PLANNING BEYOND RETIREMENT: Discussing the importance of revocable trusts by Ron Copley, Ph.D, CFA, LOL contributing writer
Estate planning extends a person’s retirement plan by looking beyond life to the disposition of assets. An important tool most people should consider is a revocable trust. The key tool allows the granter—who may be known as the settler or creator of the trust—to retain control of the assets during life while providing for beneficiaries after death. A revocable trust also eases the disposition of assets in case the granter becomes incapacitated or incompetent, and can protect assets from a lawsuit.
A revocable trust is a legal entity with rights similar to those each of us enjoy individually. It also can be known as a living trust or an interviews trust. A revocable trust provides the granter privacy, creates a means for paying estate taxes, and saves time and money in the disposition of assets by avoiding probate. Once the trust is created, the granter must fund the trust with assets retitled into the name of the trust, a crucial step some granters fail to accomplish. Unless funded, the trust has no practical use.
In setting up a trust, document language protects the grantor’s interests over interests of the beneficiaries, especially in terms of risk. A granter is usually more interested in protection of principal and generation of income than in growth, which requires a higher level of risk when investing the assets. For example, a retiree with a $500,000 brokerage account could create a revocable trust naming himself/herself as trustee and invest the assets into low-risk securities yielding 4-to-5 percent with income and some principal distributed annually back to the granter for as long as the granter lives. At death the trust document would distribute remaining assets to named beneficiaries who could then modify the investment strategy, depending on their individual risk preferences. From this perspective, the trust distributes assets similar to how a will works.
Most revocable trust documents name the granter the primary trustee who is responsible for managing all aspects of the trust. At death the responsibility passes on to a successor trustee, who can also be known as the acting trustee. The successor trustee steps into the shoes of the original trustee and incurs the legal responsibility of carrying out the wishes of the granter as outlined in the trust document.
In addition to identifying beneficiaries, the trust document typically identifies assets the granter has or will assign to the trust as non-taxable gifts. For example, I could set up the Copley Family Revocable Trust and assign or retitle a brokerage account to the trust be managed by myself with my wife named as the successor trustee at my death. My wife could, if she wishes, hire a financial adviser to assist in managing the account with all adviser expenses and other reasonable expenses paid out of the trust. During life I retain the right to dissolve the trust, and reclaim the assets after all debts and expenses have been paid. The trust may not be revoked after I die; it then becomes irrevocable. Successor trustees are held to a high standard of care as a fiduciary acting in good faith in the interest of the trust, and are entitled to receive reasonable compensation for services rendered.
During life the grantor’s social security number identifies the trust. At the grantor’s death, the successor trustee petitions the IRS for a new tax ID number. Revocable trusts are governed by the law of the state in which the trust was created, and may allow protection of assets from creditors, depending on the applicable law. Until a revocable trust becomes irrevocable by the death of the granter, it is easy to modify, for example, in case of newly acquired assets, or changes in the trustee or beneficiary.
The trust document should be notarized, and contain a schedule of real and personal assets to be held in the trust. The document can name a co-trustee who would have equal responsibility with the primary trustee for managing trust assets. If a residence is placed in the trust, the trust document may provide the trustee to allow the granter or beneficiary to live in the residence without rent.
While revocable trusts can be set up cheaply online, I generally recommend having a qualified estate-planning attorney assist in its creation and implementation. Although involving an attorney means an expense, subtle terms used in the trust document can take on great importance down the road. Interpretation of such terms become important at the time the trust is created.
While avoiding probate is a major advantage, a revocable living trust has a few disadvantages. A trust can be expensive to create, and it can be difficult to transfer certain types of assets, such as real estate, into it. Moreover, a will is needed still to supplement assets held outside the trust. Revocable living trusts are also subject to challenge by dissatisfied relatives, but so are wills. Retirement plan assets, such as IRAs and 401k plans, should not be placed in a trust; retitling the accounts can trigger an untimely tax liability. All things considered, with proper planning and professional assistance, a revocable trust can be a powerful component of one’s financial plan. LOL
Ron Copley is principal of Copley Investment Management, a Registered Investment Adviser in Wilmington. Besides managing money for individuals, retirement plans, and foundations, he conducts business valuations for the legal community and teaches part-time at UNCW.