Frequently Asked Questions about Revocable Living Trusts

Orlando, FL Estate Planning Law Firm

What is a Revocable Living Trust?

A revocable inter vivos trust, or a “living trust”, is a popular estate planning tool. Like any trust arrangement, a living trust is an agreement between a settlor, who gives property to the trust, and a trustee, who administers the trust for the benefit of certain beneficiaries. The settlor, sometimes called the grantor, is the person who creates the living trust and who contributes property to the trust. The trustee is the person who manages trust property and administers the property pursuant to the directions contained in the trust agreement. Upon the death of the settlor, the trustee distributes the trust property to beneficiaries. The trustee has a fiduciary duty to the grantor and the beneficiaries to carry out the intent of the grantor and the provisions of the living trust in a fair and reasonable manner.

A trust document, sometimes called the Trust Agreement, sets forth the terms and conditions of the trust. The trust document does not have to be recorded in the public records and does not have to be filed with any government agency. It is, therefore, a relatively private document between the parties. During a grantor’s lifetime, a living trust does not need its own tax identification number and there is no need to file a tax return on behalf of the trust. To considered be legal, however, the trust document must be properly executed. Under Florida Statutes, any living trust that includes testamentary provisions must be executed with the same formalities as a will.

How is a revocable living trust different from other types of trusts?

One feature that distinguishes a living trust from other trusts used in estate planning is that in a living trust individuals usually play more than one role in the trust agreement. Normally, a client who forms a living trust will designate himself or herself to act as the trustee and also as the beneficiary during the client’s lifetime. The client, therefore, is filling all three primary roles in the trust agreement. This distinguishes the living trust from most other trusts generally used in estate planning. In a living trust, the grantor typically receives all income earned by the trust assets during the grantor’s lifetime. Upon the grantor’s death, trust property is distributed to successor beneficiaries named in the trust agreement.

Revocability of a Living Trust

A living trust may be amended in part or revoked by the grantor at any time during the grantor’s lifetime. The grantor can add or withdraw assets from the trust as he or she pleases. Because the grantor is also the trustee, he or she has complete control over management of trust assets. For tax purposes, all taxable income or tax losses generated by trust assets flow through to the grantor during his or her lifetime. A living trust has a negligible effect over a grantor’s management and enjoyment of his or her property during that grantor’s lifetime. Because the trust is revocable, the grantor retains the right to adapt the trust document to changing circumstances in his or her family as they unfold.

Benefits of a Living Trust

The basic benefit of a living trust is that it provides for the private administration and management of the grantor’s property in the event of his incapacity or death, and the property is not subject to the jurisdiction of the courts. The two most often cited advantages of a living trust is its role in the event of the grantor’s incapacity and the avoidance of probate upon the grantor’s death. First, the living trust provides that in the event of the grantor’s incapacity a successor trustee automatically takes over the administration of the trust and the trust property. Incapacity is a term defined within the trust document, and procedures for determining the grantor’s incapacity are set forth in the trust. The incapacity provisions of a living trust permit the grantor and the grantor’s family to avoid the appointment of a guardian by the courts to manage the grantor’s property, if he or she becomes fully or partially incapacitated. The client has piece of mind of knowing that if he or she is unable to manage their affairs as they become older, the transition to management by other family members can be accomplished privately, without public intervention, through the procedures set out in the living trust document. Financial professionals typically find that fear of incapacity is a primary motivation for a client establishing a revocable living trust.

Avoiding Probate

The other primary attraction of the living trust is the avoidance of probate upon the grantor’s death. Many negative things have been written and said about the probate process. Those comments will not be repeated here, except to restate the most commonly expressed sentiments concerning probate:

1. It is a public process. The individual’s Will can be inspected by anyone who takes the time to visit the courthouse.
2. Probate assets are subject to the claims of the decedent’s creditors. In addition, probate assets may tempt disgruntled heirs to challenge the Will or other aspects of the probate process.
3. A number of state laws apply to probate assets. Under current law, the surviving spouse may exert a claim for the elective share, a child (or spouse) who is not named in a Will may make a claim for a “pretermitted share,” a spouse may claim a community property interest with respect to property acquired while the decedent and spouse lived in another state, and a whole host of other probate laws may apply to probate assets. These laws may operate in contravention to the decedent’s intent.
4. Probate can be a time-consuming and expensive process. The amount of paperwork that a probate matter can generate is sometimes staggering. Quite obviously, the bulk of the paperwork is generated by lawyers and that usually means that a great deal of expense is involved. Attorney’s fees are a first priority claim against an estate. The net result is that a probate estate might ultimately mean less money is distributed to the decedent’s heirs.

Florida Statutes set forth a schedule of “reasonable attorney’s fees in probate.” These statutory fees are not mandated fees but are presumed reasonable fees, which may be altered by negotiations of the personal representative and his attorney. Nevertheless, the attorney’s fees involved in probate are an expense most people wish to avoid.

Property titled in the name of a living trust is not subject to probate. This is because the property is not owned by the grantor at the time of death, but is owned instead by an individual named as successor trustee on behalf of the revocable living trust. As long as property is correctly titled in the name of the trust, or the trustee, the property is not part of the grantor’s probate estate. However, the property is still included in the decedent’s taxable estate. The mere creation of a living trust document provides no benefit to the grantor unless the trust is properly funded with the grantor’s assets. Only those assets whose title is transferred to the trust are protected in the event of incapacity or death.

Laws Regarding Payment of Creditors

One criticism of the living trust has been that as well as allowing people to avoid probate proceedings, they also permitted the trust grantors to circumvent creditors’ bonafide claims. An important purpose of probate is to provide a fair procedure by which creditors of a decedent may assert their claims against that decedent’s property. Absent probate, there exists no formal legal procedure by which creditors are made aware of the decedent’s death. With a trust, the successor trustee may distribute money to the beneficiaries before creditors can assert claims against the property, if ever. Once the property is in the hands of beneficiaries, many of which may be in different states, it is difficult for creditors to recover money owed to them by the decedent.

In recent years, the Florida Legislature has taken steps to remedy this problem. The Florida Legislature has passed laws that require a successor trustee of a living trust to notify known creditors of the decedent and to publish a public notice of the decedent’s death so that unknown creditors may have a reasonable opportunity to assert their claims. The laws contain provisions that require a living trust to release money to a decedent’s personal representative to pay creditor claims. The trend in Florida is toward a compromise that protects the rights of creditors while permitting clients to use a living trust to avoid unnecessarily long and expensive probate proceedings. One problem with the corrective statutes is that, thus far, they do not impose penalties on successor trustees who fail to follow the statutory requirement of creditor notification.

Other Living Trust Benefits

In addition to provisions for incapacity and avoidance of probate, living trusts have other estate planning attractions. For clients with property located in multiple states, a living trust that owns all of the client’s property avoids multiple probate proceedings in states where property is located. The administration of a client’s property is consolidated through the use of a single trust document. Multiple living trusts may be employed if there are substantial differences in the laws of particular states where property is located, such as those states which have community property laws or laws giving certain rights to a surviving spouse.

Finally, because there is no interruption in the administration of the grantor’s property upon death or incapacity, the revocable trust provides the family members with an uninterrupted source of income. The grantor’s property is immediately available to provide for family emergencies such as health or education expenses. For clients who own their own business, the efficiency of a living trust ensures the ongoing operation of a business and protects business operations from intervention of probate or guardian courts.

Living Trust Taxation

The tax effect and benefits of a living trust depend on whether the grantor is alive or has deceased. During the grantor’s lifetime, the trust has no income tax effect on the grantor. All income and losses are passed through to the grantor and are reported on his or her personal tax return. Income and losses are attributed to the grantor during his or her lifetime because they have complete control over the trust property. Likewise, upon the death of a grantor, a living trust affords no immediate estate tax benefits. As previously mentioned, property that the grantor placed in the revocable trust is included in the grantor’s estate because the grantor had control over the property at the time of his or her death.

The living trust may incorporate tax savings to the grantor’s spouse and family depending on how the trust is drafted and what provisions are incorporated in the trust. A living trust may provide that upon the death of the grantor, part of his or her estate may be placed in a unified credit trust to take full advantage of the decedent’s estate tax exemption, while the balance of property is typically devised to a marital deduction trust if the grantor is survived by a spouse. These important estate planning devices may be incorporated in a living trust document, and in doing so, the living trust may take full advantage of potential estate tax savings for the family.

Do I still need a will?

A revocable living trust does not totally replace a will. A person who creates a living trust needs a will to appoint a personal representative who will represent him in legal proceedings after his death. As a rule, people who utilize a living trust use what is known as a “pour-over-will.” The pour-over-will is so called because it “pours over” assets titled in the decedent’s name into his or her living trust at the time of death. The will makes the trust the beneficiary of the decedent’s estate. In this way, any property inadvertently not transferred to the living trust, or property which was acquired after creation of the trust but which was not titled in the name of the trust, is administered pursuant to the testamentary provisions of the trust.

Funding: Putting Fuel In the Engine

The process of retitling a person’s assets into the name of a living trust, or more accurately, to the trustee of the trust, is known as “funding” the trust. A living trust provides estate planning benefits only if it is funded. A useful analogy is that the trust is like an automobile and the funding is gas. Funding is required to make the trust do what it is supposed to do. Far too often people will execute a trust but leave the trust unfunded. An unfunded living trust provides virtually no benefit to the client.

Not all assets are transferred to a living trust. Whether an asset is to be part of a trust depends on the nature and value of the asset. A person’s homestead property may be transferred to a trust. But if a person is married, or if he is unmarried and has minor children, he may want to leave the homestead property in his own name inasmuch as the property is exempt from creditors and the property is not part of his probate estate. On the other hand, a person who is unmarried, will not marry in the future, and who has no minor children, may decide to put homestead property in the trust. Other real estate is usually retitled in the name of the trust. Financial assets such as stocks, bonds, and mutual funds are also good candidates for trust ownership. Bank accounts may be transferred to the trust, although relatively small household operating accounts are often left out of the trust and handled with pay-on-death designations.

Many types of assets are not transferred to a living trust. A good example is assets involving contractual relations with third parties. Life insurance policies, annuities, and similar products involving contractual relationships with insurance companies are usually not owned by one’s living trust. Qualified retirement plans are also not transferred to trust ownership inasmuch as such transfer may constitute a taxable distribution. Personal automobiles and tangible personal property are other types of assets not typically owned by a living trust.

Joint and Single Trusts

In situations where a husband and wife are working together on their family estate plan, a question often arises as to whether each spouse should have their own living trust, or whether they both should execute a joint trust. Recently, the advantages and disadvantages of a joint living trust have been debated in estate planing publications. Traditionally, a living trust is an individual document, and each spouse has their own trust which includes their individually-owned property. A joint trust, however, is attractive to many people, especially in small, non-taxable estates. Clients who have always owned their property jointly are attracted to the concept of a joint trust because it avoids the requirement of dividing property into individual ownership during estate planning. Where spouses’ property is already divided into their respective individual names, or where one spouse has a predominant amount of property owned individually, a joint trust is difficult to use effectively.

Another factor pertaining to the joint trust is whether spouses have separate children by previous marriages. Where all children are common children of both spouses, and each spouse trusts the surviving spouse to treat the children fairly, a joint trust can be used effectively, but where spouses have been previously married and have separate children, the joint trust loses its advantages and becomes difficult to administer.

Many clients and financial professional do not realize that a so-called joint trust is “joint” in name only. In fact, the joint trust is really an illusion because it essentially operates as separate trusts. It is “joint” only because it incorporates these separate trusts in a single trust document. Upon the death of the first spouse, the joint trust document provides that the property is separated into individual shares with the surviving spouse owning his or her separate property and half of joint property outside of trust. Additionally, each spouse has the right to withdraw his or her share of property while they are both alive. Essentially then, a joint trust divides property and separates ownership after the death of the first spouse.

The problem is that a joint trust which is not properly drafted may give rise to any one of several tax problems, the individual nature of which are beyond the scope of these materials. Additionally, even a properly drafted joint trust may be difficult to administer inasmuch as it requires spouses to keep track of property contributed by either spouse individually during the duration of a trust. Nevertheless, the joint trust may be useful in certain circumstances, and in reality, it is often employed because of the psychological attraction to those clients who wish to maintain an estate plan that appears to be a joint estate plan with jointly owned property.