Revocable Living Trusts

In meeting with our clients regarding their estate planning needs over the years, many questions have arisen about Revocable Living Trusts. The following questions seem to be asked most frequently.

What is a Revocable Living Trust?

A Revocable Living Trust is a trust created by an estate owner during his or her life and may be as simple or complex as desired. It may be altered, amended or revoked during the estate owner's lifetime. It becomes irrevocable upon the death of the owner.

Why bother to create a Revocable Living Trust?

Although a comprehensive Estate Plan can be developed without the use of a Revocable Living Trust, several advantages can be obtained through its use. Among these advantages are:

  1. Avoidance of probate procedure and its associated costs and time delays;
  2. Possibility of federal estate tax savings;
  3. Long-term financial protection of children and grandchildren without continued court intervention;
  4. Protection against the incapacity (physical, mental, or legal) of the person creating the Revocable Living Trust or a beneficiary;
  5. Provides vehicle to plan for special needs of physically or mentally disabled beneficiaries;
  6. Withholding of complete control of their inheritance by children until they reach a designated age;
  7. No public disclosure of details of estate; and
  8. Professional management, if desired, of trust assets.

To what extent will the existence of a Revocable Living Trust avoid probate?

To the extent that it is funded with assets of the estate owner which were solely owned by the estate owner at the time of his or her death. These assets, were it not for the Revocable Living Trust, would be subject to the jurisdiction of the Probate Court, whether the estate owner died with or without a Will.

How large should our estate be before we consider the possible use of a Revocable Living Trust?

For tax savings from a Revocable Living Trust, an estate should be approximately $1,000,000 in 2002 and 2003, $1,500,000 in 2004 and 2005, $2,000,000 in 2006, 2007 and 2008, and $3,500,000 in 2009. Currently, the law provides that the estate tax is to be repealed in 2010, only to return again in 2011 with an estate tax exemption of $1,000,000 (rather than $3,500,000). The impact of inflation and the resulting future growth of the estate are also factors in making the determination of the appropriateness of the use of a Revocable Living Trust.

However, even where tax considerations are not of major importance, a Revocable Living Trust can be useful in making provisions for the future of a family member with particular needs, such as educational requirements or continuing physical problems.

What if I have minor children?

If your minor children inherit your estate through a Will or if you have no Will and there is no trust to control the property, your children are entitled to receive the property outright, without restrictions, at age 18 regardless of their level of maturity. A Revocable Living Trust can be used to delay their receipt of your wealth and to control the way in which the funds are used on their behalf.

Can insurance be used to fund a Revocable Living Trust?

Yes. It is wise to name a trust as the beneficiary of the death benefits of a life insurance policy. The death benefits will then be administered according to the terms of the Revocable Living Trust. This avoids the possibility that the proceeds will become part of the probate estate of the insured. It may also reduce the impact of the Michigan Inheritance Tax. It also ensures that the proceeds will be administered according to the desires of the owner of the policy.

How can a Revocable Living Trust save federal estate tax on the death of a surviving spouse?

By dividing an estate into shares, one share of which is taxable on the death of the surviving spouse and one share of which is not. The share which is taxable on the death of the surviving spouse (the Marital Trust) may be fully and readily accessible. The income and principal of the portion which is not taxable (the Family Trust or Credit Shelter Trust) can be made available to the spouse, if so desired. For example, by taking advantage of this arrangement (with an estate of approximately $3,000,000), the estate taxes on the death of a surviving spouse in 2005 (assuming the death of the first spouse in 2004 when the estate tax exemption amount is scheduled to be $1,500,000) could be reduced from approximately $695,000 to $0, a savings of $695,000. Of course, these numbers are subject to change, depending on the type of Estate and Financial Plan adopted, changes in the law, and growth of the assets.

The law allows an alternative method of providing for a spouse. This alternative allows certain interests in property, known as "qualified terminable interest property," to pass to a surviving spouse without the imposition of an estate tax at the time of death of the first spouse. Specifically, it permits a spouse to give the surviving spouse a life-long income interest in property, and, yet, allows the first spouse to control the ultimate distribution of the property at the time of death of the surviving spouse. This type of transfer qualifies for the unlimited marital deduction.

However, these transfers will be included in the estate of the second spouse to die. In summary, use of the "qualified terminable interest property" provisions allows the first spouse the opportunity to control the ultimate distribution of the family's assets. In this fashion, for example, children of a current marriage can be protected from being disinherited as a result of a second marriage of the surviving spouse.

Certain problems this alternative creates are the following:

  1. Conflicts may be created between husband and wife, since the first spouse to die can effectively limit the ultimate control of the surviving spouse over a substantial portion of the first spouse's estate.
  2. Increased need for life insurance on the surviving spouse to protect against liquidity problems caused by a larger taxable estate upon the second spouse's subsequent death.

Are there other kinds of trusts?

Yes. One type of trust which can be used in certain situations is an "Irrevocable Life Insurance Trust." Typically, in this type of trust, an individual irrevocably assigns to the trust all of the right, title and interest in insurance policies on the individual's life. The principal of the trust will consist of the proceeds of the policies at the insured's death. After the insured's death, the income will be payable to the insured's spouse. Upon the spouse's death, the proceeds will be payable to their children. For estate tax purposes, the value of the insurance is removed from the estate of both the insured and the spouse. There may be gift tax consequences connected with the establishment and maintenance of an Irrevocable Life Insurance Trust, but these can generally be minimized and certainly do not out weigh the estate tax benefits.

Prior to the passage of the Tax Reform Act of 1986, several other alternative types of trusts were available for use as income shifting devices. These alternatives are no longer available.

GENERAL TAX AND FINANCIAL PLANNING

Finally, we want to remind you that the proper time to review your tax, estate and financial planning situation is NOT on December 31 or April 15. The proper time to seek advice regarding these matters is throughout the entire year so that appropriate, economically-sound, unhurried decisions can be made.