Life Death Taxes

Living Trust

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We’re following up on Friday’s post (the third in this group of four posts), where we began discussing this vehicle.  A well-defined revocable living trust covers three phases of the Settlor’s life: his or her productive lifetime, possible incapacitation, and what happens after his or her death.

Phase One of a Revocable Living Trust: The Settlor is Alive and Well

The trust’s formation documents should include specific provisions allowing the Settlor to invest and spend the trust assets for his/her benefit while alive. S/he can go about business as usual with the assets that have been transferred or funded into the trust’s ownership, assuming one hasn’t appointed someone else to act as trustee. In that case, the trustee would typically take direction from the Settlor.

The Settlor reserves the right to undo a revocable trust — thus the term “revocable.” One can reclaim assets placed into it, divert the trust’s income to himself/herself or another beneficiary, sell the assets or place more assets into it. The Settlor maintains final control.

A revocable living trust does not have its own taxpayer identification number, unlike an irrevocable trust — one where the Settlor gives up all control.

A revocable trust and its Settlor share the same Social Security number. Trust taxes are filed on the Settlor’s Form 1040, just as though the Settlor continued to hold ownership of the assets personally.

Phase Two of a Revocable Living Trust: The Settlor Becomes Mentally Incapacitated

The trust agreement should also specify what happens if the Settlor becomes mentally incapacitated and can no longer manage his/her affairs and those of the trust.

The trust documents should name a “successor trustee,” someone to step in and take over management of the trust should the Settlor is determined to be mentally incompetent. The successor trustee can then manage the Settlor’s finances and the assets that have been placed into the trust.

Phase Three of a Revocable Living Trust: The Settlor’s Death

A revocable trust automatically becomes irrevocable when the Settlor dies. At that point, it’s clear the Settlor can no longer make changes to it. The named successor trustee steps in now as well, paying the Settlor’s final bills, debts and taxes, just as one would if the Settlor became incapacitated. In the case of death, however, the successor trustee now distributes the remaining assets to the trust’s beneficiaries according to instructions included in the trust’s formation documents or last will and testament. (I hope it’s obvious how problematic things could be if the trust instructions are not in concert with the Settlor’s will!)

How a Revocable Living Trust Avoids Probate

The Internal Revenue Service and probate courts view revocable trusts a little differently. Because the Settlor and the trust share the same Social Security number, assets placed in the trust do not avoid estate taxes. The Settlor can reclaim them anytime one likes, so the IRS takes the position that no one has technically relinquished ownership as would occur with an irrevocable trust (that vehicle can escape estate taxation).

The probate court, on the other hand, considers ownership to have been relinquished. Probate rules stipulate that the assets were given to the trust, even though one could theoretically take them back. Assuming one hasn’t done so as of the date of death, the trust’s assets would not pass through probate. The successor trustee can settle the trust outside of court, without supervision.

So, why are you waiting?

Isn’t it time you protect yourself and your loved ones with a Living Trust?

Roy A. Ackerman, Ph.D., E.A.

A SAMPLE LIVING REVOCABLE TRUST AGREEMENT

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2 thoughts on “Living Trust”

  1. Yes, I can see why it would be a good idea! It’s one of those things you think you’ll get around to but putting it off could lead to never doing it all.

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