A revocable living trust—sometimes simply called a living trust—is a legal entity created to hold ownership of an individual's assets. The person who forms the trust is called the grantor or the trustmaker, and they also serve as the trustee of this type of trust in most cases, controlling and managing the assets they've placed there.
Some trustmakers prefer to have an institution or an attorney acts as trustee, although this is somewhat uncommon with a revocable trust.
How a Revocable Living Trust Works
A trust is a legal entity that's specifically created to hold an individual's or a family's assets and property. But it's an empty vessel unless and until the trustmaker transfers ownership of those assets and property into the name of the trust and its trustee. This process is referred to as "funding" the trust.
The major distinction between a revocable and an irrevocable trust is that the trustee still technically owns the assets in a revocable trust and manages those assets when they act as trustee. The trustmaker must step aside and appoint someone else to serve as trustee of an irrevocable trust.
As the name suggests, the trustmaker cannot take property and assets back after funding them into an irrevocable trust.
The trustmaker reserves the right to undo a revocable trust––thus the term "revocable." They can reclaim assets they've placed into it, divert the trust's income to themselves or another beneficiary, change beneficiaries, sell the assets, or place more assets into the. The trustee retains final control.
A revocable living trust doesn't have its own taxpayer identification number, unlike an irrevocable trust. A revocable trust and its trustmaker share the same Social Security number. The trust's income and deductions are reported on the trustmaker's personal Form 1040 tax return, just as though they continued to hold ownership of the assets personally.
How a Revocable Living Trust Avoids Probate
The Internal Revenue Service and probate courts view revocable trusts differently.
Assets placed in a revocable trust don't avoid estate taxes because the trustmaker and the trust share the same Social Security number. The trustmaker can reclaim the assets held within the trust anytime they like, so the IRS takes the position that they haven't relinquished ownership as they would with assets placed in an irrevocable trust.
Assets held in an irrevocable living trust are not subject to estate taxes because the trustmaker no longer owns them or has any control over them.
The probate court says that they have indeed relinquished ownership, however. They've given the assets to the trust, even though they can take them back. The trust's assets would not pass through probate for this reason, assuming that the trustmaker hasn't taken them back as of their date of death. The successor trustee can therefore settle the trust outside of probate court, without supervision.
Phase #1 of a Trust: Trustmaker Is Alive and Well
A revocable living trust covers three phases of the trustmaker's life: their lifetime, their possible incapacitation, and what happens after their death.
The trust's formation documents should include specific provisions allowing the trustmaker to invest and spend the trust assets for their benefit during their lifetime. The trustmaker can go about business as usual with the assets that have been transferred or funded into the trust's ownership, assuming no one else has been appointed to act as trustee.
The trustee would typically take direction from the trustmaker if the trustmaker does not act as trustee.
Phase #2: The Trustmaker Becomes Incapacitated
The trust agreement should also specify what happens if the trustmaker becomes mentally incapacitated and can no longer manage their own affairs and those of the trust. The trust documents should name a "successor trustee," someone who will step in when and if the trustmaker is determined to be mentally incompetent and take over management of the trust.
The successor trustee can then manage the trustmaker's finances and the assets that have been placed into the trust.
Phase #3: The Trustmaker's Death
A revocable trust automatically becomes irrevocable when the trustmaker dies because the trustmaker is no longer available to make changes to it.
The named successor trustee steps in now as well, paying the trustmaker's final bills, debts, and taxes just as they would if the trustmaker had become incapacitated. They would then settle the trust, distributing the remaining assets to the trust's beneficiaries according to instructions included in the trust's formation documents.
Trusts vs. Wills
Trusts have many advantages, but one of the most significant might be that, unlike a last will and testament, a trust can prevent the details of one's estate from becoming available to the public. Elizabeth Taylor used a trust in her estate plan because she wanted to keep the details of her bequeathment private.