Revocable and Irrevocable Living Trusts
The Revocable Trust serves a number of purposes. One important purpose is that assets in the trust will not be subject to probate administration. However, any property which is not transferred to the Revocable Trust and which is probate property will pass under your Will and will be subject to probate. A second purpose is that the trust affords you greater privacy since the terms of your estate plan are contained in your trust rather than in your Will. Also, another purpose is that when you name a successor Trustee in the trust document who will be able to manage your financial and other business affairs should you become incapacitated. This may avoid a guardian or conservatorship proceeding at the courthouse, and it could save you and your family considerable time and money. Upon your death, the Revocable Trust will terminate and the remaining trust property will be distributed as provided in the trust agreement.
To obtain the maximum benefit from the Revocable Trust, it is necessary for you to transfer some or all of your assets to the Revocable Trust. This is accomplished by retitling assets to the Revocable Trust. For example, real estate can be transferred to the Revocable Trust by means of a Deed, bank accounts and brokerage accounts should be retitled to the name of the Revocable Trust, and stock held in certificate form can be transferred by issuing a new certificate in the name of the Revocable Trust. Note, though, you should not transfer ownership of any retirement accounts or annuities to the Revocable Trust, as these types of investments should remain outside the trust, otherwise unintended income tax consequences might result. Even though your retirement accounts and annuities will not be owned by the Revocable Trust, probate can still be avoided as long as the beneficiaries you designate are coordinated with your Revocable Trust.
A pour over will is executed along with your trust. Your Will may not be needed at your death. If all of your property is either held in the Revocable Trust or is held in the form of non-probate property, then your Will will not dispose of any property, and it can be disregarded. A pour- over Will is executed just in case you own property at your death in your name, and it becomes necessary to transfer that property to the Revocable Trust.
The creation of irrevocable trusts offers a number of key advantages. For instance, trust property is insulated from most creditors of the trust beneficiaries. Trusts also help protect the trust property from loss in the event a beneficiary divorces. Further, when a trust beneficiary dies, any remaining trust property will be distributed according to the wishes of the person who established the trust, except to the extent a power of appointment might be exercised by a beneficiary. And depending on how a trust is written, when a trust beneficiary dies during the existence of a trust, the remaining trust property contained within trusts that are exempt from the generation skipping transfer tax will generally not be taxed (although exceptions can apply). These are just a few of the key advantages to creating trusts.
But along with these advantages come several potential disadvantages. For example, trust ordinary income that is not distributed to a trust beneficiary is taxed at the highest marginal income tax bracket (currently 39.6%, and an additional 3.8% surtax might apply as well), and this level of taxation begins to apply at only $12,300 of the trust's ordinary income. However, this high level of trust income tax can be avoided by distributing trust ordinary income to one or more trust beneficiaries who are entitled to trust income, if such distributions are permitted by the terms of the trust, as that will cause the ordinary income to be taxed to the beneficiaries who receive the income, and not the trust. Avoiding taxation of capital gains at the trust level is more complex.
Also, the fact that the remaining trust property may not be included in the beneficiary's taxable estate is only a good tax result if the beneficiary has an estate large enough to be subject to Federal estate taxes, because it also means the trust property will not receive an adjusted cost basis for income tax purposes. In other words, upon the death of a trust beneficiary, the trust property will pass to the next beneficiary with the same cost basis. If trust assets have appreciated, the lack of an adjusted cost basis can be a significant disadvantage, especially if the beneficiary's estate would not be subject to estate tax even if the trust assets were includable in the beneficiary's estate. On the other hand, if trust assets have depreciated in value, not having the cost basis adjusted downward upon the beneficiary's death would be a good result.
Further, after a trust is created, the trustee must file annual income tax returns and possibly make quarterly estimated tax payments. Thus, there are administrative burdens that come with the creation of trusts. Last, trusts are complicated, certainly more complicated than simply owning properties outright, and some trust beneficiaries might prefer to be given property outright rather than in the protected environment of a trust. As the foregoing discussion illustrates, trusts offer a number of advantages and are a key component of an estate plan, but there can be important trade-offs.