The Revocable Living Trust

The Revocable Living Trust is a financial vehicle for transferring wealth outside the probate process while minimizing tax exposure. For the purposes of this discussion, we'll assume the federal estate tax exemption is set to the 2008 level of $2 million per person. This is reasonable even though in 2010 the estate tax has been repealed and it is set to return to $1 million in 2011, since Congress will most likely settle on some value greater than $1 million for future years.

Prior to establishing the trust, a typical couple may not have their assets properly positioned to take advantage of these benefits. After establishing the trust, and properly funding it, this same couple can redirect large sums of money away from Uncle Sam and to their family or charity.

Consider a couple with $4 million net worth, all of which is consolidated in joint (marital) assets. This asset structure is represented schematically by the "A" on the diagram below; the "A" stands for "Awful," because on the death of one spouse, the assets become the property of the surviving spouse, who is only eligible to leave $2 million to his/her heirs tax-free. The $2 million tax-free benefit which could have been realized by the deceased spouse has been forfeited, to the tune of $2 million payable to Uncle Sam when the surviving spouse dies.

revocable living trust

Now consider a couple who, through proper planning, has established and funded a revocable living trust. They have distributed their assets equally between themselves, in their own (separate) names, with each of them holding $2 million in assets individually. Their joint assets have decreased to zero (represented by the dotted line on the "A" diagram).

Their net worth is the same; however, on the death of one spouse, the full $2 million tax-free benefit is realized. The surviving spouse retains his/her net worth of $2 million plus any distributions from the trust. On the death of the second spouse, that $2 million is again non-taxable and can be distributed to his/her heirs or to charity, leaving Uncle Sam out in the cold.

This asset structuring is represented by the "M" on the diagram below - standing for "Marvelous."

revocable living trust

You can think of your assets as being contained in a "chest of drawers," with the drawers being your Trust, your bank accounts, life insurance policies, mutual funds, etc. Repositioning the contents appropriately prior to death - a process known as "funding the trust" - enables you to realize the maximum tax benefit for the assets you leave to others. A good estate plan usually shunts funds to Family and/or Charity instead of the default choice of Government. Discretionary funds placed in the trust are distributed as you stipulate.

revocable living trust

For couples or individuals with less than $2 million in assets, a simpler, will-based plan may be more appropriate. However, as your net worth increases, the tax benefit of the trust approach is not realized. This amounts to a "pay me now or pay me later" approach: although it costs a little more to design and implement a Trust, the savings realized in the long-term more than offset the additional expense.

revocable living trust

The Unified Tax Credit

The IRS allows a certain amount to be deducted from your estate tax, called a credit. A credit is an amount that eliminates or reduces tax. A unified credit applies to both the gift tax and the estate tax. You must subtract the unified credit from any gift tax that you owe. Any unified credit you use against your gift tax in one year reduces the amount of credit that you can use against your gift tax in a later year. The total amount used against your gift tax reduces the credit available to use against your estate tax.

Previously, the unified credit was $192,800, which eliminated taxes on a total of $600,000 of taxable gifts and taxable estate. These amounts were increased for gifts made, and for estates of decedents dying, after 1997. The following table shows the unified credit and the applicable exclusion amount for the calendar year in which a gift is made or a decedent dies. This chart is consistent with the current Tax Law which passes out the Federal Estate Tax in 2010. The law expires at that time (the so-called "sunset provision") at which point the exemption reverts to the $1 million that would have held under the previous law.

Year

Applicable Exclusion Amount

2001 $1 million
2002 $1 million
2003 $1 million
2004 $1,500,000
2005 $1,500,000
2006 $2,000,000
2007 $2,000,000
2008 $2,000,000
2009 $3,500,000
2010 unlimited
2011 $1 million (old law revived)

Further information can be obtained at the IRS web site, www.irs.gov, especially in their publication 950, which can be downloaded in pdf or other formats.