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Many people are familiar with revocable living trusts, which are created to assist individuals in transferring assets to their beneficiaries, while simultaneously avoiding probate. However, what many people are less familiar with is what happens to a revocable living trust once the creator has passed.

Although this article will focus on the mechanics of post-death administration of a revocable living trust created by an individual, much of what is addressed can be adapted, with some modifications, to a situation involving a joint revocable trust created by a married couple.

Post-Death Trust Administration

During life, the creator of a revocable living trust and the trust are considered one and the same for tax and legal purposes. However, once the creator is deceased, that is no longer the case. Beginning on the day of death, the IRS and state laws recognize that the once revocable trust has become irrevocable and is now a separate legal entity. This separate legal entity is often referred to as an “Administrative Trust” or an “Interim Trust” and is used to bridge the gap in time between the cessation of the revocable living trust and the disposition of the revocable living trust assets either outright to individual beneficiaries or to irrevocable trusts for a spouse and/or children. This temporary trust has its own tax identification number, is taxed on any income, and can deduct certain expenses during its existence. Once this period of administration has ended and the trustee is satisfied that there is nothing further to be done, the trustee can then make distribution of the assets of the former revocable living trust. In doing so, the trustee will look to the distribution provisions of the revocable trust agreement following the death of the creator.

Family Trust – Surviving Spouse

Another common use of most revocable living trusts is to take full advantage of the remaining federal gift and estate tax exemption of the creator at the time of death. In 2022, that exemption is $12.06 million per person, which can be used for lifetime gifts or at death. Whether an individual predeceases their spouse or is the second spouse to die is instrumental in knowing how to proceed in most estate plans. If there is a surviving spouse, traditionally the decedent will request that the amount of the remaining federal estate tax exemption ($12.06 million in 2022) unused at death be set aside for their spouse in a Family Trust. If there are children from the marriage, the decedent may choose to include the children as possible beneficiaries of this Family Trust. Since the federal estate tax exemption is effectively a credit against any potential tax that would be owed by the estate, this trust is sometimes referred to as a “credit shelter” trust. It has many other names as well (“B” trust or “non-marital” trust).

Marital Trust – Surviving Spouse

Assuming a decedent leaves behind a surviving spouse and more than $12.06 million, where does the remainder go? Federal estate and gift tax laws allow for an unlimited marital deduction between spouses, which means that a couple may gift or transfer any assets between them, either during life or at death, without incurring any transfer tax, regardless of the amount. Therefore, gifting an amount exceeding $12.06 million (using a formula clause) to a surviving spouse, either outright or in a Marital Trust, does not cause any tax, but it does require the surviving spouse to include this gift in the calculation of their estate upon death, assuming any assets from this gift remain at the time of the second spouse’s death. If the gift is in trust, the surviving spouse can be the only beneficiary of this trust during his or her lifetime. This trust is also sometimes referred to as an “A” trust or “QTIP Trust.”

No Surviving Spouse

If the decedent leaves behind no surviving spouse, then clearly there cannot be a Marital Trust. In this case, if there are any living children, all the decedent’s assets that were in the former revocable trust would either be distributed to the decedent’s children or other beneficiaries or used to fund a Family Trust for the benefit of those beneficiaries

Family Trust – Distributions

Distributions from a Family Trust can be as flexible or as rigid as the decedent desires. Trusts all have two types of interests: income interest and principal interest. A decedent can simultaneously give both his or her spouse and children an equal right to the income interest from the Family Trust, though this potentially creates an adversarial relationship by possibly pitting the financial interests of a parent against those of a child. In this instance, it would be helpful to the trustee for the decedent to note in the trust agreement that the surviving spouse is the preferred beneficiary.

In most trust agreements, decisions regarding distributions of principal during the lifetime of the surviving spouse are commonly left up to the discretion of the trustee, often with the assistance of an ascertainable standard (for the “health, education, maintenance and support” of the beneficiary). After the death of the surviving spouse, the principal of the trust is typically distributed to the children of the trustor, either outright or in trust, under the terms outlined in the initial revocable trust.

Marital Trust – Distributions

As mentioned above, the surviving spouse can be the only beneficiary, income or principal, of a Marital Trust during their lifetime. A decedent may choose to give the surviving spouse an annual right to withdraw from the trust a fixed percentage or a fixed dollar amount of the principal of the Marital Trust; however, any funds removed from the trust are subject to potential attachment by creditors (see below). After the death of the surviving spouse, the trust assets can be either distributed outright to the trustor’s children or combined with the assets of the Family Trust.

Creditor Protection

Given that both the Family Trust and the Marital Trust are irrevocable trusts, one significant benefit to these types of trusts is that they provide a level of protection from creditors that cannot be found in an ordinary revocable trust. During the lifetime of the trustor, a revocable trust does not operate any differently than if the trustor owned the assets themself. They are effectively one and the same. Since this is the case, any creditor who obtains a judgment against the trustor could access the assets of the revocable trust in order to satisfy this judgment. By contrast, the presence of a “spendthrift clause” in the revocable trust agreement protects the interest of a beneficiary (other than the trustor) because it prevents the beneficiary from prospectively assigning away its interest in the trust assets. Since the beneficiary cannot assign, pledge, or give away its interest prior to receiving it, correspondingly, a creditor could also not get to trust funds prior to any distribution to a beneficiary. This provision, therefore, can be very beneficial for a trust beneficiary going through a divorce or other litigation. However, each state will differ on the extent to which they recognize the validity of a spendthrift clause and on any state exceptions that may allow creditors to gain access to trust assets in certain situations.

Reach out to a wealth advisory professional at FORVIS or submit the Contact Us form below if you have questions.
 

FORVIS Private Client services may include investment advisory services provided by FORVIS Wealth Advisors, LLC, an SEC-registered investment adviser, and/or accounting, tax, and related solutions provided by FORVIS, LLP. The information in this presentation should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies, mentioned in this presentation may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax, or other strategy mentioned herein. The information herein is believed to be accurate as of the time it is presented and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.

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