Joint Revocable Living Trusts: The Good, The Bad, and The Ugly
A revocable living trust is an estate planning tool that basically serves as one’s “alter ego” during lifetime, holding legal title to assets but having no separate tax identity. The creator of the trust, known as the “grantor,” “settlor” or “trustor,” also typically serves as the sole trustee of the trust, and has complete control and freedom over use of trust property during his lifetime. At the settlor’s death, property the settlor transferred to the trust during his lifetime is not included in the settlor’s “probate estate” – property administered under a will in a court proceeding. Instead, the trust agreement serves as a “will substitute” for trust property. Typically the settlor’s will is written to “pour over” to the trust any assets left in the settlor’s name at death that may require a probate administration.
A joint revocable living trust essentially allows a married couple to have one “family” revocable living trust instead of two separate individual living trusts. Ownership of assets the couple transfers to the trust during their lifetime is allocated between the spouses according to rules they set up in the trust agreement. The couple enjoys a sense of marital harmony from owning their property mutually in the “family” living trust, but for larger estates the lawyer drafting the trust must be highly skilled at defining the individual estates of each spouse within the trust, and preventing the sort of comingling or confusion that can result in each spouse being taxed on the entire trust at death.
The joint revocable trust is widely used by estate planning attorneys in community property states. Colorado’s Uniform Disposition of Community Property Rights at Death Act (the “Act”) allows couples who move to Colorado from community property states to maintain the character of community property they bring here, and its proceeds. The principal advantage of doing so is that under current federal tax law, at the first death between the spouses the surviving spouse receives new tax basis in the entire property, not just the portion acquired from the deceased spouse. For an older couple who retires in Colorado with highly appreciated community property assets, this can be a huge income tax advantage for the surviving spouse.
While the Act allows Colorado residents to maintain community property here, it provides no practical guidance on how to title such property. Some practitioners recite community property language on a Colorado real property deed, such as “to Husband and Wife as their community property.” Under Colorado law the result of this language is a tenancy in common, which allows each spouse to pass half of the property through his or her own estate. A joint revocable living trust is a superior vehicle for retaining community property in Colorado, as no special community property language is required on a real property deed or on an investment account titled in the trust, as long as community property is defined and identified in the trust agreement, and the couple can trace the property back to property or proceeds of property they owned in a community property state.
As mentioned, a good joint revocable trust is one that is expertly drafted and updated to carefully define the ownership interests of each spouse in trust property, allowing lifetime withdrawals of trust property without causing taxable transfers between the spouses, and avoiding any confusion in identifying the taxable estate of the first spouse to die. A bad joint revocable trust is one that has not been expertly drafted or updated, and which may cause unintended tax or other consequences at death. An ugly joint revocable trust is one that has been provided by a financial advisor connected with a trust mill, a business association that aggressively promotes estate planning trusts, often exploiting the elderly by misrepresenting their need for such trusts and overcharging them for boilerplate documents prepared with little regard to suitability for the client’s situation, sometimes selling them unneeded annuities in the bargain. Clients who bring these documents into our estate planning practice inevitably have little or no understanding of why they have the trust or how it operates at their death. If one spouse has already died, the survivor is often surprised and upset to learn the results directed by the trust and the cost to avoid them.
If you have questions about a living trust or another estate planning or administration issue, please email or contact Michael Smeenk.
Note: a more extensive version of this article written for the legal community is available here: Joint Revocable Living Trusts: The Good, The Bad, and The Ugly