You’ve probably heard of revocable living trusts, but do you know their history, or how they can be used to help clients avoid the Secure Act?
In this post, we’ll walk you through a brief history of revocable trusts, advantages and disadvantages of revocable living trusts, and how such trusts can be used to help your clients. (Click here to request a guide that provides detail on these uses of trusts).
Early Trust Concepts and the Birth of the Revocable Living Trust
As we discussed in the first post in this series, the modern legal entity that we call a “Trust” dates back to medieval England, but the specific idea of the revocable trust (also called a “living trust”) developed in America.
We can’t say “United States” because it is believed that the first revocable trust was established in 1765 for Francis Fauquier, who was the Lieutenant Governor of Virginia, and for whom Fauquier County in Virginia is named. There was no country called United States of America until September 9, 1776. (Yes, apparently, we all learned it wrong. The Constitution Center has a fuller explanation.[1])
As you will recall, a trust is a legal arrangement in which one person (natural or corporate) legally owns and manages property for the benefit of another party. The person who owns and manages the property is called the trustee, and the person on whose behalf the property is being managed is the beneficiary.
Revocable trusts can be designed to achieve various objectives, including managing assets, avoiding probate, providing for future generations, and as standby beneficiaries for avoiding the SECURE act tax on retirement plans. (Click here to request a guide that provides more detail on these uses of trusts).
As the word revocable implies, a revocable trust is characterized by its flexibility: the person who creates the trust (typically called the grantor or settlor) retains the right to change the terms, or completely cancel (i.e. revoke) the trust during that person’s lifetime. This right distinguishes it from irrevocable trusts, which cannot be changed once they are established.
Evolution in the Mid-20th Century
The revocable or living trust gained popularity in the mid-20th century as an estate planning tool. There are (at least) three major factors that have driven the popularity of living trusts.
Avoiding Probate
One of the primary motivations for using a revocable living trust is to avoid probate. Probate is the legal process through which a deceased person’s estate is settled and distributed. It can be time-consuming, expensive, and public, as well as subject to dispute by heirs and would-be heirs.
By owning assets in a revocable living trust, individuals can ensure that their assets are transferred to beneficiaries without the need for probate,[2] thereby saving time and money and maintaining privacy.
When the grantor dies, the trust becomes irrevocable. Thus, the rules for who gets what, when, become “written in stone” as it were, and the grantor’s wishes will be respected.
Incapacity Planning
A second potential benefit of a living trust is to provide a mechanism for managing assets in the event the grantor becomes incapacitated. If the grantor, (we’ll call him Adam), is no longer able to manage his own affairs, a co-trustee or successor trustee can smoothly step in and manage the trust assets on Adam’s behalf, without the need for delays, cost or uncertainty involved in a court proceeding.
Flexibility and Control
A third benefit of the revocability of the trust is that it provides the grantor with the ability to change his (or her) mind. A revocable trust can easily be amended, meaning that the grantor retains full control over his or her assets and make changes as his or her circumstances or wishes change. This flexibility makes the revocable living trust an attractive option for many people.
Common Uses for Non-Taxable Estates
In recent decades, the use of revocable living trusts has continued to grow, particularly for non-taxable estates. A non-taxable estate is one that falls below the federal estate tax exemption threshold, meaning it is not subject to federal estate taxes. As of 2024, the federal estate tax exemption is approximately $13.6 million per individual, meaning most estates in the United States are not subject to federal estate tax.
For non-taxable estates, the primary benefits of a revocable living trust are probate avoidance and incapacity planning, rather than tax planning. However, the living trust offers several other advantages that make it a valuable tool for estate planning:
Privacy
Unlike a will, which becomes a public document upon probate, a revocable living trust remains private. This means the details of the estate, including the assets and the identities of the beneficiaries, are not made public. For many families, this privacy alone justifies the use of a living trust to own most of the family’s assets.
Efficiency in Asset Distribution
Probate can be a slow, cumbersome and expensive process. A living trust can bypass that process. Assets held in a living trust can be distributed to beneficiaries more quickly than assets that must go through probate. This can enable the estate executor (who might also be the trustee) to close the estate faster and with less hassle and expense than if probate had to be concluded.
Reduced Costs
As noted, avoiding probate should also avoid most of the costs associated with probate court fees, attorney fees, and other administrative expenses connected to probate. This can result in significant savings for the estate.
Simplification of Multi-State Property Ownership
What’s worse than going through probate? Going through probate in multiple states. Some people who own property in multiple states, or rather, their heirs, may discover the hard way that they are responsible for going through probate in each state in which they own property.
This requirement can be avoided if the properties are owned in a revocable trust. During the owner’s lifetime, the owner retains all the control and flexibility. Only when the owner dies does the trust become irrevocable. For individuals who own property in multiple states, a revocable living trust can simplify the transfer of those properties by avoiding multiple probate proceedings in different states.
Legal Framework and Regulation
The legal framework for revocable living trusts is primarily governed by state law, and there are some variations from state to state. However, most states have adopted provisions of the Uniform Trust Code (UTC), which provides a comprehensive set of rules for the creation, administration, and termination of trusts. The UTC aims to standardize trust law across states, providing greater clarity and consistency.
Some of the key states that have not adopted the UTC include Delaware, Nevada, Alaska and South Dakota, all considered good jurisdictions in which to domicile a trust. These states have not adopted the UTC because they believe (and many trust grantors and attorneys agree) that their own state laws are better for trust grantors and beneficiaries than the UTC rules.
Trustee Duties
A trustee has a fiduciary duty to act in the best interests of the beneficiaries of the trust. This duty encompasses several key responsibilities, including:
- Duty of Loyalty: The trustee must prioritize the interests of the beneficiaries above their own and avoid conflicts of interest.
- Duty of Care: The trustee must manage the trust assets prudently, making informed decisions and seeking expert advice when necessary. State law permitting, a trustee may delegate investment responsibility to an investment manager who is not the trustee.
- Duty of Impartiality: The trustee must treat all beneficiaries fairly and impartially, considering their respective interests.
Trustees are legally and ethically bound to uphold these duties, ensuring the trust’s purpose is fulfilled and the beneficiaries’ rights are protected.
Establishing a Trust
Establishment of a revocable trust involves several steps. Among these are:
Drafting
The trust document, or trust agreement, outlines the terms and conditions of the trust, including the identification of the grantor, trustee, and beneficiaries, as well as the distribution plan for the trust assets. Technically, a trust does not have to be drafted by a lawyer. However, in almost every circumstance it will be prudent to have the advice of someone who has knowledge and experience relevant to the situation of the grantor, so that the terms of the trust can accurately reflect the grantor’s desires and situation.
Funding
A trust doesn’t technically exist until it owns something. Thus, assets must be transferred into the trust, even if only $10.
In the old days, it was reportedly common for trust lawyers to have drawers full of trust documents that had a dollar, or a ten-dollar bill, stapled to them, representing that the trust had been funded.
For most modern purposes, the assets that the grantor wants in the trust need to be titled to the trust by some process. This involves changing the title of the assets to the name of the trust. Common assets placed in a revocable living trust include real estate, bank accounts, investments, and personal property.
Management and Administration
During the grantor’s lifetime, the grantor may, and typically does, serve as the trustee. The grantor may continue to manage the trust assets, though it is also common to have a professional manage the trust’s investment. Upon the grantor’s incapacity or death, the successor trustee takes over the management and distribution of the trust assets according to the terms of the trust document.
Practical Considerations
While the benefits of revocable living trusts are clear, there are also practical considerations. Among these are:
Initial Setup and Titling
Achieving a grantor’s objectives using a living trust requires careful thought and planning. The grantor has to think about and make decisions that some people would rather postpone. Among such decisions are who will get what, when, either while the grantor lives or more frequently after the grantor’s death. Effectively translating those desires into enforceable language will usually require legal assistance, which can involve initial setup costs.
Once the trust is set up, the next step is to transfer the assets into the trust. That process can be a bit of a pain, requiring paperwork, and often back and forth with several representatives of whatever custodian holds the assets. But once done, it should not have to be redone.
Potential Complexity
For some individuals, the additional complexity of managing a trust may be off putting. However, working with experienced legal and financial professionals can help navigate this complexity.
Common Misconceptions
There are common misconceptions about revocable living trusts, such as the belief that they provide asset protection from creditors, or somehow make the assets and income less subject to tax. In the vast majority of cases, neither of those is true. Because the grantor retains control over the trust assets, revocable trusts typically do not offer the same level of asset protection as irrevocable trusts. And because, by definition, all revocable trusts are grantor trusts, revocable trusts have essentially no effect on income taxes. (We will look at grantor trusts in a future post.)
Conclusion
The history and development of the revocable or living trust in the United States reflect its adaptability and utility as an estate planning tool.
One of the most recent innovations is the use of a revocable trust during the life of a retirement plan owner as the beneficiary of a large IRA, 401(k) or similar retirement account to reduce or avoid the dire tax consequences of the SECURE Act. For more information about such a trust, called a StretchIRA Trust, click here for our Advisor Guide to Large Retirement Plans, or call 703-437-9720 and ask for Connor or Katherine. Or email [email protected] to ask for a guide or schedule a call.
[1] https://constitutioncenter.org/blog/today-the-name-united-states-of-america-becomes-offici
[2] Trusts avoid probate because the probate process applies to the property in the decedent’s estate. But the property owned by the trust is not, in general, in the decedent’s estate for probate purposes.
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