Revocable Trust Definition

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Trusts are organizations created under state laws. Their revocability is therefore determined by the laws of the state under which they are created. Revocable trusts may be treated as distinct entities for some legal purposes, but are disregarded entities for federal tax purposes. Trusts are a popular way to distribute assets after death because the assets in a trust do not pass through probate.

Parties to a Trust

There are three roles in a trust. The person who creates the trust is called the grantor or settlor. The grantor transfers money to be held “in trust” for a beneficiary. The document that creates the trust will name one or more beneficiaries and one or more trustees, who exercise the powers granted by the grantor to manage the assets held in trust. A grantor can also be the trustee or a beneficiary, but not both simultaneously. The trustee and successor trustees are usually a trusted family member, professional or institution.

Revocability

A revocable trust is one that the grantor can alter or eliminate entirely at will. This is in contrast to an irrevocable trust, which, by nature, cannot be changed by the unilateral act of the grantor. Living trusts are typically revocable, since the grantor wants to retain control over his assets during his lifetime. Revocable living trusts generally become irrevocable at the death of the grantor. A trust can be revoked by destroying the trust documents and notifying the trustee and any other institutions that may have copies of the trust documents.

Taxation

The IRS treats revocable trusts as disregarded entities for federal income tax. This means that any income generated by the trust that is not distributed to beneficiaries is taxed as income of the grantor. The IRS generally does view trusts as either revocable or irrevocable, but instead looks to the degree of control over the trusts retained by the grantor. The grantor’s ability to revoke a trust automatically makes the trust a disregarded entity, but not all irrevocable trusts are taxed separately. Revocable trusts, though they do not go through probate after you die, are counted as part of your gross estate for estate tax purposes.

Benefits

Using a revocable trust to pass assets to your heirs can save them the costs of attorney's and executor's fees and court costs associated with probate. Because of the pass-through taxation of revocable trusts, you can also pass the assets along at a higher cost basis and save them the taxes. A trust is also an effective way to ensure that children from other marriages, or other beneficiaries, are not disinherited.

References

About the Author

Joseph Nicholson is an independent analyst whose publishing achievements include a cover feature for "Futures Magazine" and a recurring column in the monthly newsletter of a private mint. He received a Bachelor of Arts in English from the University of Florida and is currently attending law school in San Francisco.

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