A revocable living trust is a popular estate planning tool that can serve useful for incapacity planning during a person’s lifetime, but is primarily used as a convenient and efficient means to distribute a person’s property at death without the need for a formal court-supervised probate proceeding. Revocable living trusts may be amended and revoked by the person who established the trust (sometimes referred to as the trustor, settlor or grantor) during that person’s lifetime. While the trust is in place, it usually holds the person’s home, bank accounts, brokerage accounts and other property.
People often come to our office for estate planning services with some understanding about the use and benefits of revocable living trusts. Unfortunately, myths on this topic are quite common. This can result in confusion for our clients. We often spend part of our initial consultation with them discussing and dispelling these myths. In this article, we will dispel five of those myths for you:
Myth one: Transferring my assets to a revocable living trust will help me avoid income tax during my lifetime
A revocable living trust is transparent for income tax purposes. All investments held by the trust are associated with your social security number. The technical explanation is that a revocable living trust is a “grantor trust” for income tax purposes, which means that you, personally, and not the trust, are treated as owning all the trust assets for income tax purposes. When it comes time to filing your income tax returns, all taxable income earned by trust investments will be reported on your personal income tax returns as if the trust did not exist.
Myth two: If I set up a revocable living trust, my estate will pass to my beneficiaries’ estate tax-free at my death.
A revocable living trust is also transparent for estate tax purposes. Multiple sections of the Internal Revenue Code cause the assets you transfer into a revocable living trust to be pulled back into your estate for federal estate tax purposes. Also, while a revocable living trust may be drafted to take advantage of certain estate tax savings strategies, you can do the same planning with a will.
Myth three: Transferring my assets to a revocable living trust will protect my assets from creditors during my lifetime
Once again, a revocable living trust is transparent for creditor protection purposes. California law does not allow you to transfer assets to a revocable living trust in order to put those assets beyond the reach of creditors. This is true for your creditors during your lifetime and also for any creditors of your estate after your death.
Myth four: The terms of my revocable living trust will remain confidential upon my death.
When we started practicing law, it was true that the terms of a revocable living trust were essentially confidential, and this was a much-appreciated benefit of using a trust. The California legislature, however, felt that the ability to keep the trust terms private created the opportunity for fraud and abuse. Today, California law requires that the beneficiaries named in your revocable living trust and your heirs receive a written notification from the trustee following your death. Each recipient of the notification is entitled to receive a copy of the trust document.
Myth five: If I include a no-contest clause in my revocable living trust, no one will contest the terms of the trust upon my death.
No-contest clauses are used to discourage contests of trusts by providing that any beneficiary who contests the trust forfeits what they would have received under the trust. This means that including the no-contest clause alone is not enough to avoid a contest. Much to the dismay of many of our clients, if you want to effectively dissuade a person from contesting the terms of your trust, you must also include a gift to that person in the trust and that gift must be significant enough to make the person forgo litigation for fear of losing the gift. Otherwise, except for the cost of litigation, the contestant has nothing to lose.
Revocable living trusts remain a foundational component of estate planning in California because of the many benefits they provide, including probate avoidance and continuity of management. Their benefits, however, are limited. Fortunately, there are other estate planning tools available, such as limited liability companies and irrevocable trusts, which may provide some of the benefits a revocable living trust cannot provide. Understanding the benefits and limitations of revocable living trusts and other available estate planning vehicles will help you create an estate plan that is tailored to your specific needs and desires.
Jean M. Kohler, Esq. and Victoria Kaempf, Esq. are attorneys-at-law with the Kohler Legacy Law Group, PC, in Los Altos. For more information, call (650) 475-0209 or visit kohlerlegacylaw.com.
