Estate planning is a major aspect of any integral personal wealth plan. Determining the most effective, affordable, and safest way to pass on your estate to your heirs is an important consideration. Trusts can serve as useful financial tools in any estate planning strategy, as well as serving various other purposes.
One of the most popular types of trusts used for estate planning is a “Revocable Living Trust”. These trusts are convenient as they take effect during the lifetime of the grantor, and provide flexibility and control. In this article, we will explain what a revocable living trust is, how it works, and take a look at its specific benefits.
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Before we can get to understand what a revocable living trust is, we should define what is meant by the term “living trust”.
A living trust is simply the term used for any trust which is created and goes into effect during the trust grantor’s lifetime. Living trusts encompass several subcategories of trusts. By convention, the term “living trust” usually refers to a revocable trust. However, there are examples of irrevocable living trusts, and so it is important to clearly distinguish a “revocable living trust”.
Trusts can be broadly separated between revocable and irrevocable. Revocable trusts, as the name implies, are trusts whose terms may be altered or terminated altogether by the grantor of the trust. This level of flexibility and control is primarily what makes revocable trusts the more popular choice for estate planning.
In contrast, an irrevocable trust cannot be modified or canceled by the grantor of the trust. Once the trust terms are written and the trust is established, it is final. The grantor gives up personal ownership of any assets transferred to the trust, and does not have the right to withdraw them in most cases. Many are put off by the loss of control that comes inherent with an irrevocable trust. However, they do have important benefits and uses which a revocable trust does not provide, such as superior levels of asset protection, tax benefits, and privacy. There are also certain types of irrevocable trusts which allow the grantor to retain the benefits of the assets, even though they no longer legally own them.
Another major difference between irrevocable and revocable trusts is to do with taxes. The assets in a revocable trust are deemed to belong to the grantor for tax purposes. This means that you will be liable to pay taxes on any income or capital gains as you would on assets in your personal estate. The trust does not have a separate tax number, and is seen to simply be an extension of the grantor’s estate. On the other hand, an irrevocable trust has its own unique tax number and is separately liable to pay taxes on the assets in the trust. The trustee of an irrevocable trust is in charge of administering tax payments on behalf of the trust.
Deciding on whether to establish a revocable or irrevocable trust really depends on personal needs and circumstances. If the trust is meant only to act as an estate planning vehicle, then in most cases a revocable trust is sufficient.
In actual fact, although not all living trusts are revocable, all revocable trusts are, by definition, living trusts. This is because the moment that the grantor of a revocable trust dies, it becomes irrevocable, and the terms are fixed according to how they were drafted by the grantor while he/she was alive. The definition of a living trust is a trust which is formed and goes into effect during the lifetime of the grantor. In order for a trust to be revocable, the grantor must be alive so as to be able to alter or terminate the trust terms.
The revocable living trust is simply a trust agreement which outlines how your assets will be distributed after you die. A revocable trust involves three parties:
At the time that a revocable trust is created, the grantor designates a trustee (either themselves or an outside party) to manage the assets in the trust for the ultimate benefit of the trust’s beneficiaries. The way in which assets are distributed to beneficiaries, and when, depends on the specific trust terms.
The grantor will also need to make a list of assets which they are transferring to the trust. The benefit of a revocable trust is that the grantor will maintain complete control over the assets in the trust. They can be bought or sold, or transferred back to the grantor’s personal estate. If the grantor becomes incapacitated or dies, the successor trustee will step in and manage the assets in accordance with the terms which the grantor established during their lifetime.
A revocable living trust has some key benefits. Some of these are common to irrevocable trusts too, while some are unique to revocable trusts. The main advantages of a revocable trust are:
One of the main benefits of a revocable trust compared to an irrevocable trust is the fact that they allow the grantor to retain control over the assets in the trust. They have the flexibility to alter the trust terms at any time during their lifetime, and can even terminate the trust entirely.
The primary use of revocable trusts is for estate planning. They are much more effective for distributing your estate to your heirs than living wills, mainly because they avoid lengthy and expensive probate procedures. Probate is the court process whereby your assets are distributed to your heirs as per the stipulation in a living will. It is a lengthy process which can take months to complete, and involves additional costs. In contrast, the assets in a trust can be directly distributed to beneficiaries as per the trust terms, without the need to pay for probate procedures.
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A revocable trust is taxed at the personal level of the grantor. Depending on the specific tax legislation in the jurisdiction in which you reside, this can actually lead to more favourable taxation than when the trust is taxed separately. Furthermore, revocable trusts can help reduce hefty estate taxes associated with a living will.
The assets held in a revocable trust are generally better protected than those which are held in your personal estate. It is more difficult for creditors and courts to claim the assets held in a trust, even if it is revocable. In addition, revocable trusts receive FDIC (Federal Deposit Insurance Corporation) protection. FDIC usually protects money held in a bank account up to $250,000, but this amount increases for revocable trusts. The owner of a revocable trust receives FDIC protection of up to $250,000 per beneficiary, to a maximum total of $1,250,000. So, for those with a large estate, a revocable trust provides a way to increase the insurance coverage of your personal assets.
A revocable trust provides a private means to pass on your wealth to your heirs. When assets are distributed by means of a living will, the transactions enter into a public record that anyone can track. This allows anyone to see the names of your beneficiaries and what each inherited. On the other hand, when assets are distributed through a revocable trust, it is done so privately.
A revocable trust can serve as a powerful and versatile estate planning tool. It can also be used for personal wealth protection and tax optimisation. Whether a revocable trust is the right instrument for you depends on your specific circumstances and objectives. In general, if you are looking for the best way to transfer your estate to your heirs, a revocable trust is preferred over a living will for the reasons outlined above. Furthermore, you have the peace of mind knowing that you remain in full control over the assets and can change or terminate the terms of the trust at any time.
Trusts are complex financial instruments to structure and establish in the right way. For that reason, it is worth consulting with a trust expert or attorney who can help you determine the best type of trust for your needs, and walk you through the process of setting it up.
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*Note for U.S. citizens: US citizens are limited in their tax reduction possibilities due to FATCA and CFC laws. Opening an offshore company can increase privacy and asset protection, but you can not eliminate your taxes without giving up your citizenship. If you are a US citizen you are obligated to pay taxes on all worldwide income. Read more here about FATCA and CFC laws.
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