What Is a Revocable Trust?
Revocable trusts are a type of trust agreement in estate planning in which a grantor, or the owner of assets, establishes a trust for beneficiaries with the help of a trustee, who is responsible for managing the trust.
Revocable trusts can be amended or revoked during their lifetime, meaning the grantor can make changes to them or revoke them completely by withdrawing all assets.
Revocable trusts can be funded during a grantor’s lifetime or after their death.
Revocable trusts are different from last wills and testaments because they offer more flexibility in setting the terms and timeframes for execution of a trust.
They also cover a broader range of assets that may or may not be spread across multiple geographies.
Revocable trusts are also different from irrevocable trusts which “lock” funds during a grantor’s lifetime and cannot be changed for the trust’s entire duration.
How Do Revocable Trusts Help in Estate Planning?
Revocable trusts are examples of an inter vivos trust i.e., a trust created during a grantor’s lifetime and outside of the court-supervised process for asset settlements.
They are often referred to as will substitutes because they can be used in place of wills to allocate property and assets to individuals or organizations of a grantor’s choice.
Even as they ensure succession, revocable trusts make sure that the grantor remains in control of the estate for their lifetime.
Thus, grantors can alter the trust’s terms or its beneficiaries based on changes to circumstances.
For example, they can sell or add assets to a trust.
During the trust’s lifetime, it can also act as a source of income for the grantor or their immediate family through periodic distributions of income.
Upon the grantor’s death, the trust’s contents are passed onto beneficiaries based on the stipulated terms.
In effect, the revocable trust becomes an irrevocable trust. The terms specified in the trusts can take on various forms.
For example, a grantor may choose to pass on a certain amount of money to his or her offspring or beneficiary, only after they reach a certain age.
Revocable trusts are especially useful for individuals with large investment and asset holdings.
Depending on a will’s contents and their geographic distribution, the probate process can be expensive and prolonged, sometimes extending into months and years.
This is because each state has its own probate laws governing distribution of assets.
Beneficiaries may have to spend on court fees and travel to satisfy requirements for identification and validity of a will.
A revocable trust functions outside of the probate process and the grantor can determine the distribution of assets and the terms governing those assets.
Settlement of revocable trusts is quicker as compared to complicated wills.
What Are the Advantages and Disadvantages of Revocable Trusts?
Some advantages of revocable trusts are outlined below:
- Probate Avoidance: This is the main advantage of revocable trusts. Settlement of complex estates that span geographies and investment types can involve considerable time and court fee expenses. Sometimes the process can drag on for months and years. A revocable trust settlement simplifies the problem by transferring the estate’s holdings to a trust. Thus, the grantor does not own the assets by name and, therefore, the trust is not subject to the probate process. The result is an expedited settlement period, possibly days or weeks, and saving of court fees for beneficiaries.
- Flexibility in Trust Management: Modification of revocable trusts enables grantors to exercise control over their assets. For example, they can sell real estate and stock holdings or, if they are also trustees, withdraw money from the trust fund for expenses. The flexibility extends to changes to a trust’s terms and beneficiaries. For example, grantors can choose to distribute trust funds to beneficiaries immediately after their death or after a certain period of time.
- Ensuring Continuity: Revocable trusts allow grantors to designate co-trustees ensuring that the trust is managed for beneficiaries in the event of death or even when they are mentally incapacitated. Assets are registered in a trust’s name after they are transferred, meaning the grantor relinquishes their ownership. This practice helps streamline the process of managing investments when a grantor dies or is mentally incapacitated.
Some disadvantages of revocable trusts are as follows:
- Taxation on Distribution: Changes to a revocable trust, such as asset sales or distribution, are taxed at the regular income tax rate for grantors. In addition to this, beneficiaries are required to pay taxes when trust funds are distributed to them.
- Registration Charges: Since the grantor is no longer the property’s owner, all assets must be re-registered in the trust’s name. The fees, legal and otherwise, associated with this task can be considerable.
- High Maintenance Costs: As compared to wills, revocable trusts have high maintenance costs. The trust must be regularly monitored to ensure that it is producing the required returns and meeting its objectives. Besides this, annual fees to ensure that the trust is updated to reflect current legal and individual circumstances can amount to a pretty packet.
What Are the Differences Between Revocable Trusts and Irrevocable Trusts?
The main point of difference between revocable and irrevocable trusts is that the former can be altered or revoked but the latter lock in terms and assets for the trust’s entire duration.
For all intents and purposes, grantors lose ownership and control of their assets after they are entered into a trust.
But grantors can still exercise control over the assets by making changes to the trust’s terms and composition.
For example, they might sell part of the stock holding contained in a revocable trust for income distribution purposes. This is not possible with an irrevocable trust.
Here are three other differences between revocable and irrevocable trusts:
- Tax Benefits: Both trusts reduce estate taxes after the grantor’s death. The difference in structure of the trusts ensures that irrevocable trusts offer more tax advantages, however. The grantor has to pay income tax for gains accruing from the trust’s holdings. Thus, changes to the trust’s composition, such as the sale of a real estate holding, can result in tax dues for the grantor. In an irrevocable trust, grantors forgo control of their holdings for the trust’s lifetime. As such, they are not liable for tax dues arising from changes to the trust’s holdings.
- Credit protection: In certain states, such as Nevada and North Dakota, stringent trust laws protect grantors from creditors. Asset protection trusts are a type of irrevocable trust that provide protection from creditors after the grantor’s death. The definition of creditors in this context is pretty broad and can include former partners, court claims, or, even, tax agencies collecting unpaid dues. Thus, irrevocable trusts are a great option for people in professions that are susceptible to lawsuits.
- Trustee roles: In a revocable trust, trustees have a fiduciary duty only to act in the best interests of the grantor. They undertake actions or make decisions on behalf of the grantor during his or her lifetime or after their death. In an irrevocable trust, the fiduciary duties for trustees encompasses both grantors and beneficiaries. After the grantor’s death, the trustee is responsible for making sure that the trust is passed onto the beneficiaries not only based on the terms specified by the grantor but also in a manner that is fair and judicious to the beneficiary.
How to Create a Revocable Trust
There are three main parties involved in creating a revocable trust. They are as follows:
- Grantor: Also referred to as a settlor or trustor, a grantor is the person who owns an estate and transfers property and rights of assets to beneficiaries upon their death. This act is known as conveyance of assets to a trust. In a revocable trust, the grantor is responsible for making critical decisions about the trust. These decisions may relate to the trust’s terms or its functioning, such as whether to revoke or amend it. After the grantor’s death, a revocable trust turns into an irrevocable trust with terms set out by the individual.
- Trustee: The trustee is responsible for managing a grantor’s estate. In this role, they are responsible for making important investment decisions, paying trust fees, and ensuring that the trust’s funds and assets are distributed according to specified terms. A trustee can be an individual or an organization, such as a wealth management firm or a bank, experienced in estate management. The grantor can also nominate themselves as trustees to their trust. In such instances, they must establish a co-trustee to manage the estate in the event of premature death or mental incapacity.
- Beneficiary: The beneficiary is entitled to receive the trust’s proceeds after the grantor’s death. The beneficiary of a trust can be an individual, such as the grantor’s siblings or offspring, or organizations that serve various causes.
The first step to creating a revocable trust deed is to draft a Living Revocable Trust document.
The document lists the essentials of your trust: grantor, trustee, and beneficiary, and your assets.
Almost all types of assets, including real estate, stocks, and precious metals, can be included in trusts.
Depending on the nature and number of assets in your trust, the deed can be a fairly straightforward or complex affair.
While it can be manually prepared, the trust deed can also be written with trust software that contains boilerplate language customized based on your legal jurisdiction and the contents of your estate.
After the document is prepared and signed, it must be notarized.
The process to create a trust deed for estates that involve complex transfer and distribution of assets is different and requires a careful and complete inventory of all assets as well as applicable regulation in all jurisdictions.
It might be wiser to call a lawyer or a wealth management expert in such cases.
Revocable Trusts FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.