A Beginner's Guide: Estate Planning through Revocable Trusts

Article excerpt

In recent years revocable trusts have become a popular and quite common estate planning tool.

Many people, both young and old, utilize revocable trusts to pass assets to their spouse and the next generation free from probate, to plan for incapacity and in some cases to minimize estate tax liability.

A trust is an agreement, usually in writing, between two parties. The first party is the settlor, or the person who sets up the trust, and the second party is the trustee, or the person who manages the trust and holds legal title to the assets.

In most revocable trusts, the settlor and the trustee are the same person. The beneficiary of the trust is typically the settlor during his or her lifetime, and at the settlor's death the trust provides for the disposition of the assets to the settlor's spouse if he or she is living, and if not to the settlor's children -- or whomever the settlor directs in the trust agreement.

The disposition of assets can be as simple as equal distributions to the children or as complex as providing for long-term trusts to provide income payments to the beneficiaries and distributions at specified ages, or generation-skipping provisions to pass assets to beneficiaries two or more generations below that of the settlor. Of course, these complex provisions are complicated and should be considered only after consultation with a professional experienced in estate planning and tax law.

For a revocable trust to be effective, however, it is critical that the ownership or title to the settlor's assets be transferred to the trust -- known in the legal world as funding the trust.

This includes transferring the ownership or title to real property (or land), mineral interests, personal property such as vehicles, bank accounts, investments, stocks and bonds. For example, to transfer the ownership of the settlor's home to the trust, the settlor would execute and record a deed conveying the property from the settlor individually to the trustee of the revocable trust -- John Doe, trustee of the John Doe Revocable Trust.

In the introductory paragraph, we said that revocable trusts are used to pass assets to the next generation free from probate. This is accomplished by changing the legal title of the settlor's assets from the settlor individually to the trustee (funding). If all of the assets are transferred to the revocable trust prior to death, the settlor legally owns no assets in his or her name and therefore avoids the need for probate.

Revocable trusts are also used to plan for incapacity in that they enable the settlor to name an individual to take over the management of the trust property should the settlor become disabled or otherwise is unable to act on his or her own behalf. The language of the revocable trust agreement should outline how the settlor's disability or incapacity is to be determined.

In some cases, the use of a revocable trust could enable the settlor to reduce or eliminate his or her estate tax liability. By "stacking" their unified credits in 2000, a married couple could pass $1.35 million free from estate tax.

This is accomplished by using a credit shelter trust or bypass trust -- two names for the same type of trust. At the death of the first spouse, $675,000 (increased through 2006 to $1 million) worth of assets are transferred to a credit shelter trust usually titled the family trust to benefit the surviving spouse and children for their lifetimes.

The balance of the assets pass to the surviving spouse through a marital trust, taking advantage of the marital deduction. Therefore, at the first death no estate tax is due. At the second death the $675,000, including appreciation, held in the family trust would pass to the contingent beneficiaries -- usually the settlor's children. The assets in the family trust pass estate tax free to the children. The surviving spouse can utilize his or her $675,000 unified credit while passing assets held in either the marital trust or his or her revocable trust to the beneficiaries, and the only assets subject to estate tax are those exceeding $675,000. …