Revocable Living Trusts: What They Are, and How They Work

One of the basic decisions clients must make in estate planning is whether to utilize a living trust as a will substitute. Often their curiosity is piqued by flyers and newspaper ads promoting the revocable living trust (RLT) as the "slam dunk" of estate planning, but they don't really understand how the trust works, or its advantages and disadvantages. The following overview focuses on some of the common misconceptions regarding RLTs, and points out situations where they can be utilized effectively.

Very simply, the RLT is a trust funded with substantially all of the grantor's assets during his or her lifetime. In most situations, the grantor acts as trustee, with a successor named in the event of incapacity or death. The trust provides for the management of assets during the grantor's life and for their disposition after death. The RLT offers no income or estate tax benefits. All trust income is taxable to the grantor. The dispositive provisions of the trust can incorporate tax saving estate planning techniques, but none that cannot be utilized with a will.

Trust assets will not be subject to probate proceedings (the court supervised administration of a will), so the direct costs of probate are avoided. But unless essentially all assets are transferred into the trust, a will and the attendant probate are still required for the remaining assets. Furthermore, the direct probate costs (filing fees, preparation of documents to open up the estate, etc.) are generally only a fraction of the total cost of estate administration, most of which will apply with an RLT. Fees for appraisals and estate tax returns, etc., will approximate fees incurred in a typical probate situation.

Another cost consideration often overlooked involves the time and expense incurred when the trust is established and funded. The trust is usually more complicated than a will because it must address the issues of asset management during the grantor's lifetime and what should be done in the event of incapacity or disability. Transferring title to assets in the funding process also adds to the up-front cost of implementing the RLT.

Finally, the RLT does not offer the grantor any protection from creditors, including the Department of Public Aid (since the trust is revocable it will not qualify as a Medicaid trust). Nor does it offer limitations on post death creditors' claims, one of the advantages of the probate process, under which notice is published to creditors that all claims must be filed within six months. In Illinois, the period for creditors' claims for which such notice is not published runs for two years after death.

On the other hand, the RLT does offer several advantages over the use of a will as the primary estate planning document. First of all, it forces an individual to take inventory of assets and liabilities and to focus on hard issues such as incapacity and the ultimate disposition of assets. The processes of "pre-probating" one's estate and funding the trust require a more thorough approach than that required in the process of executing a will.

If an individual owns property in another state, the RLT will avoid the necessity of establishing ancillary probate proceedings in the non-resident state. This can also be accomplished through joint ownership, but in certain situations joint ownership may not be desirable.

Many wealthy individuals have concerns about the public nature of probate proceedings since the probate documents are fully accessible as public records. The RLT provides privacy to the extent that trust assets escape the probate process.

Another advantage of the RLT is the possibility of reducing any delay in the distribution of assets and/or providing for a smooth transition in asset management if the trust continues for a period after the death of the grantor. Many people are concerned about probate proceedings becoming drawn out over a period of several years. As a practical matter, the administration of a substantial estate is likely to take over a year, even if there is no probate, because of the filing requirement for federal estate tax returns for estates valued at $1,500,000 or more (for decedents dying in the years 2004 and 2005). The return is due nine months after the date of death, and extensions of time to file can be obtained for up to six months. It is imprudent to make any final distributions until a closing letter has been received from the Internal Revenue Service.

In Illinois, the probate process can be streamlined under independent administration with minimal court supervision. However, because of the six month period for creditors claims, the probate period usually extends seven to nine months, even if the estate is under $1,500,000 and no federal estate tax return need be filed.

If the RLT provides for continuation of the trust after the death of the grantor, perhaps to provide asset management for a financially unsophisticated surviving spouse, the transition can be much less disruptive than establishing a testamentary trust through probate.

Finally, the RLT can provide for the uninterrupted management of trust assets in the event of the grantor's incapacity, without the need to establish a legal guardianship pursuant to a court proceeding. The successor trustee can assume management responsibilities immediately upon the determination of incapacity (who determines incapacity, and how, is spelled out in the trust agreement).

Whether an RLT is appropriate depends on individual preferences and circumstances. Privacy is often a determinative issue. Generally, cost saving is not. For individuals who require asset management assistance, either currently, in the event of incapacity, or after death for a surviving spouse, the RLT can be an effective estate planning instrument. Age, health, level of wealth accumulation, and asset mix may have an impact on whether or when an individual should implement an RLT. Even if an RLT is used, it may be desirable to subject some assets to probate in order to take advantage of the six month (as opposed to two year) exposure to creditors' claims.