Understanding How Revocable Trusts Are Used In Estate Planning

The use of trusts in estate planning is not just for Rockefeller-sized estates. However, knowing the correct trust to use and when certain changes need to be made requires the help of an experienced estate planning attorney to achieve estate planning goals.

Estate planning often gets lumped into the same category as a visit to the dentist: we know it's important, but we'd rather go sailing. Or paint the house. Or do anything else to avoid it. But you spend a lifetime accumulating assets—as we are reminded by foster.com in "When to amend your revocable trust." As such, it is necessary to take the time to create a plan to ensure that when we do pass away, our wealth and assets are transferred to others in a way we want.

If your estate plan includes a revocable living trust, start by examining the provisions for potential revisions. First, look at who was named as successor trustee and make certain that he or she is still willing and able to serve in that role when called upon. Also, terms governing how assets in the trust are to be distributed after your death should be reviewed carefully to make sure the named beneficiaries and amounts they are to receive from the trust are still as you would like.

Providing for your spouse is typically an estate planning goal for couples, as well as ensuring that property is transferred with the least amount of loss from estate taxes. You can do this by adding a "credit shelter" or "bypass" provision to revocable trust documents.

Federal estate and gift tax rules state that spouses can pass an unlimited amount of property to each other without incurring gift or estate tax. Each spouse is also given a specific exemption amount to shelter property from tax liability when passed to others at their death.

When the first spouse dies, estate tax can be avoided by leaving all property to the surviving spouse. At the survivor's death, the estate tax will be due to the extent that the couple's remaining assets exceed the federal estate tax exemption.

However, the problem with leaving all property outright to a surviving spouse is that the first spouse can't use his or her estate tax exemption. It would be wiser to include a bypass provision in the trust that transfers an amount equal to the federal estate tax exemption amount to a separate trust—with the remainder going directly to the survivor.

The bypass trust can provide income to your survivor spouse and can make additional distributions for his or her health, support, education, or maintenance. However, the trust can't give him or her unlimited access to the funds. This way, the bypass trust's assets will not be a part of the surviving spouse's estate and subject to the estate tax. Taxes are minimized by the bypass trust because both spouse's estate tax exemptions are fully utilized.

Bypass trusts were an effective planning tool when the federal estate tax exemption was just $1 million, but in 2012, Congress upped the exemption amount and portability of the exemption between spouses. In 2016, the estate tax exemption amount is $5.45 million. As a result, bypass trusts may no longer be needed to avoid federal estate tax.  However, in Massachusetts, where there is a $1 million exemption, bypass trusts are alive and well.

Every situation is different, so for your particular case, your attorney may speak with you about reasons to keep the bypass trust language in place. Some of those reasons include protecting the trusts assets against creditor claims, being able to make larger gifts to heirs without gift tax impacts, or preserving assets for minor children.

At CannonMurrayLaw, we invite our clients to come back in every three years and go over trust language as well as looking at the successor trustees or changing family needs.  Trusts are complicated, and having it explained more than once can be a big help during times of change or crisis.

Reference: foster.com (January 17, 2016) "When to amend your revocable trust"