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Revocable Living Trusts: A Beginner's Guide

Living Trusts Basics

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Living Trusts Basics

This section covers the basics of living trusts. I’ve broken it down by commonly asked questions, which are listed below. You can click the links below to jump to a particular question.

Contents

What is a revocable living trust?

Before I explain what a revocable living trust is, let’s back up a bit for a moment. I first want to explain what a trust is more generally.

As its essence, a trust is an agreement. The agreement is between two parties:

  • The first party is the person making the trust (commonly referred to as the grantor, settlor, or trustor).
  • The second party is the person who administers the trust, known as the trustee.

In broad terms, the trustee agrees to accept property that belongs to the grantor and to make it productive (i.e., generate income) for the benefit of one or more beneficiaries. In administrating the trust, the trustee agrees to the terms set by the grantor.

All trusts, revocable and irrevocable, follow this arrangement.

Now that you’ve seen what a trust is generally, let’s talk in particular about a revocable living trust and what makes it different from other types of trusts.

A revocable living trust has two salient characteristics. First, as the name implies, it’s revocable during the grantor’s lifetime. (Upon the grantor’s passing, the trust becomes irrevocable.) Second, during the grantor’s lifetime, the grantor is also the trustee and the beneficiary. Or, in other words, when you create a revocable living trust, you are the grantor, the trustee, and the beneficiary.

From a legal perspective, what this means is that when you create a living trust, you (acting as the grantor) will give your property to yourself (in your capacity as the trustee). You (in your capacity as the trustee) will manage and control that property for the benefit of yourself (the beneficiary).

This begs the question, why bother with this complex arrangement? Keep reading to learn why.

The primary purpose of a revocable living trust is to avoid probate.

What is the purpose of a living trust?

Probate is the court process used to transfer a deceased person’s belongings to their legal heirs or beneficiaries. It’s required when some dies with or without a will. Let me say that again: Probate is required when a person dies with a will or without a will.

Most people want to keep their estates out of probate. Here’s why:

There are three main drawbacks of probate.

  • First, it’s a public proceeding, which means that every document filed is publicly accessible.
  • Second, probate is typically a lengthy process. The judge must approve any major action and you can’t move from one step to the next without the judge’s permission. It’s not uncommon for a simple probate to take 18 to 24 months.
  • Third, probate is expensive. Most probates will cost about 3-5% of the fair market value of the estate’s assets. This figure includes court costs, bond fees, attorney fees. Because many probates include a piece of real estate, the cost of probate can easily exceed $25,000.

Because of these downsides, most people want to avoid probate. There are a few asset-specific strategies for avoiding probate (e.g., payable-on-death accounts, transfer-on-death deed), but these often come with significant limitations.

The most straightforward way to ensure that all your assets avoid probate upon your passing is to use a revocable living trust.

Keep reading to learn how a revocable living trust avoids probate.

How does a living trust avoid probate?

As previously mentioned, to create a trust, the grantor gives property to a trustee to hold and administer for the benefit of a beneficiary. In the case of a revocable living trust, you’ll wear each of these three hats:

  • grantor,
  • trustee, and
  • beneficiary.

Here’s a quick example.

John Smith decides to create a living trust, which he names The John Smith Revocable Living Trust. To fund the trust, he transfers title to his home and to his other assets from himself to the trust (he will continue to own some of his assets, such as retirement accounts and bank accounts, in his individual capacity). As a consequence, the “new” owner of that property is John Smith, Trustee of the John Smith Living Trust.

During John Smith’s lifetime, as the trustee, he will have full control of all of “his” property. He decides what to keep, what to sell, and what to spend money on.

As the grantor, John Smith retains the right to revoke the trust or to amend it.

In other words, between his authority as trustee and his retained rights as grantor, John has 100% complete control over this assets in his living trust.

Now, what happens when John dies?

The trust agreement that he used to create the trust says that the trust will continue on after his passing, except, at that point, it becomes irrevocable (i.e., no one can change the terms set by John).

In that trust agreement, John selected a successor trustee, whose job it is to take over administration of his trust after he dies. So, when John passes, the successor trustee steps in and begins settling John’s estate.

That process involves collecting all the trust property, paying off any claims, dealing with any accounting and tax issues, and, finally, distributing John’s property to his designated beneficiaries.

John’s property stays out of probate because the “owner” of the property is the trust. So, even though John dies and can no longer serve as trustee, the trust does not. It just keeps going, with John’s sucessor trustee stepping in to manage the settlement of John’s estate.

How does a living trust work?

In a nutshell, a revocable living trust works as a distinct legal entity. To ensure that you receive the benefits of your living trust (i.e., avoid probate), you’ll need to adhere to certain trust formalities. For example, when dealing with trust property, you’ll need to act in your capacity as trustee, not your individual capacity.

Thankfully, the IRS does not require you to treat your living trust as a distinct entity during your lifetime. You do not need to file a separate tax return for your trust and any financial accounts/assets owned by the trust will be tied to your social security number.

What are the advantages of a living trust?

The main advantage of a revocable living trust over a will is that a revocable trust avoids probate. A related advantage is that conservatorship proceedings can also be avoided.

Avoiding Probate

Most of my clients strongly desire to avoid probate for three main reasons. First, staying out of probate means the settlement of your estate will be private. Aside from any recorded real estate deeds, none of the documents will be publicly accessible.

Second, post-death administration of a living trust can happen as quickly or as slowly as preferred. With probate, you’re at the mercy of the court. Simple probates can take 12 to 18 months. By contrast, a simple estate settlement can be 95% complete within 60 to 90 days.

And third, probate is expensive. In California, probate can cost around 5% of the fair-market value of the estate. For many estates, the most valuable asset is typically a piece of real property. So, for example, take an estate that consists of only home with a fair market value of $1 million. The cost to probate that estate in California would be around $50,000, which is about 10 times the cost of administering a trust holding the same asset.

Avoiding Conservatorship

Another advantage of using a living trust is avoiding conservatorship proceedings. Establishing a conservatorship is necessary when a person loses the capacity to handle his or her own financial affairs.

In California, these kinds of proceedings are extremely expense. The total cost to have a conservator appointed can easily run $10,000 to $20,000. Likewise, the ongoing costs to keep a conservatorship in place are very expensive, particularly if a professional conservator is used. And, like probate, these proceedings are for the most part public. While some filings are confidential, most of the papers filed with the court are publicly accessible.

A living trust can keep a person out of conservatorship proceedings because most trust documents authorize a successor trustee to step in an manage the trust property when the grantor (the person who created the trust) loses capacity.

Avoiding probate is why most families opt for a living trust over a will. But there are some downsides you should be aware of. Keep reading to find out.

What are the disadvantages of a living trust?

As compared to using only a will, an estate plan that uses a living trust typically costs more and requires more upfront effort.

Whereas a will only must be signed to be effective, a revocable trust must be properly funded after it is signed. This process entails transferring title to all your assets to the trust. Depending on the asset, this can be a lengthy a time-consuming process. For example, deeds to real-property holdings must be drafted, executed, and recorded.

Similarly, to ensure that your trust, you must adhere to trust formalities when conducting business on behalf of the trust.

How do you create a living trust?

Typically, a revocable living trust is created when the grantor (i.e., the person creating the trust) expresses or implies an intent to create a trust. For example, express intent would include signing a written trust agreement.

For practical purposes, this means that to create a revocable trust, you need to sign a trust agreement or declaration of trust stating that you intend to create a revocable trust.

Should I use an attorney to create a revocable living trust?

It depends.

Many attorneys will tell you that you should never go with a DIY option like Legal Zoom or Trust & Will. I don’t agree with that. There are definitely situations where using an online company to create your estate planning documents is the best option for you.

The obvious benefits are cost and convenience. Simply put, attorney just can’t compete on price with these online companies.

The downsides are that you must educate yourself about estate laws and you must make legal decisions without the benefit of legal advice.

Attorneys are obviously more expensive, but they can provide legal advice and they can produce customized documents that are specifically designed to deal with your family’s situation.

One of the major goals of estate planning is for the settlement of your estate to be organized, streamlined, and free of conflict. The major issue with DIY estate planning is that you could make a bad decision, or one that’s very likely to lead to conflict, without even knowing it. For example, I’ve reviewed an estate plan that a client created online that would have given half the estate to his daughters prior to the death of his wife. That was a huge mistake; and one that didn’t get caught by the “attorney review” that was provided with the service. Thankfully, we updated and amended his plan before it became an issue.

If you have a straightforward estate (i.e., no family business or complicated investments) and are planning on a vanilla distribution of your estate (i.e., split evenly between your children), then DIY estate planning tools might be the right fit.

If one or more of the following apply, I’d stay away from DIY options and go with an attorney drafted plan.