February 24, 2021
By Joe Price
Here is a short true/false quiz to help you figure out what your revocable trust can and cannot be expected to do during your life, and at the time of your death. So, true or false:
- Titling assets in a revocable trust during my life protects them from creditors.
- Titling assets in a revocable trust during my life will reduce my estate taxes.
- I can name my testamentary trust (which is different from a revocable trust, as explained below) as a beneficiary of my IRA or 401(k) account.
Titling assets in a revocable trust during my life protects them from creditors.
FALSE. When you establish a revocable trust, you as grantor maintain complete control over the trust assets and that pretty much rules out the possibility that those assets will be protected from creditors in any of the 50 states.
Now having said that, I will mention that titling assets in a revocable trust can protect assets from creditors in one instance, but that is in a situation where you could have the same degree of asset protection within the revocable trust as you would have if you held the assets in joint names outside of the trust.
That situation is only possible in the state of Missouri and the other states (not including Kansas) that recognize the form of ownership called Tenants By the Entirety (TBE).
What is TBE? It is a form of joint ownership between a husband and wife. The effect of it is that assets owned as TBE are protected from the creditors of only one of the spouses. So, if husband is obligated on a contract and wife is not obligated, then husband’s creditors should not be able to seize any assets held in TBE.
I mention TBE because Missouri recognizes a form of trust ownership called the Qualified Spousal Trust (QST) that allows a husband and wife to jointly establish a QST and obtain the same degree of asset protection that they would have as TBE.
The QST ownership does not provide extra asset protection by itself. It is more accurate to say, “If TBE would have provided asset protection in a situation, the QST ownership won’t undo that protection.”
Titling assets in a revocable trust during my life will reduce my estate taxes.
FALSE. The revocable trust does not reduce estate taxes because you as grantor have full control over assets held in a revocable trust, and it is very difficult to avoid estate tax includability on assets in your estate that you have control over.
I should mention that the well-drafted revocable trust will contain a formula that optimizes the allocation of your estate’s assets between a unified credit trust, which will take full advantage of your lifetime estate and gift tax exemption, and a marital trust, which will exempt additional assets from estate taxation if the other spouse survives.
But as is the case with asset protection, the revocable trust doesn’t add any tax reduction over and above what a similar formula in a last will and testament would provide. In other words, you don’t need a revocable trust in order to incorporate a tax-optimizing formula in your testamentary instrument.
I can name my testamentary trust (which is different from a revocable trust as explained below) as a beneficiary of my IRA or 401(k) account.
TRUE. However, as I will explain, the fact that you can do it doesn’t mean that you would ever choose to do it because of the practical problems that it causes.
First, let’s talk about what a testamentary trust is and how it differs from a revocable trust. A testamentary trust is a trust that is created in a last will & testament rather than in a revocable trust. It may seem like the same thing, but there is one extremely important difference. The revocable trust comes into existence during the grantor’s life at the moment it is executed and funded. The revocable trust changes character at the moment of the grantor’s death (it changes from a revocable trust to an irrevocable trust), but it remains in existence both before and after death. That makes it an ideal candidate to be the beneficiary of an IRA or 401(k) account. That is, it is capable of receiving the benefits of an account at the moment of death.
By contrast, the testamentary trust doesn’t come into existence until the probate administration of the grantor’s estate ends, and the estate assets are transferred into the testamentary trust. It can take six months or more (sometimes, many months more) to wind up a probate administration. If an account is available to be distributed, but distribution is not possible because the beneficiary (the testamentary trust) has not yet come into existence, you can understand how that might be a practical problem for the grantor’s family, especially if the IRA or 401(k) account is the primary asset in the estate.
What other reasons are there for having a revocable trust?
You have just read that a revocable trust doesn’t provide you any asset protection or estate tax benefits that you couldn’t have obtained without a revocable trust. So why did we recommend a revocable trust for you?
Well, as mentioned in the question on the problems inherent in naming a testamentary trust as the beneficiary of an IRA or 401(k), the revocable trust’s primary advantage is that it exists during your lifetime. Not only can the revocable trust be named as the beneficiary of an IRA or 401(k), it can also become the owner of other assets like brokerage accounts or land. Assets that are owned by a revocable trust during your lifetime do not have to go through probate before they may be passed to the beneficiaries named in the revocable trust. They can be distributed immediately in some cases. We have had trust administrations that lasted two days from start to finish. That meant that the client’s family avoided all of the problems that can arise when beneficiaries are forced to wait extended periods to receive estate assets.
What problems can arise when beneficiaries have to wait to receive estate assets?
There can be angry creditors, including funeral directors, hospitals, banks and others who are either entitled to funds at your death or who feel insecure because you are no longer around.
In addition, there can be family members or businesses that rely on you during your lifetime to pay their living expenses or business expenses. Any delay, especially a delay of six months or more, can severely disrupt lives. The revocable trust can alleviate either problem.
This information contained in this publication is for general informational purposes only and is not intended, and should not be construed, as legal, accounting or tax advice. The author expressly disclaims all and any liability and responsibility to any person or corporation who acts or fails to act as a consequence of any reliance upon the whole or any parts of the content above.