The Importance of Including Revocable Trusts in Estate Planning

What is a revocable trust?

A revocable trust is a trust created by a person, known as the settlor, during his or her lifetime that can be amended or revoked by the settlor at any time prior to the settlor’s death. A revocable trust usually contains the provisions of the settlor’s estate plan, specifying how the settlor’s assets should be distributed at death. The settlor may serve as the sole initial trustee of their revocable trust. In many ways, a revocable trust functions just like outright ownership of any assets with which it may be funded.

What are the advantages of a revocable trust?

Some of the principal advantages of incorporating a revocable trust into an estate planning strategy include:

1. Avoidance of Probate

One of the most significant benefits of a revocable trust is its ability to bypass the probate process. Probate is the legal procedure through which a will is validated and assets are distributed, and depending on the jurisdiction, can potentially involve lengthy court proceedings and associated costs. When assets are held in a revocable trust during one’s lifetime, upon death they will not go through probate, allowing for a more expedient and efficient transfer to beneficiaries. This not only expedites the distribution process but also saves court and legal fees that can accumulate during probate. The key here is for the revocable trust to be funded during one’s lifetime because probate will not be avoided to the extent that assets are held in one’s own name at death and “pour over” under one’s will to an unfunded revocable trust.

Additionally, for individuals who own property in multiple states, a revocable trust can simplify matters considerably by avoiding the need for ancillary probate proceedings in each state where property is located.

2. Flexibility and Control

Revocable trusts offer flexibility that can be advantageous both during the settlor’s lifetime and after their passing. As the name implies, a revocable trust can be modified or revoked entirely by the settlor at any time while they are alive. This adaptability allows individuals to make changes as their circumstances evolve, whether due to changes in family dynamics, financial situations, or personal preferences. Changes can be easily made throughout a settlor’s life because, unlike a will, a revocable trust does not generally require a formal signing ceremony with required words spoken before at least two attesting witnesses. Depending on the jurisdiction, only the settlor’s signature with a notarial acknowledgment may be required to create a valid trust instrument.

Furthermore, revocable trusts allow settlors to maintain control over how their assets are distributed even after they pass away. By specifying conditions for distributions, such as tying them to certain milestones or behaviors, settlors can ensure that their wishes are honored.

Finally, revocable trusts can include co-trustees or professional trustees, which can be helpful in reducing any administrative burden (particularly in the case of an aging or ill settlor) and managing family dynamics.

3. Avoiding Court for Trustee Changes

A revocable trust also offers a streamlined approach to changing trustees without court involvement, which is a stark contrast to a testamentary trust. A testamentary trust is created when a decedent’s will includes trust provisions. Such a trust is subject to ongoing probate court supervision and something as straightforward as appointing a successor trustee may involve petitioning the court, obtaining approval, and creating public records, resulting in less flexibility and privacy and incurring court and legal fees along the way.

A revocable trust, however, allows for trustee succession to be addressed in accordance with the trust terms and outside of the court system. As noted above, the settlor retains direct control over the revocable trust and can modify the trust during their lifetime, including appointing or removing trustees through simple amendments or designations in writing. This flexibility extends to incapacity planning, allowing for automatic succession of trustees without court-appointed conservatorships. Additionally, a revocable trust maintains privacy as it avoids probate, and therefore trustee changes remain confidential.

4. Avoidance of Guardianship

As noted above, if the settlor becomes incapacitated while serving as trustee, the successor trustee can take over management of the settlor’s trust assets, often making guardianship proceedings unnecessary.

5. Privacy Protection

A revocable trust affords the settlor privacy because unlike a will — which becomes a public record during the probate process — the details of a revocable trust remain confidential. This means that the terms of the trust, including information about assets and beneficiaries, are not disclosed to the public. For individuals who value discretion in their financial affairs, this aspect of a revocable trust can be particularly appealing.

6. Business Succession Planning

For business owners, revocable trusts can play a critical role in succession planning. By placing business interests into a trust, owners can ensure a seamless transition of ownership and management in the event of incapacity or death. This not only helps maintain business continuity but also provides clarity and direction for the future of the enterprise.

Are there tax advantages to a revocable trust?

During the settlor’s life, income earned by the trust assets is taxable to the settlor. No separate income tax returns need be filed for the trust so long as the settlor is acting as one of the trustees. Although assets in a revocable trust at the settlor’s death are not subject to probate, they are still subject to federal and state estate and death taxes. Therefore, there are no transfer tax advantages (or income tax advantages) to setting up a revocable trust. However, just like a will, a revocable trust can provide for an estate plan that will maximize estate tax savings.

Does a revocable trust provide creditor protection?

While a revocable trust offers numerous advantages, it does not provide asset protection for the settlor during their lifetime.

What is a semi-revocable trust and how does that work?

A semi-revocable trust is a revocable trust whose revocability is tied to a specific timeline, such as being revocable only following a thirty or sixty-day “cool-down period” after notice of revocation is delivered to the trustee, or condition, such as requiring the consent of a “non-adverse” party (generally someone who is not a beneficiary of the trust) to revoke. Semi-revocable trusts can be great vehicles for planning for children. For example, if a child becomes entitled to his or her custodial account, such as accounts created under the Uniform Transfers to Minors Act or Uniform Gifts to Minors Act (collectively, “UTMA accounts”) or certain irrevocable trusts referred to as “2503(c) trusts,” at age 18 or 21, they can agree to transfer assets from the UTMA account or 2503(c) trust account to a parent in the parent’s capacity as trustee of a new semi-revocable trust. As trustee, the parent should continue to manage the assets, with appropriate investments and withdrawals for necessary expenses. Then, upon attaining a particular age (30 or 35, for example), the adult child would reacquire complete access to the funds. Building in a “cool-down period” such as thirty or sixty days can be particularly advantageous by allowing the consequences of revocation to be talked through.

Semi-revocable trusts can also be helpful to facilitate a transfer to a child or other individual without incurring gift tax by providing that the power of revocation shall be exercisable solely upon the prior written consent of a person not having a substantial adverse interest in the disposition of the transferred property or the income generated by the trust property. For this purpose, Treasury Regulations provide that a trustee, acting in such fiduciary capacity —assuming that the trustee is not also a beneficiary of the trust who has a substantial adverse interest to its revocation — is not considered a person having a substantial adverse interest in the disposition of the trust property or its income. Thus, requiring such an “independent trustee” (or some other independent person, which could include a “trust protector”) to approve the trust revocation provides a safeguard to prevent an improvident revocation of the trust, while steering clear of triggering potential gift tax consequences to the person who is transferring property to the trust.[1]

To determine whether a revocable trust is the right choice for your estate plan, it is advisable to consult with experienced legal advisors who will be able to review and analyze your goals and circumstances to advise accordingly. The Private Clients, Trusts and Estates practice at ArentFox Schiff is a nationally ranked practice with attorneys across the nation who are happy to discuss further.