Does a Revocable Trust Avoid Estate Taxes?

You worked hard to accumulate plenty of assets to care for your loved ones. Now, how do you protect those assets from the long arms of the federal government? In other words, does a revocable trust avoid estate taxes?

Like many people, you might think that establishing a revocable living trust helps you avoid estate taxes after you die. However, setting up a revocable trust to avoid estate taxes depends on who you choose as beneficiaries and the terms written into the formal trust agreement.

If you are the grantor of a revocable trust, you can modify the terms of the trust. You also have the legal power to add and remove assets. The flexibility to make changes while the grantor is alive appeals to many estate planners.

Income generated by a revocable trust is distributed to you while you are alive. After you die, assets held in the trust pass on to the named beneficiaries of the trust.

A revocable trust protects the assets of the grantor while the grantor is alive. The grantor can assign a trustee to manage the assets in the trust, or the grantor can decide to take charge of the assets. After the grantor dies, a trustee distributes the assets in the revocable trust to the named beneficiaries. If the grantor managed the revocable trust until death, the trust must include the name of the person who takes over as trustee.

The assets held by the trustee for the financial benefit of the beneficiaries are referred to as the trust principal. Depending on financial markets, the value of the principal can either appreciate or depreciate. Since a revocable trust names at least one beneficiary, the trust avoids going through the time-consuming probate process.

If you are the only grantor of a revocable trust, then all the assets held in the trust are subject to estate taxation if the beneficiaries are people such as your children and siblings. If you are the only grantor of a revocable trust and you designate one or more charities as your beneficiaries, then the assets held in the trust remain off-limits for estate taxes. Single grantors who designate both individuals and charitable organizations as beneficiaries must pay estate taxes on the assets that are passed on to the individuals.

Suppose you are married and name your spouse as the sole beneficiary — all the assets held in a revocable trust pass on to your spouse after you die. The assets passed on to your spouse do not qualify for estate taxation. For married couples, drafting a revocable trust also delays the payment of estate taxes until both spouses die. However, if you name your spouse and children as beneficiaries, then the assets designated for your children qualify for estate taxes.

If a revocable trust does not reduce your estate tax bill, then why should you set one up? The answer consists of three compelling reasons.

1. You avoid the costly and time-consuming probate process.
2. A revocable trust gives you a way to pass on your assets if you become incapacitated.
3. A revocable trust represents a private agreement, which means every term written into the trust agreement remains private after you die.

For married couples, drafting a revocable trust also delays the payment of estate taxes until both spouses die. To determine if a revocable living trust is your best option for protecting your assets, we recommend speaking with an experienced estate planning attorney.