Revocable Living Trusts
Since the Middle Ages, people with assets have used the “Trust” to pass their real estate and personal property to the next generation. In the past fifty years, Living Trusts have become the de facto foundation of all estate planning tools.
What exactly does a Living Trust do?
A Revocable Living Trust is a legal arrangement that allows you to control how your assets are managed during your lifetime and distributed after your death.
With a Revocable Living Trust, you can choose who will manage your assets and how they will be used. You can also specify how and when your assets will be distributed to your beneficiaries.
Revocable Living Trusts Can be Amended or Revoked
Revocable Living Trusts are flexible and can be modified, amended or revoked at any time. They are also revocable, which means that you can dissolve the trust at any time. Revocable Living Trusts can be an effective way to manage your assets and ensure that they are distributed according to your wishes.
A Living Trust is Like a Container for Your Estate
It is helpful to think of a Living Trust as a container (such as a glass) that one person passes to another. Everything inside of the glass (liquids, ice cubes, etc.) will be successfully passed to the other person. Everything that remains outside of the glass will not be passed on to them.
Funding is the process of adding your real and personal property – the “water” and “ice cubes” – to your Revocable Living Trust, so that they successfully make it to your beneficiaries.
In many cases, where there is a “failure” of an Estate Plan, it is not because the container (the Living Trust) was bad or somehow defective, but because the container was empty, or only partially filled with the property of the Decedent.
See our article, I’ve Got My Living Trust, Now What Do I Do?
Three Essential Roles
A Living Trust has Three Essential Roles:
- The Grantor / Settlor / Creator – This is the person who Establishes the Living Trust. In a married couple, both spouses are Grantors. The Grantor of a Living Trust never changes.
- The Trustee – This is the Person who manages the affairs of the Trust for the benefit of someone else (the Beneficiary)
- The Beneficiary – this is the ultimate recipient of the benefits of the Trust.
While You Are Alive and In Good Health and Sound Mind
During your lifetime, when you set up a Trust, you serve all three roles. You are the Grantor – you created the Trust. You are the Trustee. And you are the Beneficiary during your lifetime.
Very little of your life changes when you put your assets into the Trust, as long as you are alive and of sound mind. The Trust remains Revocable, and does not need a Taxpayer Identification Number (TIN) while it remains revocable.
In addition, as long as it remains a Grantor Trust, it is a disregarded entity to the IRS, the California Franchise Tax Board, and all other government agencies.
How a Living Trust Works During Incapacity
If you are incapacitated, but still alive, then you are still the Grantor and the Beneficiary. But someone else will need to be your Successor Trustee, to handle your affairs for your benefit – if you cannot do so.
With a married couple, the Non-Incapacitated Spouse generally serves alone as the Successor Trustee, if they are healthy and of sound mind. If they are unable or unwilling to do so, then the Successor Trustee would be another person chosen by the Grantors (such as an adult child, or a Professional Trustee).
How a Living Trust Works After Death
Once you have passed on, your property then is managed by your Successor Trustee, for the benefit of your children or heirs (Beneficiaries).
After you pass away, your Successor Trustee will be responsible for managing your property. They will make sure that your assets are distributed according to your wishes, and they will also handle any debts or liabilities that you may have left behind.
This person will be a key figure in ensuring that your estate is handled properly, so it is important to choose someone who you trust and who has the experience to handle this type of situation.
|During Incapacity||YOU||Successor Trustee||YOU|
|After Death||YOU||Successor Trustee||Children/Heirs|
Revocable vs. Irrevocable Living Trust
During the Settlor’s lifetime, the Living Trust is completely revocable. This means that the person who created the Living Trust can alter, amend, or revoke the Living Trust during his or her lifetime.
Upon the Incapacity or Death of the Settlor, the Living Trust becomes irrevocable. This means the Living Trust can no longer be altered, amended, or revoked without court permission.
Amending, Restating or Revoking a Living Trust are serious matters that should only be done in consultation with a California Estate Planning Attorney.
The Joint Husband and Wife Living Trust (A-B Trust)
Often a Husband and Wife will jointly settle (create) a Living Trust, which is commonly known as an A-B Trust. While both Spouses are alive and not incapacitated, the A-B Trust acts as one unified trust. No subtrusts exist until one spouse passes away.
Upon the death of the first spouse, the Living Trust splits in to two (2) separate and distinct subtrusts.
The Survivor’s Trust (Trust A)
The Survivor’s Trust (Trust A) is also known as the Marital Trust. This Trust remains revocable during the Surviving Spouse’s lifetime. The Surviving Spouse has unlimited use of Trust A’s Principal and Income during their life, and is free to add or remove beneficiaries of Trust A.
In general, the Survivor’s Trust is funded with all of the Separate Property of the Surviving Spouse, along with the Surviving Spouse’s share of the Community Property.
The Bypass Trust (Trust B)
The Bypass Trust (Trust B) is also known as the Credit Shelter Trust. This Trust becomes irrevocable upon the death of the first spouse to die. The Bypass Trust is generally funded with all of the Deceased Spouse’s Separate Property, along with the Deceased Spouse’s share of the Community Property.
The Surviving Spouses Right to Bypass Trust Property during their Lifetime
The Surviving Spouse is entitled to All Income from Trust B, usually paid out monthly, semiannually or annually. However, the Surviving Spouse is usually only allowed to invade the Principal of the Bypass Trust for clearly specified purposes, such as for their Health, Education, Maintenance and Support (HEMS). The HEMS standard is known as an Ascertainable Standard, and these terms have been clearly defined and expanded upon both by the California Legislature, as well as California case law.
Ascertainable Standards Are Required for Tax Purposes if Surviving Spouse acts as Trustee
For Estate Tax purposes, an Ascertainable Standard (such as HEMS) is required if the Surviving Spouse continues to serve as Trustee of Trust B. Giving the Surviving Spouse unlimited access to all Income and Principal, if they are the Trustee of Trust B, could cause that trust to forfeit its Estate Tax credit. The IRS would argue, rightfully so, that if there are no meaningful limitations on the Surviving Spouse’s right to invade principal of Trust B, then it is not any different than the money in the Survivor’s Trust.
Distribution of Trust B on the Death of the Surviving Spouse
Upon the death of the Surviving spouse, Trust B will be distributed to its stated beneficiaries. If proper Federal Estate Tax planning has been done, Trust B should distribute without being subject to Federal Estate Taxes.
Distribution of Trust A on the Death of the Surviving Spouse
Upon the death of the Surviving spouse, Trust A can either be (1) Folded into Trust B and distributed according to the terms of Trust B, or (2) Distributed to the beneficiaries that the Surviving Spouse has chosen during their lifetime.
As a reminder, the Surviving Spouse may only change the beneficiaries of the Survivor’s Trust, which remains revocable and amendable during the life of the Surviving Spouse.
|During Joint Lifetime||H & W||H & W||H & W|
|First Spouse Dies||H & W||Surviving Spouse||Surviving Spouse|
|Second Spouse Dies||H & W||Successor Trustee||Children/Heirs|
The Critical Requirement of Trust Settlement When One Spouse Dies
The process of dividing the Living Trust into Trust A and Trust B is commonly referred to as the Trust Settlement process. This is a critical process that cannot be skipped or overlooked.
When one spouse dies, and a fully-funded Living Trust is in place, there is still work that needs to be done. While the assets funded to the Living Trust should not have to be Probated, ignoring this Trust Settlement until the Surviving Spouse dies can have disastrous results for the beneficiaries.
Failure to Divide Can Have Catastrophic Consequences
Failing to properly divide the Living Trust upon the death of the first spouse may (in some cases) cause you to lose the Estate Tax exemptions that might otherwise be available. It can also cause major headaches when property is distributed to the Beneficiaries.
It is important to remember that while a Living Trust has many benefits, it is important to use it in the manner it was designed.
Are there any downsides of a living trust?
One downside of Revocable Living Trusts is that they are more expensive to set up than a Will or other methods of transferring assets.
In addition, you will need to transfer all of your assets into the trust, a process known as Funding, which can be a time-consuming process.
In some smaller estates, Revocable Living Trusts may not always necessary. If you have a smaller estate, one that is under the California minimum estate size, you may not need one.
However, if your Estate exceeds California’s minimum threshold for Probate, or if you want to ensure that your assets are protected in the event of your death, Revocable Living Trusts can be an invaluable tool.
A Living Trust is the keystone of any comprehensive Estate Plan. By setting up a Living Trust, you can provide for your loved ones in the event of your death and ensure that your estate is handled in a way that reflects your wishes.
- Unlike a Will, which must go through Probate Court, a properly funded Revocable Living Trust should bypass the costly and time-consuming process of Probate.
- Also unlike a Will, Living Trusts have benefits during your lifetime if you are incapacitated. A living trust (along with Powers of Attorney) allow your successor Trustees to manage your financial affairs during incapacity without being subject to a Conservatorship (sometimes referred to as a Living Probate).
- Assets in a Revocable Living Trust can also be distributed much more quickly than those in a Will. Since Trust Assets generally pass without being subject to Probate, Trust assets can be distributed much quicker after the death of the Grantor. Court formalities, deadlines and other bureaucratic procedures are bypassed in favor of a streamlined distribution to the Beneficiaries.
- In addition, Revocable Living Trusts offer greater privacy than Wills, as they are not public record.
- As the name suggests, a Revocable Living Trust can be amended or revoked at any time, so it offers flexibility as well as security.
- Finally, Living Trusts have Asset Protection features that are available to your Beneficiaries. Assets not distributed outright to a Beneficiary, can be left to them in Trust, and as long as the Trust continues to manage the assets, the beneficiaries’ interests may be protected via Spendthrift language.
For all these reasons, a Revocable Living Trust is an excellent way to safeguard your assets and ensure that your wishes are carried out according to your specifications.
Contact us today to discuss how we can help you set up a Living Trust that will serve as the foundation of your Estate Plan.
We offer free consultations, so there’s no reason not to get started today!