What is a revocable trust and do I need one?

As part of an estate plan, many people decide to write a will, a legal document that describes how your property and assets should be distributed once you die. Others may decide to open a trust — a separate entity that holds the assets and has its own set of rules for distributing them.

Typically when people mention trusts, they are referring to revocable ones. A revocable trust is simply a trust that you can change. This trust is created while the creator is still alive, which is why it’s also known as living trust or inter vivos trust. (It is the opposite of a testamentary trust, which is established in someone’s will and created only upon their death.)

Revocable trusts are an important part of estate planning. They have advantages over wills and can even work in conjunction with them. If you think trusts are for the wealthy think again; revocable trusts are fairly straightforward — as a drawback they won’t minimize taxes like the estate tax. For that you’ll need an irrevocable trust. We’ll discuss those differences and more.

In this article:

• How a revocable trust works
• Reasons to get a revocable trust
• Revocable vs irrevocable trusts

How a revocable trust works

Before we get into how a revocable living trust works, here is a refresher on how the roles of the people involved in a trust:

• Grantor (also known as settlor): creates the trust
• Trustee: maintains the trust
• Successor trustee: takes over when the trustee dies or becomes incapacitated
• Beneficiary: receives the assets in the trust

The grantor transfers real estate and assets into the trust by retitling them. He or she creates a trust document or trust agreement that outlines the details of the trust, including the people in the roles mentioned above, and any rules for distributing assets.

The trustee oversees the trust by handling investments, paying taxes, and distributing money and assets to the beneficiaries, according to the trust agreement. Many grantors choose to act as the trustee as well, making it easy to move assets in and out of the trust or make any changes to it. When the trustee dies, the successor trustee takes over.

Reasons to get a revocable trust

Most people open a trust so that they can have greater control over how their assets are distributed to their beneficiaries. A trust lets you stipulate how a future heir might use the asset. If you have a spendthrift son, you could prevent him from spending all of his inheritance at once by restricting how much money he can access and what he can use it on. Here are other reasons to get a revocable trust:

Avoid probate

A major benefit to creating a trust is to avoid probate, or the legal process of proving a will. If a deceased person’s estate is valued over a certain amount, assets bequeathed in a will must go through a probate court before they are released to the beneficiaries.

For complex estates, probate can take a long time, and even longer if a potential heir decides to contest the will. All of this can be avoided with a trust, since the trust assets and property are not part of the probate estate. Your beneficiaries can receive assets faster with a trust than with a will. Revocable trusts do have their own fees, but they at least save you from probate fees, which can ultimately decrease an inheritance.

Privacy

Because the trusts do not go through probate, the terms will not be exposed to the public, as with a will, which must be filed in the local probate court.

Protect your assets from guardianship

If you are physically or mentally unable to care for yourself, the state court may appoint a guardian to make legal and financial decisions on your behalf. If the guardian is a non-family member, you risk giving access to your bank accounts and other financial assets to a stranger.

The assets in a trust however are off-limits to the guardian. Instead, your trustee or successor trustee that you appointed when you created the trust retains control and can maintain the assets as you intended should you become incapacitated.

Guardianship and how an elder law. Find an estate planning attorney who can help you understand it and plan ahead with a durable power of attorney.

Revocable vs irrevocable trusts

Another type of trust is an irrevocable trust. As the name suggests, it cannot be revoked or changed. The grantor of an irrevocable trust relinquishes all ownership and association with the trust. That means once it is created, the grantor cannot take back an asset or change the beneficiaries.

In exchange for this inability to modify its terms, the irrevocable trust offers tax advantages and asset protection. A revocable trust does not offer the same tax advantages and it also cannot shield the trust property and assets from creditors. We’ll discuss how taxes work with a revocable trust next.

You can read in depth about irrevocable trusts.

Revocable trust and taxes

Because the grantor can change the terms of the revocable trust until they die, the assets remain under their ownership. If the trust funds generate any money, the trustee must report it as income and pay taxes. The revocable trust does not have a separate tax ID number while the grantor is still alive.

Once the grantor dies, the assets in the trust are also includable in the valuation of their estate, which determines the estate tax. However, most people don't have a large enough estate for the estate tax to matter — the estate tax exemption is $11.4 million.

Keep in mind that your heirs may have to pay other types of taxes, like income tax and capital gains tax on what they receive. Some states also levy an inheritance tax. Another option would be to open up a charitable trust, which gives you tax benefits when you donate money to a non-profit organization.