By: Stephen D. Lentz, Esq.
Partner/Senior Counsel
steve@anchorlg.com
Introduction
In Virginia, many individuals seek ways to protect their assets and minimize tax liabilities, especially as they accumulate wealth and look toward estate planning. One of the tools commonly mentioned in this context is the Revocable Living Trust. This estate planning device provides flexibility, privacy, and control over assets during one’s lifetime and can ease the transition of assets after death. However, it’s important to understand that while a Revocable Living Trust offers many benefits, it is not a catch-all solution for asset protection or tax savings.
This article will explore the basic functions of a Revocable Living Trust, its potential benefits for tax planning, and clarify its limitations when it comes to asset protection.
What is a Revocable Living Trust?
A Revocable Living Trust is a legal document that allows individuals to transfer ownership of their assets into the trust while still retaining control over them during their lifetime. The key term, revocable, means that the trust can be altered, amended, or completely dissolved at any point during the grantor’s life. The trust becomes irrevocable upon the grantor’s death, at which point it serves as a mechanism to distribute assets according to the grantor’s wishes without going through probate.
- Grantor: The person who creates and funds the trust.
- Trustee: The individual (often the grantor) or entity responsible for managing the assets.
- Beneficiary: The person(s) or organization(s) who benefit from the trust.
How Does a Revocable Living Trust Aid in Asset Protection?
One of the primary benefits often cited for a Revocable Living Trust is asset protection. However, this benefit comes with significant caveats.
A Revocable Living Trust does not provide the kind of asset protection many people assume it does. Because the grantor retains control over the trust and its assets, those assets remain accessible to creditors during the grantor’s lifetime. In legal terms, this means that:
- No Creditor Protection: If you are sued or owe money, creditors can still go after the assets within the trust.
- Divorce and Marital Property: A Revocable Living Trust does not shield assets from claims made in divorce proceedings.
For true asset protection, individuals might consider alternatives such as an Irrevocable Trust or asset protection trusts (APT), which place assets beyond the reach of creditors since the grantor relinquishes control over the assets.
Tax Implications of a Revocable Living Trust
When it comes to tax planning, the Revocable Living Trust offers several benefits, but not necessarily direct tax savings.
- Income Taxes: During the grantor’s lifetime, all income generated by the assets in the trust is reported on the grantor’s personal tax return. There are no special income tax benefits. Essentially, the trust is tax-neutral as far as income taxes are concerned.
- Estate Taxes: While a Revocable Living Trust does not offer estate tax savings during the grantor’s life, it can simplify the estate settlement process after death. Importantly, assets in the trust will still be included in the grantor’s taxable estate for purposes of federal estate tax. However, with strategic planning, the trust can help structure the estate to take advantage of estate tax exemptions and other tax-saving strategies after the grantor’s death.
- Avoidance of Probate: A key benefit of a Revocable Living Trust is that it allows the grantor’s estate to avoid probate. Probate can be time-consuming and costly, especially in states where probate fees are high. By avoiding probate, the grantor’s heirs may save money and time during the distribution of assets. The average length of time for probating a simple estate can be up to sixteen months! During that time, there is an interruption of access to the assets until the probate process in concluded.
- Step up in Basis: All property transferred at death through a Revocable Living Trust enjoys a “step up in basis”, which affords the beneficiaries enormous benefits with appreciated property.
- Unified Credit: The Grantors can claim what is called the “Unified Credit”, which allows them to shelter up to $25,000,000.00 worth of wealth ( in 2024-2025), and pass their inheritance to their beneficiaries with no “estate tax” or “death tax”.
When is a Revocable Living Trust the Right Tool?
A Revocable Living Trust is ideal for individuals seeking flexibility and control over their assets during their lifetime, while wanting to provide a clear and private path for distributing those assets upon their death. The trust can be particularly beneficial for individuals with complex or sizable estates who want to avoid the probate process, protect their family’s privacy, and ensure smooth asset transfer.
Limitations of a Revocable Living Trust
While a Revocable Living Trust offers flexibility, it is not a solution for everything. The following limitations should be noted:
- No Protection from Lawsuits: As mentioned, assets in a Revocable Living Trust remain available to creditors, including for lawsuits or medical debts.
- No Immediate Tax Benefits: The trust does not provide income or estate tax reductions during the grantor’s lifetime. Estate taxes still apply after death.
- Costs of Set-Up and Maintenance: Creating a Revocable Living Trust involves legal fees, however the up-front costs of creating a Revocable Living Trust in many instances is much more economical than the expense of Probate after death.
Conclusion
A Revocable Living Trust provides a strong foundation for estate planning—offering control, privacy, and avoidance of probate. However, it is not a solution for asset protection or immediate tax savings. For those seeking to protect their assets from creditors or minimize taxes during their lifetime, additional strategies such as Irrevocable Trusts or gifting plans may be more appropriate. Our estate planning attorneys at Anchor Legal Group are eager to hear each family’s unique story and craft the most meaningful estate plan for the family.