As you get older, there are two major things that you should consider. One is retirement. Having the necessary retirement savings and a financial plan will allow you to live the kind of life you want to live during your golden years. The second thing to account for is what will happen to your estate, and estate planning is not just for rich people. Having a strategy in place to pass on your assets will make it smoother for you and your loved ones later in life. A financial advisor can help you with living trusts and other estate planning issues, ensuring they line up with your overall financial plan.
At the most basic level, a revocable living trust, also known simply as a revocable trust, is a written document that determines how your assets will be handled after you die. Assets can include real estate, valuable possessions, bank accounts and investments.
As with all living trusts, you create it during your lifetime. (There are also testamentary trusts, which don’t take effect until after you die.) Assets you place in the trust are then transferred to your designated beneficiaries upon your death. What sets a revocable living trust apart is that you can change or cancel the provisions at any time. Hence, the term “revocable” is in its name.
Before we go into more detail about why you should or shouldn’t get a revocable living trust, there are some terms you should understand. (You may also want to brush up on the basics of how trusts work.) Also, know that the exact laws governing trusts vary by state. The rules in Arizona or Florida won’t be the same as those in Oregon or Michigan.
The person who creates the trust is the trust-maker. You will also see the terms, trustor and grantor. All three words refer to the same person. Typically, the trust-maker of a revocable living trust is also the trustee. The trustee is the person who handles the administration of the trust – such as keeping track of income and tax returns. One thing that you will do in your trust documents is to name a successor trustee. This is the person who will manage the trust when you no longer can. The final term to know is beneficiaries. These are the people, organizations or other entities that will receive assets from your trust after your death.
If you think that a revocable living trust is right for you, get ready. You will have to do most of the work upfront so that the dissemination of your estate is easier down the road. Start by taking an inventory of your assets. Then, think about who you want to inherit your assets and who you can assign as trustees. Once the document is drawn up, transfer any property you want to be covered into the trust.
For some items, all you’ll need to do is list the asset. For others, you’ll have to contact banks, insurance companies and transfer agents to update beneficiaries, issue new investment certificates, retitle cars, and sign new deeds. You’ll also want to establish a “pour-over” will, which adds unfunded or unallocated assets to your trust.
If you are considering trusts, you will also want to compare irrevocable living trusts. To decide which is better for you, let’s look at what differentiates those two types of trusts.
One major advantage of a revocable living trust is that it is revocable. As mentioned earlier, that means you can alter or even void the trust whenever and however you want. You can remain as the trustee and so you have the ability to make any and all decisions as you see fit. If you decide that you no longer want to give assets to a specific beneficiary, you can remove that beneficiary. This is the opposite of an irrevocable living trust.
With an irrevocable living trust, you cannot modify or terminate the trust without approval from everyone named in the trust. If you want to remove a beneficiary from an irrevocable trust, that beneficiary needs to agree and sign off. The reason for this inflexibility is that as soon as the trust-maker signs the documents for an irrevocable living trust, he or she removes all ownership rights to the assets.
Another important difference between revocable and irrevocable trusts comes with taxes. The assets in a revocable trust are still yours and you will pay taxes accordingly. That includes any income taxes, inheritance taxes or estate taxes. In fact, your revocable trust will have the same Social Security number as you. The effect is that any income from assets in the trust will go on your own income return. In irrevocable trusts, the assets are no longer yours. They belong to the trust and all taxes are applicable to the trust itself.
One technical thing to note is that once a trust-maker dies, a revocable trust becomes irrevocable. The trust-maker no longer has the ability to make changes to a trust.
You should also note that revocable trusts do not offer the same type of protection that irrevocable trusts offer against creditors. This means that because assets in a revocable trust still belong to the creator of the trust, creditors could go after assets to satisfy a judgment.
Both living trusts and living wills enable you to name beneficiaries and plan the distribution of your assets. They both also allow you to revise the document if your circumstances or desires change. However, a living trust covers three stages of your life: while you’re alive and well, while you’re alive but incapacitated and after your death.
The terms of your living will only go into effect after you pass. Plus, living trusts avoid the probate process, reduce the chance of court disputes, and keep your documents private. Wills become public records, where anyone can access them.
It’s important to note that creating a living trust does not negate your need for a will. This is particularly true if you didn’t properly add all your assets to your trust or if your trust does not have enough funds to cover the costs of distributing your assets.
Wills also allow you to name guardians of minor children. A revocable trust only allows you to decide when your children can receive their inheritance and who will administer the trust until the children reach 18.
Overall, wills are easier and cheaper to set up than trusts and are effective in keeping your family outside of probate court. Trusts, on the other hand, are valuable for complex estates with more assets. And because they are private, staying out of the public eye can also help keep wealth in the family.
Financial expert Suze Orman once told CNBC that everyone needs a revocable trust. “A living revocable trust serves as far more than just where assets are to go upon your death and it does that in an efficient way,” she said. Here are six reasons a revocable trust should be part of your estate plan:
Revocable living trusts allow you to make amendments at your own discretion. That can prove invaluable if your circumstances change or if you just aren’t sure who you want to name as your beneficiaries. That flexibility also makes these trusts a popular option if you are starting your estate planning young.
As outlined above, a living trust covers grantors during three phases of life. If you become incapacitated, your trustee can take over and manage your affairs. (Don’t worry: This person has a fiduciary duty to act in her best interest.) This happens automatically. You do not need to go through court proceedings or appointed conservators. Revocable living trusts also account for guardianship. You can stipulate living situations and spending habits for minor children in the terms of your trust.
If you have a will when you die, your assets will go through probate. That is a court proceeding where your assets are distributed per your stipulations. Probate is a relatively slow process that can take up to several months. If you own property in more than one state, your beneficiaries may have to go through multiple probates.
The costs of going through probate can also cut down on what your beneficiaries inherit. With revocable living trusts, probate is not necessary. Your successor trustee will be able to pass your assets on to your beneficiaries without the need to wait for a court order. That usually means a quicker and more affordable process for your beneficiaries.
Drafting a living trust usually requires more funds and effort upfront because it’s a more complex legal document than a regular trust or will. So that means you will need to spend some time and money to properly set up and maintain your trust. However, that work can save you the headache and higher expenses associated with probate. Living trusts also tend to hold up better if someone contests a provision, potentially saving more money and time.
After your death, wills and their requisite transactions enter into the public records. Anyone can see what stipulations are in your will, who your beneficiaries are and what each beneficiary is inheriting. Estates in a living trust are distributed in private. No one can search the public records to see where your assets went. This protects the privacy of your assets as well as your beneficiaries.
The FDIC (Federal Deposit Insurance Corporation) typically protects money in a bank account up to $250,000. However, that coverage amount goes up with revocable living trusts. According to the FDIC, the owner of a revocable trust account receives insurance of up to $250,000 per beneficiary. The maximum insured amount you can have is $1,250,000, equal to $250,000 for the owner and each of the four beneficiaries.
Creating a revocable living trust can take more time and more than writing a will because it requires a lot of work upfront. For instance, you must re-title all assets you want to transfer to the trust. Any assets you don’t re-title may be subject to probate. There may be exceptions, however, like retirement plans, insurance policies, and annuities.
In addition to re-titling assets, you must contact your bank and any relevant entities that hold your assets. This is because all the accounts you want to be owned by the trust must also be updated. As mentioned, this can be a long and expensive process, so it’s not always a good idea unless your estate is complex.
These trusts don’t have direct tax benefits. This is because you still retain control of the assets while you are alive, and any income on those assets passes through you. This is different from an irrevocable trust, wherein you completely give up control over your assets. But because you still retain control while you are alive with a revocable living trust, income is reported and taxed on your personal tax return.
A revocable living trust is a powerful tool as you begin the process of estate planning. It offers flexibility that you cannot get from some other trusts or wills. This is especially useful for people who are beginning to plan their estate and are not yet sure who exactly to name as beneficiaries.
Revocable estates will require considerable work upfront to move all of your assets into the trust, but this usually pays off in the long run. Without the trust, your beneficiaries will need to go through a long and potentially costly probate process.
Photo credits: ©iStock.com/eyetoeyePIX, ©iStock.com/BrianAJackson, ©iStock.com/MartinPrescott
Liz SmithLiz Smith is a graduate of New York University and has been passionate about helping people make better financial decisions since her college days. Liz has been writing for SmartAsset for more than four years. Her areas of expertise include retirement, credit cards and savings. She also focuses on all money issues for millennials. Liz's articles have been featured across the web, including on AOL Finance, Business Insider and WNBC. The biggest personal finance mistake she sees people making: not contributing to retirement early in their careers.
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