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FINANCIALLY SPEAKING Best Individual Taxpayer Victories of 2001 (Mar/Apr-02)
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FINANCIALLY SPEAKING Paperwork Mistakes That You Must Straighten Out Before Filing Your Income Taxes (Nov/Dec-01)
The Seven Deadly Sins of Running a Business (Sep/Oct-01)
Five Tools For Cutting College Tuition Costs (Jul/Aug-01)
Now That You’ve Got All The Numbers … What do They Mean? (May/Jun-01)
Ten Timely Tax Tips (Jan/Feb-01)
Pros and Cons of Revocable Living Trusts (Nov/Dec-00)
Thinking About Improving Your Company? (Sep/Oct-00)
Employee Benefits (Jul/Aug-00)
Have You Thought About the Future? (May/Jun-00)
Taxes (Jan/Feb-00)
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FINANCIALLY $PEAKING: Pros and Cons of Revocable Living Trusts

Many promoters advertise the wonders of living trusts. Indeed, such trusts offer many advantages to their creators. But the claims advanced for living trusts are often misleading and sometimes just plain false. Only if you know the real benefits and drawbacks of living trusts can you construct a trust with the features that best meet your needs.

Trusts fall into two categories:

  • Living trusts established while the creator (grantor) is alive.

and

  • Testamentary trusts, those that go into effect after the grantors death, as spelled out in the will.

Living trusts are further divided into two types:

  • Revocable trusts which can be materially changed or even canceled altogether.

and

  • Irrevocable trusts that can't be rescinded after they go into effect. A revocable trust must be a living trust, i.e. set-up while you're alive. However, many types of living trusts must be irrevocable, such as an insurance trust. Simply put, a revocable trust is impermanent.

You generally can serve as trustee and beneficiary of a revocable trust you create. Therefore, you can retain control over any assets you transfer into the trust.

ADVANTAGES

1. Incapacity Protection: For those who become ill or incompetent, a successor trustee can take over management of the trust assets. And there will be no costly public time control of your finances. This type of transfer cannot be handled as seamlessly by relying upon a power of attorney.

How It Works: when you create your revocable trust and name yourself as trustee, you also select a successor trustee. You might also designate co-successors perhaps including an institution that will assume financial responsibility.

The Strategy: When the trust is created you should spell out the circumstances in which you no longer can manage your own affairs and who will make the determination. For example, two doctors have to state in writing that you are incapacitated. If this event should occur the successor trustee can step in immediately and the successor of successors will have a fiduciary responsibility to protect your interests.

To illustrate, Joe Smith's estate was to go to his two nieces. As he grew older, he no longer could care for himself. His nieces than could provide him with quality long-term care, or they might not, hoping to preserve Joe's assets that they would eventually inherit.

Fortunately, Joe has drawn up a revocable trust, naming a bank along with the nieces as successor trustees. The trust documents required the successors to provide the best care for Joe and the bank made sure this instruction was carried out to Joe's comfort.

Vital: It's best to go through the formalities of transferring assets into your revocable trust so the trustee will have funds to carry out required responsibilities.

2. Probate Avoidance: Often, revocable trusts are promoted heavily as a means to circumvent the time and expense of probating a decedents will in a local court. The reality is that in most states probate is not burdensome or expensive. Many localities offer a simplified probate process that you may be able to use. Many types of assets are excluded from probate anyway, whether or not you have a revocable trust. For example, jointly held property passes to the surviving owner automatically including insurance proceeds and retirement accounts (including IRAs).

Out Of State Property: If you own property in another state, your survivors will have to go through a separate probate for the out-of-state asset(s). That may mean hiring an attorney far away or making unwanted trips. Holding out-of-state property in a revocable trust avoids this ancillary probate as well as local probate.

The Trap: Using a revocable trust to hold out-of-state property works fine for a vacation home. However, such trusts don't provide asset protection (see below) so investment property should be held in a limited liability company (LLC) or family limited partnership (FLP) for asset protection as well as ancillary probate avoidance.

3. Administrative Rigor: One of the unsung benefits of creating a revocable trust is the need to get your affairs in order. This will help you manage your affairs as you grow older and assist your heirs in handling your estate. To illustrate, Betty Jones created a revocable trust and began putting assets in the Betty Jones Trust. She found she had 17 mutual funds and four brokerage accounts. In re-titling her assets she consolidated them to a few accounts making record keeping easier and reducing expenses.

DRAWBACKS

1. No Tax Benefits: Despite what you might hear or read, revocable trusts are neutral from a tax point of view.

For income tax purposes trust income is taxed to you as the grantor. For estate tax purposes assets transferred to a revocable trust are included in your taxable estate.

The Trap: Misinformation about revocable trusts can lead you to neglect necessary tax planning, especially when it comes to estate tax.

The Good News: Virtually all sophisticated estate and income tax planning strategies can be used in conjunction with revocable trusts.

An Example: After transferring your assets into a revocable trust you can give away trust assets to reduce your taxable estate, using the $10,000 (per recipient) annual gift tax exclusion. A recent change in tax law erased doubts about this tactic.

2. There is No Asset Protection: Assets held in a revocable trust are just as vulnerable to your creditors as assets you hold personally. For example, if you hold investment property in a revocable trust, a tenant whose child eats lead paint may sue you personally for damages. As mentioned earlier, a family limited partnership or limited liability company should be used for asset protection.

3. Complacency: Merely setting up a revocable trust won't provide you with a complete estate plan. You should take the time to re-title assets given to the trust. Have a will to cover those assets not held in the trust. Select suitable trustees, get their agreement to serve, and make arrangements for backup trustees. Work with a knowledgeable professional on tax planning. Explain all of these arrangements to your heirs.

SINGLE OR JOINT

Married couple must decide whether to use a joint revocable trust or to have each spouse create his/her own trust. Individual trusts are generally best for the following reasons. Both spouses gain investment and financial experience. If one spouse dies the survivor may have easier access to the assets in his own trust than would be the case with a joint trust. Each spouse builds an individual credit history.

The Trap: Be wary of any attorney who tells you that the cost of creating two separate trusts will be much greater. There should be only a token extra charge. For more on revocable living trusts, including a sample document, visit www.laweasy.com.

For more information, click on the Authors Biography at the top of this page.

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