a fiduciary duty to manage such property in accordance with the terms of the trust agreement for the beneficiaries. A common plan is for the grantor and the grantor’s spouse to be the co-trustees and beneficiaries during the grantor’s lifetime, and upon the grantor’s death, the grantor’s spouse or family members will become the beneficiaries. A properly executed trust agreement must be signed by the grantor and trustees in front of two witnesses or acknowledged before a notary public pursuant to EPTL 7-1.17.
Trust During Grantor’s Lifetime
Grantors are almost always the trustees and beneficiaries of their own revocable trusts so that during your lifetime, you continue to control your own assets. Revocable trusts are tax neutral under Internal Revenue Code § 677 which means the grantor’s transfer of assets to the revocable trust is not a taxable event. All income earned by the assets in the trust is reported under the grantor’s social security number on his regular 1040 income tax return. Being tax neutral, a separate tax identification number or tax return is not required.
We recommend that each spouse have her or his own revocable trust that names both spouses as co-trustees to enable both spouses to access and manage the assets owned by each other’s trusts. This puts each spouse in a position to act if the other spouse becomes incapacitated and does not involve the court.
Trust After Grantor’s Death
When the grantor dies, the co-trustee or successor trustee steps in and will distribute the trust assets to the beneficiaries named in the trust agreement, these assets will avoid probate (the process of submitting a will to the court to have an executor appointed). Revocable trusts are sometimes referred to as “testamentary substitutes” or “will substitutes” because the terms of the trust agreement direct the disposition of the decedent’s property, and like a will, a revocable trust can be revoked or changed during the grantor’s lifetime. When preparing a revocable trust plan, we always draft a type of last will and testament known as a “pour over will” which directs that all the decedent’s assets be distributed to her revocable trust which are then distributed to the trust beneficiaries. Ideally, the grantor will have worked with her attorney and financial advisors to ensure none of her property need go through probate upon her death, and thus avoid the court fees and legal expense associated with a court proceeding. Probate is avoided by transferring assets to a revocable trust and naming beneficiaries on assets that remain outside the revocable trust.
When the grantor dies, a revocable trust becomes irrevocable and is treated as a separate entity instead of as an extension of the grantor. The name of the trust does not change after the grantor’s death and will continue to be called a “Revocable Trust” even though the trust becomes irrevocable upon the grantor’s death. This change in character imposes additional obligations on the trustee. The trustee must obtain a taxpayer identification number for the trust and will have to file a fiduciary income tax return (IRS Form 1041) for any income generated by the trust assets after the grantor’s death. The trustee should also work with a knowledgeable attorney to provide receipt and release agreements to all beneficiaries and consider preparing an accounting before distributing the trust assets and closing the trust.
Inheritances from a Revocable Trust
You may want to protect an inheritance for certain beneficiaries if they have developmental or intellectual disabilities, addiction issues, are spendthrifts, have taxable estates themselves, or have a desire not to comingle property with a spouse. A knowledgeable estate planning attorney can draft a revocable trust to accommodate the unique needs of each beneficiary by creating trusts for such beneficiaries within the revocable trust agreement. This avoids the time and expense of a court proceeding. Such trusts can be drafted to qualify as a special needs trust to protect an inheritance from Medicaid while enabling the beneficiary to enjoy the benefit of the inheritance. New trusts can also be drafted as lifetime trusts to provide some protection from creditors, a spouse, and taxes.
Please contact us if you would like to schedule a consultation with one of our estate planning attorneys to discuss making a revocable trust part of your estate plan or to review a revocable trust you may already have.
