Advantages and Limitations of the Revocable Living Trust

The living trust is a topic of substantial controversy. The controversy began a number of years ago with a book called "How To Avoid Probate" by Norman Dacey. Since then, numerous books have been written that offer do-it-yourself revocable living trusts that are promoted as being able to help you to avoid the costs and other problems of probate. Some books also claim that a revocable living trust can help you to save estate taxes. I'm surprised that none of the books I've seen went so far as to claim that a living trust could help you to save income taxes because it's technically true - and also misleading.  

In addition, seminars on living trusts have been extremely popular in most larger cities. Most of the seminars are being promoted by lawyers, insurance agents or financial planners. The headlines promoting the trusts virtually scream at you about the terrible pitfalls of probate, which are often exaggerated.

A number of articles have been critical of the promotional hype. A headline in Retirement Life (3/93) says, "Avoiding Probate Is Certainly Desirable, But Beware Of The Income Tax Implications." The Jan. 18, 1993 issue of Business Week had an article with the headline "Before You Trust In A Living Trust". An article in Probate and Property discusses the post death tax benefits of a will compared to a living trust. A Personal Financial Planning article (9/93) discusses the "hidden estate planning problems" of a joint (living) trust.

An extensive article about the living trust appeared in the August 12, 1996 issue of Medical Economics. Written by Martin A. Goldberg, J.D., the author argues that for many people the living trust does not save money or hassles. According to Goldberg,  

"These highly touted estate-planning tools are more glitter than gold. Sometimes they're even counterproductive."  

The problems are not so much due to any defects of the revocable living trust as with the pre-packaged, do-it-yourself books and manuals that are being peddled as low cost alternatives to the expense of hiring a qualified lawyer to help you develop an estate conservation plan that is appropriate for you.

And .... in case you are wondering if I'm a lawyer, the answer is "No. I'm not." But I was the trustee for my mother's living trust and co-trustee for my mother-in-law's living trust and my wife and I each have our own living trust. As a tax accountant, I have studied the tax implications of different kinds of trusts.

During the period of almost eight years when my wife and I were taking care of the financial affairs of our mothers, we found the living trust arrangement to be indispensable. Even though we each had a durable power of attorney for our mothers, we found that financial institutions and vendors with whom we had to deal were much more comfortable with us in our capacity as trustees than with reliance on our power of attorney.

The purpose of this article is to provide a layman's explanation to this highly controversial legal device. 

What Is A Living Trust ?

 There are two ways to create a trust.

1.       You can create one while you are living or

2.       you can create one by will, after your death.

The first is called an "inter vivos" (living) trust and the second is called a testamentary trust. One author has coined the phrase "Loving Trust" to describe a living trust. Various authors have used their own name (i.e.,, The "Austin Living Trust") to describe a specific trust that they drafted.

There are also two types of trusts.

1.       A trust can be revocable or

2.       it can be irrevocable.

However, since the concept of revocation usually applies to the person who creates the trust, only a living trust can be revoked by the creator. (It's technically possible for a testamentary trust to give the beneficiary the power to revoke the trust, but it's rarely done.)

The type of trust that is commonly used to avoid probate is a revocable, living trust. In most cases, whenever anyone refers to a "living" trust, they're also referring to a revocable trust.   

The Three Parties To A Trust

There are at least three parties who are involved in any type of trust.

One is the grantor, who is sometimes called the "settlor", the "creator", "grantor" or "trustor". The grantor selects the terms of the trust and puts the property into the trust.  

The second party is the beneficiary - the one who is to benefit from the trust. The two types of beneficiaries are income and remainder beneficiaries. The income beneficiary gets the income earned by the trust. The remainder or principal beneficiary gets what is left after the death of the income beneficiary or upon some event spelled out in the trust agreement. In a revocable, living trust, the grantor is often the only beneficiary.

The third party to every trust is the trustee. This is the party who is responsible for the management of the trust property in accordance with the provisions of the trust agreement. The title to the trust property is in the name of the trustee. In a revocable, living trust, the grantor is usually the trustee or a co-trustee. With a co-trustee arrangement a spouse is usually the other co-trustee. Where there is no living spouse, a child is usually the co-trustee.  

What Is Probate and Why Do So Many People Want To Avoid It? 

Why would anyone put property into a trust when they are the beneficiaries and the trustee? The main reason is to avoid probate. Adrian G. Berg, author of Keys To Avoiding Probate and Reducing Estate Taxes (Baron's Educational Services) said,  

"Many people would like to avoid probate, but very few people actually know what probate is"  

Probate is the legal process of carrying out the desires of the decedent with respect to the disposition of his estate. If there is a will, then the court attempts to oversee the actions of the  executor. If there is no will, the court will administer the estate according to the laws of the state.

The following are often mentioned as the "Pitfalls of Probate".

1. The Costs: Legal fees, accounting, appraisal fees and executor fees can consume a large part of a small estate. These costs can range from 5% to 25% of the gross estate. In a few extreme cases, these fees have consumed all the assets in a modest estate.  

2. The Delays: It can take anywhere from eight months to many years to close an estate. Where heirs are hard to locate or where a will is contested, the probate process can drag on interminably.  

3. The Publicity: Probate is a public process. In fact, the executor or administrator of an estate must advertise that there is an estate so that all potential creditors have an opportunity to file any claims they may have against the estate. The details of the will and an inventory of the assets are available for public inspection.  

4. Family Disputes: The probate process gives everyone who might have any interest in the estate a chance to submit their claims. Thus, there is a greater chance that disgruntled heirs would contest a will than a trust or joint ownership arrangement.  

5. Multi-state Probate: Where real property is owned in more than one state, there will be a probate process in each state where real property is owned -- unless the property is held in trust.  

6. Bureaucratic Inflexibility: The probate process is often obsolete and more concerned about the details of the applicable laws than about the survivors. There is less flexibility than with a trust.

However, a number of states have adopted uniform rules of probate administration to reduce this problem.

Some of The Benefits of A Living Trust

Despite the fact that the revocable, living trust has been oversold to a lot of people, it does offer some real benefits to many families. Here are some of the reasons why a revocable, living trust might be worth the costs and inconveniences to you.

1. You want to avoid the publicity of probate: This may be one of the most real concerns about probate and one of the major benefits of the living trust. But if any assets are probated, some states may then require disclosure of the trust agreement and assets. Although probate can also be avoided with joint ownership (with the right of survivorship), that exposes your assets to two sets of creditors. Where asset protection is desired, a living trust is an alternative to joint ownership.

2. You want to avoid probate if you are incapacitated or disabled: If you become disabled or incompetent, your family will have to get the probate court to give them the power to manage your affairs. A living trust can include provisions to avoid that problem. So can a durable power of attorney, but some financial institutions may not accept the power of attorney. When parents reach an advanced age where they are no longer able to manage their own affairs, a living trust is a much more flexible device than a durable power of attorney - but the power of attorney is also necessary.  

However, while your parent is still able to manage his or her own affairs, he or she will want to be the trustee, with you as the alternate trustee in the event of death, disability or incapacity. To accomplish this, the trust document should include a provision that will give you the sole power to manage the trust assets upon a finding by a competent physician that the parent is not able to manage his or her financial affairs. The "trigger" to change trustees must be something with which the parent will be comfortable or the parent simply won't execute the trust agreement. An alternative to this is a trust provision that permits either trustee (where there are co-trustees) to act alone. Again, this provision is one with which the parent must be comfortable.

Once a living trust is established, it becomes critical to change the title of any assets from the name of the grantor to the name of the trust. Jointly owned assets must be re-titled because they will otherwise pass to the joint owner outside the trust. 

3. You want to reduce the costs of probate: By pre-arranging your financial affairs, it won't be necessary to hire a battery of legal and financial professionals to gather your assets and debts and appraise your assets after your death. But that means you must be willing to do that work yourself, and to keep it up from year to year. However, you could accomplish most of those savings without a trust.  

4. You want professional management now: One of the best reasons for having a revocable, living trust is because you want someone to manage some of your investments NOW, and you want to be able to change trustees or the terms of the trust or to take back any money in the trust at any time. As mentioned above, a revocable trust is also an effective device to enable children to help their elderly parents to manage their financial affairs after they are incapacitated with senility, dementia, Alzheimer's, a stroke or other forms of disability.  

5. You want a trust to separate marital assets:. In some states, living trusts can be used instead of a pre-nuptial agreement so you won't have to ask a fiancée to sign such an agreement. The assets in the trust before you marry are not marital property if you don't co-mingle those assets with post marital assets after you are married. And, the trust protects your own children if a spouse remarries after you die. Without the trust, a second spouse who inherits property can re-title the assets in joint name with their own children and legally disinherit the children of the deceased. 

6. You want to avoid multi-state probate problems: If you have real property in multiple states, that's a good justification for having a living trust. 

For more on living trusts, see the article on Myths of a Living Trust.

Copyright, 2003, Vernon K. Jacobs

Vernon Jacobs is the Editor/Publisher of The International Wealth Protection Reports, which are a collection of research reports on legal methods of asset protection and tax avoidance. Further information on this subject is available at http://www.offshorepress.com/  Jacobs is a CPA who has worked as a free lance tax and financial author/editor since 1977. Details about his credentials and experience are online at http://www.offshorepress.com/vkjcpa/

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