When a Revocable Living Trust is created, property is transferred to a trust but the owner reserve the power to alter or terminate the arrangement and reclaim the property. Since the transfer is deemed incomplete (the grantor retains many ownership rights), the asset is still part of the grantor's estate for federal estate, gift and income tax purposes. In this analysis, we assume that if there is a living trust, all assets are held within the living trust.
The main benefit of a living trust is that it will avoid probate, which can be a costly, time consuming and public process.
However, there are numerous other non-tax reasons to use this type of trust both before and after the death of the grantor (the person who creates the trust). A trustee manages the trust assets both during the lifetime and after the death of the grantor. This means that there are no disruptions or neglect if the grantor is too busy to properly manage the assets or if the grantor dies or becomes incapacitated. While the grantor is still living, the grantor can observe firsthand how the Trustee is managing the trust’s affairs. This can give the grantor peace of mind of having chosen the right trustee or the ability to change the trustee prior to death if they are not satisfied with the management.
After death, assets in this type of trust can be less vulnerable to contests and claims of dissatisfied heirs. A trust is usually less expensive than probate with fewer delays. There is also the benefit of added privacy where assets in the trust at death do not form part of the estate but remain in the trust and out of the public domain of probate. Probate may be avoided in some states through the use of a living trust.
Although there are many benefits to establishing a living trust, there are a few limitations. There are no real tax advantages for the grantor as the assets are considered to be owned by the grantor for tax purposes. Once property is placed in the trust, it cannot be used as security for financing purposes. Trust assets still may be vulnerable to the claims of creditors. In the event of a divorce, there is no automatic revocation. This means that assets may remain in the trust for the benefit of the beneficiaries even if the beneficiary is a spouse pending divorce.
Lastly, a living trust is a formal arrangement and must be operated within the confines of the trust agreement. During creation, there are expenses involved in drafting and funding the trust. Once the trust is established, fees are normally paid to the trustee for the ongoing management of the trust.