Sarah was heartbroken. Her beloved husband, Nick, had succumbed to cancer. How could this happen? He had been so healthy, so young. After Nick’s passing, Sarah focused completely on the emotional wellbeing of her elementary school age children—Mark and Emily. Thanks to Nick’s earlier inheritance from his dad—a successful entrepreneur—Sarah and the kids were financially comfortable. Sarah had sworn to Nick before he died that the kids would always come first, and she meant it. After three years of learning how to move forward without Nick, Sarah met John, a divorcee with one daughter, Laura. A marriage proposal from John followed two years of dating. Sarah accepted, even though Mark and Emily had never quite warmed up to John.
Six years later, Sarah died in a car accident. She left all her assets to John. John had assured Sarah that he’d pass on all the assets she’d brought into their blended family to her children. But by the time of Sarah’s death, years of friction with Mark and Emily had taken their toll. Without Sarah around, John had little inclination to see Mark and Emily. Soon after Sarah’s death he updated his will, naming Laura sole heir. This cut Mark and Emily out of an inheritance that their grandfather had worked hard to accumulate. Their loving late mother had accidentally disinherited Mark and Emily.
This tragic story is just one of the potential catastrophic outcomes that can happen when a family relies on a less than comprehensive estate plan. With children and assets involved, or other complicating circumstances, a simple will is usually an insufficient document to smoothly govern the disposition of your assets after you’re gone. If Sarah had set up a revocable living trust to protect Mark and Emily, this disastrous outcome could have been avoided.
Living Trusts: Revocable vs. Irrevocable
While a multitude of trusts exist as solutions for various estate planning needs, living trusts—those that are set up during a person’s lifetime rather than after death—broadly fall into two major groups: revocable and irrevocable.
A revocable trust allows the owner of assets placed in the trust to retain control of them and to revoke or amend the terms of the trust at any time before death. This provides the owner with flexibility to adapt the planned disposition of assets in response to evolving personal circumstances. An irrevocable trust requires the owner of the assets placed in the trust to permanently give up ownership and control of them, and generally does not allow the terms to be modified at a later date, except in very limited circumstances. A key benefit of giving up ownership to an irrevocable trust is that the assets are removed from the original owner’s estate for the purposes of estate taxes.
How a Revocable Living Trust Works
Revocable living trusts (RLTs) have become a popular vehicle for families with children due to both their flexibility and their ability to safeguard assets of parents after their death for the benefit of children. While a will is just as flexible as an RLT, it does not facilitate the management of assets for the benefit of beneficiaries.
The mechanics of RLTs are straight forward: the RLT is named as primary beneficiary of assets such as investment accounts and insurance policies, and other assets are retitled in the trust’s name. At the death of the trust-maker (“grantor” in legalese), the RLT becomes an irrevocable trust. The trust provisions and the trustee or trustees then govern the management and disbursement of the assets after the death of the trust-maker.
A trustee’s role is to make sure the provisions of the trust are carried out for the named beneficiaries. Grantors of RLTs usually list themselves as the first trustees, with backups who takeover after disability or death. For example, a married couple with one RLT might appoint themselves as trustees, with the surviving spouse remaining as trustee until his or her death, after which a trusted family member or close friend might take over. Sarah could have followed this general approach with an RLT for her assets before she married John. She could have been the initial trustee and listed a trusted family member or friend as backup trustees. Mark and Emily of course would have been the beneficiaries.
Advantages of Revocable Living Trusts
A great aspect of trusts used in estate planning is that your estate attorney can customize them to suit many varied situations.
There are four major categories of advantages that revocable living trusts have over wills:
- Protects assets. The first advantage is protection of assets. Since the assets end up in the trust at the owner’s death, the trust document and the trustee that you nominate, determine to whom, how, and when your assets are distributed. A trust could have helped prevent John’s disinheritance of Mark and Emily. Assets left in the trust would also have some protection from creditors, lawsuits, and ex-spouses of trust beneficiaries. The trust can potentially even withhold assets from a beneficiary demonstrating irresponsible behavior, such as wasteful spending or substance abuse.
- Encourages assessment of needs. The second advantage of RLTs is that their implementation invites families to assess more deeply their planning needs beyond just disposition of assets, to tax minimization, healthcare preferences, and contingencies for the raising and education of minor children. Forming an RLT necessitates the drawing up of other essential estate planning documents, such as a durable power of attorney and a healthcare power of attorney. You’ll usually nominate guardians for your children and provide guidance for doctors on how you’d like treatment to proceed according to various medical scenarios. For example, if Sarah’s assessment of needs raised concern about the capacity of Mark and Emily to manage a large inheritance early in adulthood, she could have specified that they receive assets upon reaching certain ages or achieving important milestones, such as a college education.
- Avoids probate. The third category of advantages are at end of life. Any asset in an RLT avoids the public court process called probate. Complaints about the probate process are that it publicizes your private financial circumstances, it’s expensive, because lawyers are involved, and it’s slow, because the courts are the venue. So, if you want your personal affairs resolved after your death privately, at a lower cost, and more quickly, consider an RLT.
- Keeps it simple. And finally, our fourth category is not so much an advantage over a will, as it is a positive aspect that you should be aware of. RLTs keep things simple from an ownership standpoint. You stay in control of the assets, which means you can move assets in and out of the trust, or change account beneficiaries, whenever you like right up until death. Since you still own the assets, you keep reporting any income from those assets on your tax return, with your social security number, just as you did prior to forming the RLT. And apart from an up-front attorney fee to set up your RLT, ongoing maintenance costs are typically low. Obviously, this might not be the case if there are major changes in the law or your family circumstances, because the RLT will have to be updated accordingly. However, some law firms do offer unlimited update services for a modest annual fee.
While you can’t avoid dying, you can make sure you look after your loved ones as well after you’re gone as you do now. A good estate planning attorney in partnership with a fiduciary wealth advisor, who stays abreast of your circumstances, can help make this a reality.
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